UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549











FORM
10-K











x
            ANNUAL REPORT PURSUANT TO SECTION
      13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year
      ended - DECEMBER 31, 2009





OR





 ̈
            TRANSITION REPORT
      PURSUANT TO SECTION
      13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition
      period from





Commission
file number 0-024828





SORL
AUTO PARTS, INC.


(Name of
Issuer in Its Charter)





DELAWARE
            
            30-0091294(State
      or Other jurisdiction
            
            (I.R.S.
      Employer Identification No.)of
      Incorporation or Organization)





NO.1169
YUMENG ROAD


RUIAN
ECONOMIC DEVELOPMENT DISTRICT


RUIAN
CITY, ZHEJIANG PROVINCE


PEOPLE’S
REPUBLIC OF CHINA


(Address
of Principal Executive Offices, including zip code.)





86-577-65817720


(Issuer’s
Telephone Number, Including Area Code)





Securities
registered pursuant to Section 12(b) of the Act:





TITLE OF EACH CLASS
            
            NAME OF EACH
              EXCHANGE ON WHICH REGISTEREDCOMMON
      STOCK: 0.002 PARVALUE
            
            NASDAQ
      GLOBAL MARKET





Securities
registered pursuant to Section 12(g) of the Act: NONE





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.


Yes  ̈ No x





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange Act. Yes  ̈ No x





Indicate
by check mark whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports) and (2)
has been subject to such filing requirements for the past 90 days. Yes x No  ̈





Indicate
by check mark if disclosure of delinquent filers in response to Item 405 of
Regulation S-K is not contained in this form, and no disclosure will be
contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by referenced in Part III of this Form 10-K
or any amendment to this Form 10-K. x





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definition of “accelerated filer”, “large accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.


Large
accelerated filer  ̈  Accelerated filer
 ̈ 
Non-accelerated  ̈  Smaller Reporting
Company x





Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).


Yes  ̈ No x





State
issuer’s revenues for its most recent fiscal year December 31, 2009:
$124,979,741





State the
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
sold, or the average bid and asked price of such common equity as of the last
business day of registrant’s most recently completed second fiscal quarter. As
of June 30, 2009, the value was approximately $26,433,831.





State the
number of shares outstanding of each of the issuer’s classes of common equity:
19,304,921 as of March 17, 2010.





DOCUMENTS
INCORPORATED BY REFERENCE





Portions
of the registrant’s definitive proxy statement for its annual meeting of
shareholders, scheduled for May 27, 2010, are incorporated by reference
into Part III of this report.









TABLE
OF CONTENTS





PART
      IITEM
      1.
                    DESCRIPTION
      OF BUSINESS
                    2ITEM
      1.A.
                    RISK
      FACTORS
                    14ITEM
      1B.
                    UNRESOLVED
      STAFF COMMENTS
                    27ITEM
      2.
                    PROPERTIES
                    27ITEM
      3.
                    LEGAL
      PROCEEDINGS
                    27PART
      IIITEM
      5.
                    MARKET
      FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS AND ISSUER
      PURCHASES OF EQUITY SECURITIES
                    27ITEM
      6.
                    SELECTED
      FINANCIAL DATA
                    28ITEM
      7.
                    MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
                    29ITEM
      7A.
                    QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
                    37ITEM
      8.
                    FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA
                    37ITEM
      9.
                    CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE
                    63ITEM
      9A(T).
                    CONTROLS
      AND PROCEDURES
                    63





ITEM
      9B.
                  OTHER
      INFORMATION
                  63PART
      IIIITEM
      10.
                  DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
                  63ITEM
      11.
                  EXECUTIVE
      COMPENSATION
                  64ITEM
      12.
                  SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS
                  64ITEM
      13.
                  CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE
                  64ITEM
      14.
                  PRINCIPAL
      ACCOUNTANT FEES AND SERVICES
                  65PART
      IVITEM
      15.
                  EXHIBITS,
      AND FINANCIAL STATEMENT SCHEDULES
                  65SIGNATURES
                  67


1





PART
I





ITEM
1. DESCRIPTION OF BUSINESS





BUSINESS





Through
its 90% ownership of the Ruili Group Ruian Auto Parts Co., Ltd., a
Sino-foreign joint venture (the “Joint Venture”), SORL Auto Parts, Inc.
(together with our subsidiaries, “we,” “us,” “our” or the “Company”) develops,
manufactures and distributes automotive air brake systems, air controlling
systems and other related components to automotive original equipment
manufacturers, or OEMs, and the related aftermarket both in China and
internationally. Installed on the chassis, air brake systems include a
collection of various air brake components using compressed air and functioning
as the execution device for service braking and parking braking. The Company’s
products are principally used in different types of commercial vehicles,
such as trucks and buses. Air brake systems, air controlling systems and other
related components are critical components that ensure driving
safety.





The Joint
Venture was formed in China as a Sino-foreign joint venture on January 17, 2004,
pursuant to the terms of a Joint Venture Agreement (the “JV Agreement”) between
the Ruili Group Co., Ltd. (the “Ruili Group”) and Fairford Holdings Limited
(“Fairford”), a wholly owned subsidiary of the Company. The Ruili Group was
incorporated in the People’s Republic of China (“PRC”) in 1987 and specialized
in the development, production and sale of various kinds of automotive parts.
Fairford and the Ruili Group contributed 90% and 10%, respectively, of the
paid-in capital of the Joint Venture, which totaled $43.4 million.





Effective
January 19, 2004 the Joint Venture acquired the business segment of the Ruili
Group relating to the manufacture and sale of various kinds of valves for
automotive brake systems and related operations (the “Transferred Business”).
The Ruili Group began the automotive air brake valve business in 1987. The
acquisition was accomplished by the transfer from the Ruili Group to Fairford of
the relevant assets and liabilities of the Transferred Business including
trade receivables, inventories and machinery, and the assumption of short
and long term borrowings for a purchase price of $6,390,000. The consideration
was based on a valuation provided by Ruian Ruiyang Assets Valuation Co., Ltd.,
an independent PRC valuation firm. Fairford then transferred these assets and
liabilities to the Joint Venture as consideration for its 90% ownership interest
of the Joint Venture. The Ruili Group transferred inventory as its capital
contribution for its 10% interest in the Joint Venture. The assets and
liabilities transferred to the Joint Venture by Fairford and the Ruili Group
represented all the assets and liabilities of the Transferred Business. Certain
historical information of the Transferred Business is based on the operation
of the Transferred Business when it was owned by the Ruili
Group.





On
November 30, 2006, the Company completed a follow-on public offering of
4,285,714 shares of common stock at $7.25 per share. Gross proceeds were
approximately $31.1 million. Net proceeds after approximately $2.2 million of
underwriters’ commissions and approximately $0.7 million of related offering
expenses were approximately $28.2 million. On December 13, 2006, Maxim Group
LLC, the lead underwriter of offering, exercised its over-allotment option
in full to purchase an additional 642,857 shares of common stock. After
deduction of underwriter’s discount of approximately from $0.3 million, the
Company received $4.3 million. The aggregate net proceeds to the Company of this
offering was approximately $32.5 million, which included the $4.3 million as a
result of the exercise of the over-allotment option granted to the
underwriters.





On
December 8 and 26, 2006, through Fairford, the Company invested $32.67 million
in its operating subsidiary, the Ruili Group Ruian Auto Parts Co., Ltd. To
maintain its 10% shareholding in the Joint Venture, the Ruili Group increased
its capital investment by $3.63 million. Accordingly, the
Company continued to hold a 90% controlling interest in the operating
subsidiary.


2


Our
primary location is in Ruian City, Wenzhou, Zhejiang Province, People’s Republic
of China. Wenzhou is a southeast coastal city and is a center of automotive
parts manufacturing in China. The Company’s main products include spring brake
chambers, clutch servos, air dryers, and main valves and manual valves, all of
which are widely used in the brake systems for various types of commercial
vehicles such as trucks and buses. Reliable functioning of those valves is
critical to safety both when driving and parking.




On
November 11, 2009, the Company entered into a joint venture agreement with MGR,
a Hong Kong-based global auto parts distribution specialist firm and a
Taiwanese investor. The new joint venture was named SORL International Holding,
Ltd. ("SIH"). SORL holds a 60% interest in the joint venture, MGR holds a 30%
interest, and the Taiwanese investor holds a 10% interest. SIH is primarily
devoted to expanding SORL's international sales network in Asia-Pacific and
creating a larger footprint in Europe, the Middle East and Africa with a target
to create a truly global distribution network. Based in Hong Kong, SIH is
expanding and establishing channels of distribution in international markets
with SORL's primary products, including spring brake chambers, clutch servos,
air dryers, relay valves and hand brake valves.





STRATEGIC
PLAN





The
Chinese government has initiated several measures to expand China’s domestic
demand and to stimulate economic growth, and has provided a 4 trillion RMB
economic stimulus package. These have helped drive an 8.7% increase in
Chinese GDP and enhanced the development of China’s auto industry. The
international macroeconomic environment and international markets remain
uncertain, and have caused us to adjust our 2010 business plan and strategy. In
2010, our plan includes these elements:





l
            Enhance
      sales to OEM customers. We intend to enhance sales to OEM customers
      by improving customer service and increasing sales of integrated
      systems and modular supplies.





l
            Focus
      on bus market. We aim to enhance our relationships with major bus
      clients in order to achieve a higher profit margin. We have established a
      team devoted to the development of bus products, so that we can
      best respond to the needs of our bus customers and to help achieve
      higher margins.





l
            Expand sales
      to the agricultural vehicle market and light-duty vehicle markets. We
      will attempt to take advantage of the market opportunity created by the
      “Automobile Go To Village” policy (a policy begun by the
      Chinese government in an attempt to boost the country’s auto industry), to
      further develop our agricultural vehicle and light-duty vehicle
      businesses. The agricultural vehicle market and light-duty vehicle
      markets are an area of focus in the government’s stimulus plan,
      and therefore present us with a market
  opportunity.





l
            Expand sales
      into the railway transportation market to further extend the product line.
      We will continue to enhance our ability of development and supply high
      value-added products to our railway market
  customers.





l
            Develop
      new products. We plan to enhance the development of several new products
      including automotive electronics and energy-saving products. We are
      working to upgrade traditional air brake drive products to electronically
      controlled products to achieve a higher profit margin. We are working to
      develop energy-saving products which will do less harm to the
      environment, both in the manufacturing process and in
      use.





l
            Improve
      manufacturing technology and further computerize our manufacturing. We
      will continue to seek to improve our manufacturing process to enhance
      product quality. We anticipate that improvement of manufacturing
      technology will further automate our manufacturing process, thereby
      reducing human error, increasing manufacturing efficiency, lowering
      production costs and further ensuring consistent quality of our
      products.





l
            Expand
      through strategic alliance and acquisitions. We are exploring
      opportunities to enter the passenger vehicle market and to expand
      our international sales network through new joint ventures or
      acquisitions of other automotive parts manufacturers in China, as well as
      auto parts distributors or repair factories with established sales
      networks outside of China. We will seek acquisition targets that can
      easily be integrated into our product manufacturing and corporate
      management, or companies that have strong joint-venture partners that
      would become major customers.


3





The
Company’s Products





Through
the Joint Venture, the Company manufactures and distributes commercial vehicle
air brake systems, air controlling systems and other related components in China
and internationally. Installed on the chassis, air brake valves include a
collection of various air brake components using compressed air and functioning
as the execution device for service braking and parking braking.
Our products are principally used in different types of commercial
vehicles, such as trucks and buses. Air brake systems and other related
components are critical components that ensure driving safety.





We
produce an extensive range of products covering 40 categories and over 1000
specifications in air brake system, air controlling system and others,
which are widely used in different types of commercial vehicles. Additionally,
we offer a more complete product line including non-valve products, which are
sourced from the Ruili Group. Such outsourced non-valve products include power
steering pumps and other pumps, automobile electrical components and auto
meters. We seek to introduce new products, maintain high quality, and provide
excellent customer support. When working with a customer, our goal is to
understand the design intent and brand image for each product and leverage our
extensive experience and innovative technology to deliver products. The Company
supports its products with a full-range of styling, design, testing and
manufacturing capabilities, including just-in -time and in-sequence
delivery.





Sales
from air brake systems, air controlling systems and other related components
accounted for 70.7%, 15.6%, 13.7%, respectively, of our total
sales in 2009. In 2008, these products accounted for 62.2%,
13.9% and 23.9% of sales, respectively.





The
Company obtained ISO9001/QS9000/VDA6.1 System Certifications in 2001. We passed
the ISO/TS 16949 System Certification test conducted by the TUV CERT
Certification Body of TUV Industrie Service GmbH in 2004, and its annual review
in 2009. The ISO/TS 16949 System, a higher standard replacing the
ISO9001/QS9000/VDA6.1 System, was enacted by the International Automotive Task
Force and is recognized by major automobile manufacturers all over the world.
The annual reviews for other certifications which we passed in
2009 included ISO14001 on environmental management and OHSAS18001
for health and safety management, reflecting the Company’s commitment to
workplace safety, health and environmental protection.





CHINA
AUTOMOBILE AND AUTO PARTS INDUSTRY





The
automobile industry is one of China’s key industries, contributing significantly
to the growth of China’s economy. Based on statistics published by the China
Association of Automobile Manufactures, in 2009, China’s automobile output
and sales volume both reached record high levels of 13.79 million and 13.64
million units, increasing by 48% and 46%, respectively, compared
with 2008 figures. The output and sales volume of commercial vehicles
increased 33% and 28% to 3.41 million units and 3.31 million units,
respectively.





Based on
statistics published by the China Association of Automobile Manufactures, China
is currently the largest automotive market in the world. Historically, the
growth of truck and bus markets in China is a little slower than the growth of
the overall automotive industry, but higher than the national GDP growth.
According to China’s State Information Center, the commercial vehicle market in
China has the potential to grow at a long term rate of 9% through 2020. If
achieved, this growth will also spur growth in the auto parts
industry.





The
Chinese auto parts industry is highly fragmented. Management believes that
the future trends of China’s auto parts industry will be:





·
            To keep pace with the rapid
      development of new automobile
  technologies.


4





·
            To meet the requirementsofincreasingly demanding OEM
      customers, such as zero defects, and cost
  reduction.





·
            To partner with OEM customers in
      the entire process from product design, development and production to
      costing, quality control and final
  delivery.





·
            To implement industry
      restructuring
      through integration to form several large sized auto parts manufacturing
      groupsbetter able
      to competewithleadinginternational
      manufacturers.





MARKET
AND CUSTOMERS





We are
the largest commercial vehicle air brake systems manufacturer in China. In
general, our customers are divided into three groups: OEMs in China, aftermarket
distributors in China, and international customers, accounting for approximately
50.5%, 25.2% and 24.3%, respectively, of the Company’s annual sales for
2009.





OEM Market- We have established
long-term business relationships with most of the major automobile manufacturers
in China. We sell our products to 62 vehicle manufacturers, including
all of the key truck manufacturers in China. In addition to heavy-duty trucks,
our products are also widely used in air brake systems for buses.
Typically, bus manufacturers purchase a chassis from truck chassis manufacturers
which already have incorporated our air brake systems.





The table
below presents comparative information for 2009 and 2008 on the
Company’s top 5 OEM customers.





Ranking
                                              
                                              Customer
                                              
                                              %of
                                                2009
                                                Sales
                                              
                                              
                                              Customer
                                              
                                              %of
                                                2008
                                                Sales1
                                              
                                              FAW
      Qingdao Automobile Works
                                              
                                              
                                              8.6
                                              %
                                              
                                              FAW
      Jiefang Automotive Co., Ltd.
                                              
                                              
                                              6.53
                                              %2
                                              
                                              Dongfeng
      Axle Co., Ltd.
                                              
                                              
                                              5.7
                                              %
                                              
                                              Dongfeng
      Axle Co., Ltd. ShiYan Automobile Works
                                              
                                              
                                              5.97
                                              %3
                                              
                                              Dongfeng
      Axle Co., Ltd. ShiYan Automobile Works
                                              
                                              
                                              4.9
                                              %
                                              
                                              FAW
      Qingdao Automobile Works
                                              
                                              
                                              5.34
                                              %4
                                              
                                              FAW
      Jiefang Automotive Co., Ltd.
                                              
                                              
                                              4.7
                                              %
                                              
                                              Dongfeng
      Axle Co., Ltd.
                                              
                                              
                                              2.64
                                              %5
                                              
                                              Beiqi
      Foton Motor Co., Ltd. Beijing Auman Heavy-Duty Vehicle
    Works
                                              
                                              
                                              3.8
                                              %
                                              
                                              Beiqi
      Foton Motor Co., Ltd. Beijing Auman Heavy-Duty Vehicle
    Works
                                              
                                              
                                              2.44
                                              %





A few of
our principal OEM customers are: Foton Motor Group, Dongfeng Motors
Group and FAW Group Corporation, which were the top three commercial vehicle
manufactures in China in 2009, according to the China Association of Automobile
Manufactures. According to a news release from Foton Motor Group,
Foton Motor Group was the largest commercial vehicle manufacture in the
world in 2009. Baotou North-Benz Heavy Duty Truck Co., Ltd. and Anhui Hualing
Automobile Co., Ltd., with rapid growth in the light-duty vehicle
market in 2009, also are our customers.





Aftermarket - The Company’s
Chinese sales network consists of 28 authorized distributors covering the
following 7 regions nationwide: Northeast Region, North
Region, Northwest Region, Southwest Region, Central
Region, East Region and South Region.


5


The
28 authorized distributors sell only “SORL” products and in turn channel
the products through over 850 sub-distributors.





International Market– Our international
sales were adversely affected by global economic conditions and by
protectionism. We regard increasing our export sales as an important way to
upgrade brand and expand market share. We address expansion in the export
market through the following measures:





l
            Focus
      on both overseas aftermarket and OEM customers at the same time. The
      Company is selling its products into 101 countries and regions, and has
      begun to supply products to OEMs in
India.





l
            The
      Company also actively participates in international trade shows including
      more than ten international exhibitions such as Automechanika in
      Frankfort Equip Auto in Pairs, Automotive Aftermarket Products Expo
      in Las Vegas, Automechanika Middle East in Dubai and China Import and
      Export Fair in Guangzhou, to acquire new customers and new
      orders.





l
            We
      established a new joint venture in Hong Kong in 2009, focus on expanding
      SORL’s international sales network in the Asia-Pacific region and creating
      a larger footprint in Europe, the Middle East and Africa with a target to
      create a truly global distribution network. We presently have four
      international sales centers. These are located in UAE, USA,
      Australia, and India. They carry out localization strategies to meet the
      different market demands and to strengthen service
  support.





In
2009, export sales accounted for 24.3% of total revenue. Products are exported
to more than 101 countries and regions in the world. Total export sales in
2009 decreased by 34.5% compared with 2008.





Ranking
                                  
                                  Country
                                  
                                  CustomerName
                                  
                                  %of
                                    2009
                                    Sales
                                  
                                  
                                  Country
                                  
                                  CustomerName
                                  
                                  %of
                                    2008
                                    Sales1
                                  
                                  United
      Arab Emirates
                                  
                                  GOLDEN
      DRAGAN AUTO SPARE PARTS
                                  
                                  
                                  3.30
                                  %
                                  
                                  United
      Arab Emirates
                                  
                                  GOLDEN
      DRAGAN AUTO SPARE PARTS
                                  
                                  
                                  6.65
                                  %2
                                  
                                  USA
                                  
                                  SAP
                                  
                                  
                                  1.71
                                  %
                                  
                                  USA
                                  
                                  ITM
                                  
                                  
                                  3.17
                                  %3
                                  
                                  South
      Africa
                                  
                                  MICO
                                  
                                  
                                  1.04
                                  %
                                  
                                  USA
                                  
                                  SAP
                                  
                                  
                                  1.95
                                  %4
                                  
                                  India
                                  
                                  TATA
                                  
                                  
                                  0.93
                                  %
                                  
                                  USA
                                  
                                  LLW
                                  
                                  
                                  1.38
                                  %5
                                  
                                  USA
                                  
                                  Fleet
      Pride
                                  
                                  
                                  0.69
                                  %
                                  
                                  India
                                  
                                  TATA
                                  
                                  
                                  1.25
                                  %6
                                  
                                  Australia
                                  
                                  SORL
      Australia
                                  
                                  
                                  0.58
                                  %
                                  
                                  South
      Africa
                                  
                                  MICO
                                  
                                  
                                  1.22
                                  %7
                                  
                                  Taiwan
                                  
                                  Mita
                                  
                                  
                                  0.57
                                  %
                                  
                                  Indonesia
                                  
                                  LIL
                                  
                                  
                                  0.8
                                  %


6


COMPETITION





We
conduct our business in a complex and highly competitive industry. The global
automotive parts industry principally involves the supply of systems, modules
and components to vehicle manufacturers for the manufacture of new vehicles.
Additionally, suppliers provide components to other suppliers for use in their
product offerings and to the aftermarket for use as replacement or enhancement
parts for older vehicles. In the current global automotive industry, vehicle
manufacturers generally only engage in assembling but not manufacturing non-key
automotive parts. Rather, they source these components through a global network
of suppliers. As a result, only those automotive parts manufacturers with
large-scale production, advanced technology and the ability of producing system
modules, can supply their products to vehicle manufacturers directly. The
automotive parts industry in China is fragmented and there are many small
manufacturers which mainly target the aftermarket. However, there are not many
companies who have established both nationwide aftermarket sales networks and
close relationships with leading OEM manufacturers. As the largest commercial
vehicle air brake system manufacturer in China, we have established long-term
business relationships with most of the major automotive manufacturers in China,
such as FAW Group (a.k.a. First Auto Group), Dongfeng Motors Group, Beiqi Foton
Motor Co., Ltd., Baotou North-Benz Heavy Duty Truck Co., Ltd. and Anhui
Jianghuai Automobile Co., Ltd. Management believes that the key success factors
in the commercial vehicle air brake systems are product quality, price
competitiveness, technical expertise and development capability, new product
innovation, and reliability and timeliness of delivery, which may be enhanced by
recruiting highly qualified managers and other employees, developing improved
product design capability and facilities, and maintaining better customer
service.





Domestic Competition
- Our most significant competitors in China are: VIE, Weiming and
CAFF.





·
            China VIE Group: Its principal
      products are main valves and unloader/governors, with a majority supplied
      to OEM’s, such as Anhui Jianghuai
      Automobile Co., Ltd., and the remaining portionallocatedfortheaftermarket and
      export.





·
            China Shandong
      WeimingAutomotive
      Products Co. Ltd.: This is a joint venture with WABCO of Germany, and
      mainly produces air dryers, and ABS, primarily supplying to truck and bus
      OEM’s such asChina Heavy Duty Truck Group
      Corp., Ltd., andsome major bus
      manufacturers in China.





·
            Chongqing CAFF Automobile Braking
      and Steering Systems Co., Ltd.: Its main products are air dryers and main
      valves. Its principal customer is Chongqing Heavy Vehicle Group Co.,
      Ltd.





Management
believes the Company has the competitive advantages:





·
            Brand Name: As China’s largest commercial vehicle air
      brakesystems manufacturer, the “SORL”brand is widely known in the
      country.SORLhas wonawards from theChinaChamber of Commerce for Import
      & Export ofMachinery& Electronicproductsas a“China Top Brand”and the“ExportBrand ofthe Year 2006”.





·
            Technology:We viewtechnological innovation and
      leadership as the critical means to enhanceourcore competence.Ourtechnology center
      includesa laboratory specializing in the
      research of automotive brake controlling technologies and development of
      airbrake system
      products.We upgraded our test equipment in
      2009, which improved system test
  capability.





·
            Product Development:Because management believes thatourproducts ultimately defineoursuccess, we continue to increase
      our budget for research anddevelopment activities.Throughourinternational sales offices in
      the US, Australia,the Middle Eastand India, we areable to promptly collect
      information about current trends in automotive technologies, which in turn
      is applied to our new product developmentand used to enhance ourability to
      providedomestic
      OEMs with advanced products. In addition, IT application and
      strict implementation of ISO/TS16949 standards in the development process
      greatly shorten the development lead time and improve new
      product
      quality.


7





·
            ChinaSales Networks:We have28authorized distributors covering
      7 regionsinChina.We help train their sales force
      and improve their service quality. These authorized
      distributorsin turn
      channel “SORL”products through over850sub-distributors throughout
      China.




·
            Production
      Management: During 2009, we implemented an Enterprise Resource
      Planning system, which is an integrated computer-based system used
      to consolidate all business operations into a uniform and enterprise
      wide system environment. We follow Six Sigma management practices, which
      is a customer centered, systematic, data driven way of doing work more
      efficiently. Also we have improved our manufacturing process to better
      assure the stability and consistency of product quality and improved
      material utilization and decreased manufacturing
  cost.




International Competition - In
the international market, our largest competitors are WABCO and Knorr. While
management believes our current advantage over WABCO and Knorr is lower pricing,
management also believes that the Company’s product quality and brand awareness
are improving. Our competitive advantages over other competitors in the
global market are:





·
            Performance-Cost Ratio:Ourproducts enjoy lower production
      costs leveraging thelow labor costs in China. Through
      the Company’s improved product line as a
      result of technology and manufacturing improvements,ourproducts’performance-cost advantage is
      increasing.





·
            Quick Adaptation to Local Market:
      Throughourinternational sales
      channels in the US,
      Australia,
      theMiddle
      Eastand
      India,we havebeen able to respond to local
      market needs.





·
            Diversified Auto Products: In
      addition toourair brake valve products, to
      fully support existing export customers,wealso distribute a wide
      range of non-valve
      products which are sourced from the Ruili Group. This reduces
      customers’transaction
      costs.





SALES
AND MARKETING





We
strengthened our sales and marketing efforts in 2009. The
sales headcount for domestic (PRC) sales and international sales
was 37 and 38, respectively. Products are sold under the “SORL”
trademark, which we license on a royalty free basis from the Ruili Group. The
license expires in 2012.





In China,
the commercial vehicle air brake systems market can be divided into 2 segments:
OEM market and aftermarket.





OEM Market–In 2009, we strengthened
our long-term relationships with major domestic OEM customers, and expanded
into the municipal bus market and agricultural vehicle market. Currently, we
have 62 OEM customers. Normally, these customers sign one-year sales
contracts, which are revised as needed.





We have
successfully expanded our production capacity so that we were able to
increase our sales to the OEM market by $14.1 million or 28.8% for the year
ended December 31, 2009, as compared with the year ended December 31,
2008.





DomesticAftermarket - We place
great emphasis on the Chinese automotive aftermarket business and sell products
in the aftermarket for replacement purposes. With the rapid growth of commercial
vehicles output in recent years and the increasing number of vehicles on the
road, there has been an increasing demand for replacement parts in the
aftermarket. We have an aftermarket sales network including 28 authorized
distributors covering 7 regions nationwide in PRC. These distributors sell
only products under the “SORL” trademark to over 850 Chinese distributors. We
provide product technical services to these distributors, and also conduct
periodic performance evaluations, and reserve the right to terminate the
distributorship of those with frequent delinquencies or poor sales
records. For 2009, the Company achieved total revenue of $31.5 million
in domestic aftermarket sales, a decrease of 11.3% from 2008.


8





International Markets -Our international
sales were adversely affected by global economic conditions and by
protectionism. We regard increasing our export sales as an important way to
upgrade brand and expand market share. We address expansion in the export
market through the following measures:





l
            Focus
      on both overseas aftermarket and OEM customers at the same time. The
      company is selling its products into 101 countries and regions, and has
      begun to supply our products to local OEMs in
  India.





l
            Company
      also actively participate in international trade shows including more than
      ten international exhibition as Automechanika in Frankfort Equip Auto in
      Pairs, Automotive Aftermarket Products Expo in Las Vegas,
      Automechanika Middle East in Dubai and China Import and Export Fair
      in Guangzhou, to acquire new customers and new
  orders.





l
            In
      2009, we established a new joint venture in Hong Kong focused on focused
      on expanding SORL’s international sales network in the Asia-Pacific
      region and creating a larger footprint in Europe, the Middle East and
      Africa with a target to create a truly global distribution network. We
      presently have four sales centers, located in UAE, USA, Australia, and
      India. They carry out localization strategy to meet different market
      demands and to strengthen service
support.





DISTRIBUTION





We ship
finished products directly to OEM customers. Our products are distributed
to aftermarket customers in China through a network of 28 authorized
distributors, who also function as the distribution centers for their respective
regions. Shipments are delivered directly to international
customers.





INTELLECTUAL
PROPERTY AND INNOVATION CAPACITY





As of
December 31, 2009, we had 143 technical staff members,
consisting of 57 holding Engineer or Senior Engineer qualifications.
Our technical staff includes 4 information technology
specialists, 96 for new product development and design techniques,
10 for measurement and testing, 8 for MIS, and the other
25 persons are quality management engineers.





In
addition to our own technical force, we have cooperation arrangements with
leading universities in the automotive engineering field,
including:





·
            Tongji University at
      Shanghai andHarbin Institute of Technology:
      Contract for co-development of electronicallycontrolledbraking systemsandautomotive master cable
      technology; and





·
            Tsinghua University E-Tech Technology Co.,
      Ltd. and Zhejiang University: Contract for MIS projects, including the
      development of application software for product design innovation and
      production management.





Pursuant
to the arrangements with these universities, we have priority rights to acquire
the intellectual property which is developed. The financial arrangements as to
amount and terms of payment vary depending on the type of project. Normally, we
make an initial payment in the form of a research grant and then negotiate a
payment upon development of the technology.


9





We also
consult with the technical staff of the Ruili Group from time to time on a
no-cost basis. We collaborate with other industry research groups such as the
research centers of FAW Group and Dongfeng Group.





Capitalizing
on these resources, we have successfully developed innovative products and
technologies such as a new type of clutch servo with sensor; a combined air
dryer with build-in temperature-control device and unloader; and an inner-breath
spring chamber which enables internal air circulation.





We own a
full range of processing equipment required for development of new auto part
products, including machines for molding, die casting, cutting,pressing and surface
treatment. Furthermore, we
are capable designing and making over 90% of the technical devices such as
tools, jigs and molds that are required for producing prototypes. In addition,
the partnership with Tsinghua University and Zhejiang University in developing
software for application in new product design system has resulted in
substantial time savings in the new product development cycle.





Patented
Technologies





We
continue to invest in R&D efforts and to pursue patent protection. Currently
we own23 patents and have filed applications for 26 other patents
in China and an additional two in the U.S.





Trademarks





Our
principal trademark is “SORL” which we license on a non-exclusive royalty free
basis from the Ruili Group. The license currently expires in 2012 and we have an
agreement with the Ruili Group that the license will be extended if the
trademark registration for the trade name is extended. The Ruili Group has
obtained a registration for “SORL” from the World Intellectual Property
Organization and, in 2007, registered the trademark in US.





PRODUCTION





We
own the largest commercial vehicle air brake systems manufacturing base in
China. We are seeking to expand our production capacity. We have
re-deployed and streamlined our production / assembly lines, enabling
us to rapidly expand our production capacity to meet increasing market
demands for our products. The production process includes fixture, jig and
die making, aluminum alloy die casting, metal sheet stamping, numerical control
cutting, welding, numerical control processing, surface treatment, filming,
rubber/plastic processing, final assembly and packaging. We have
state-of-the-art manufacturing and testing facilities sourced from the US,
Korea, Taiwan and mainland China, including computerized numerical
control processing centers, computerized numerical control lathes,
casting, stamping and cutting machines, automatic spraying and electroplating
lines, cleaning machines, automatic assembly lines and
three-dimensional coordinate measuring machines and
projectors.





In
September 2007, the Joint Venture purchased land rights, a manufacturing plant
and office building with a total floor area of 712,333 square feet, from Ruili
Group Co., Ltd. The Joint Venture previously leased part of the facility from
Ruili and occupied approximately 50% of it. As a result of this transaction,
our production space is expected to meet our growth demand for the
near future.





ENVIRONMENT





In 2006,
we were granted ISO14001 certification on environmental management and
OHSAS18001 certification on health and safety management, which
reflects the Company’s commitment to workplace safety, health and
environmental protection. We conduct staff training to enhance awareness of
environmental protection. We seek in all phases of our operations to employ
practices for environment friendly production, reducing or preventing pollution,
and reduction of energy consumption and manufacturing costs. For example, noise
intensity is listed as one of the criteria in the selection of new equipment;
waste water is stored, purified and recycled in the production process; and
compressing machines are used in the disposal of aluminum and steel scraps,
saving both storage space and power consumption.


10





RAW
MATERIALS





Raw
materials used by the Company in the manufacture of our products primarily
include steel, aluminum, other metals, rubber and various manufactured
components.





All of
the materials used are generally readily available from numerous sources. We
have not, in recent years, experienced any significant shortages of manufactured
components or raw materials and normally do not carry inventories of these items
in excess of what is reasonably required to meet our production and shipping
schedules. Critical raw materials are generally sourced from at least two or
more vendors to assure adequate supply and price competition. We maintain
relationships with over twenty material suppliers. In 2009, the three largest
suppliers were Shanghai Jinshi Materials Co., Ltd., Shanghai
Dechen Commodity Co., Ltd., and Shanghai Guihao Shiye Co., Ltd.
which together accounted for 29.3% of the aggregate of raw materials we
purchased. Among these companies, only Shanghai Jinshi Materials Co.,
Ltd., which accounted for 18.5%, was the source of more than 10% of total
raw material purchases.





When
planning a purchase order, with such other terms as quality, delivery and credit
terms being substantially the same, we compare prices quoted by different
suppliers in an attempt to receive the lowest price. In order to secure a
favorable purchase price and subsequently a predictable cost of sales, we
generally make a down payment to suppliers.





Normally,
the annual purchase plan for raw materials, such as aluminum ingot and steel
sheet, is determined at the beginning of the calendar year according to our OEM
customer’s orders and our own forecast for the aftermarket and international
sales. Our purchase plans with key suppliers can be revised quarterly. Our
actual requirements are based on monthly production plans. Management believes
that this arrangement prevents us from having excess inventory when
our orders from customers change.





For raw
materials other than steel and aluminum, we normally maintain from five to seven
days of inventory at our warehouse.





DOING
BUSINESS IN CHINA





CHINA’S
ECONOMY





Management
believes that the most important factor to understand the Chinese automobile
industry is the country’s rapid economic growth. According to China’s Statistics
Bureau, China’s GDP growth rate for 2007, 2008 and 2009 was 11.4%,
9.0% and 8.7% respectively.





The
government of China has stated its intention to purse continued economic growth
and development.


11


THE
CHINESE LEGAL SYSTEM





The
practical effect of the People’s Republic of China legal system on our business
operations in China can be viewed from two separate but intertwined
considerations. First, as a matter of substantive law, the Foreign Invested
Enterprise laws provide significant protection from government interference. In
addition, these laws guarantee the full enjoyment of the benefits of corporate
Articles and contracts to Foreign Invested Enterprise participants. These laws,
however, do impose standards concerning corporate formation and governance,
which are not qualitatively different from the general corporation laws of the
several states. Similarly, the accounting laws in the People’s Republic of
China mandate accounting practices, which are not consistent with US Generally
Accepted Accounting Principles (GAAP). The China accounting laws require
that an annual “statutory audit” be performed in accordance with People’s
Republic of China accounting standards and that the books of account of Foreign
Invested Enterprises are maintained in accordance with Chinese accounting
laws.





Second,
while the enforcement of substantive rights may appear less clear than United
States procedures, the Foreign Invested Enterprises and Wholly Foreign-Owned
Enterprises are Chinese registered companies which enjoy the same status as
other Chinese registered companies in business-to-business dispute resolution.
Because the terms of the respective Articles of Association provide that all
business disputes pertaining to Foreign Invested Enterprises are to be resolved
by the Arbitration Institute of the Stockholm Chamber of Commerce in Stockholm,
Sweden applying Chinese substantive law, the Chinese minority partner in the
Joint Venture will not assume a privileged position regarding such disputes. Any
award rendered by this arbitration tribunal is, by the express terms of the
respective Articles of Association, enforceable in accordance with the “United
Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards
(1958).” Therefore, as a practical matter, although no assurances can be given,
the Chinese legal infrastructure, while different in operation from its United
States counterpart, should not present any significant impediment to the
operation of Foreign Invested Enterprises.





ECONOMIC
REFORM ISSUES





Although
the Chinese government owns the majority of productive assets in China, in the
past several years the government has implemented economic reform measures that
emphasize decentralization and encourage private economic activity. Because
these economic reform measures may be inconsistent or ineffectual, there are no
assurances that:





·
            We will be able to capitalize on
      economic reforms;





·
            The Chinese government will
      continue its pursuit of economic reform
  policies;





·
            The economic policies, even if
      pursued, will be successful;





·
            Economic policies will not be
      significantly altered fromtime to time;
      and





·
            Business operations in China will
      not become subject to the risk of
  nationalization.





Since
1979, the Chinese government has reformed its economic systems. Because many
reforms are unprecedented or experimental, they are expected to be refined and
improved. Other political, economic and social factors, such as political
changes, changes in the rates of economic growth, unemployment or inflation, or
in the disparities in per capita wealth between regions within China, could lead
to further readjustment of the reform measures. This refining and readjustment
process may negatively affect our operations.





To date
reforms to China’s economic system have not adversely impacted our operations
and are not expected to adversely impact operations in the foreseeable future;
however, there can be no assurance that the reforms to China’s economic system
will continue or that we will not be adversely affected by changes in China’s
political, economic, and social conditions and by changes in policies of the
Chinese government, such as changes in laws and regulations, measures which may
be introduced to control inflation, changes in the rate or method of taxation,
imposition of additional restrictions on currency conversion and remittance
abroad, and reduction in tariff protection and other import
restrictions.


12





EMPLOYEES
AND EMPLOYMENT AGREEMENTS





The
Company currently employs 2,419 employees, all of whom are employed full
time: 58 for quality control, 143 technical staff, 75 sales and
marketing staff, 2,101 production workers and 42 administrative staff.
There are employment agreements with all of the employees whereby administrative
staff workers agree to three years of employment and hourly workers agree to
three years. Employment contracts with all employees comply with relevant laws
and regulations of China.





The Joint
Venture is subject to the Sino-foreign Equity Joint Venture Enterprise Labour
Management Regulations. In compliance with those regulations, the Joint
Venture’s management may hire and discharge employees and make other
determinations with respect to wages, welfare, insurance and discipline of
employees. The Joint Venture has, as required by law, established special funds
for enterprise development, employee welfare and incentives, as well as a
general reserve. In addition, the Joint Venture is required to provide its
employees with facilities sufficient to enable the employees to carry out trade
union activities.





DESCRIPTION
OF THE JOINT VENTURE





General





The Joint
Venture was established on January 17, 2004 pursuant to the terms of a Joint
Venture Agreement with the Ruili Group. Below is a description of the material
terms of the Joint Venture.





Management
of the Joint Venture





Pursuant
to the terms of the Joint Venture Agreement, the Board of Directors of the Joint
Venture consists of three directors; we have the right to designate two members
of the board and the Ruili Group has the right to designate one member and we
have the authority to appoint the Chairman of the Board. The majority of the
Board has decision-making authority with respect to operating matters. As a
result, we maintain operating control over the Joint Venture. However, at this
time, our two senior executives, Messrs. Xiao Ping Zhang and Xiao Feng Zhang are
the founders of the Ruili Group, and therefore there is limited independence
between the two entities. The term of the Joint Venture will expire on March 4,
2019 although we anticipate that we will be able to extend such term. Extension
of the agreement will be subject to negotiation with the Ruili Group and
approval of the Chinese government.





JV
DISTRIBUTION OF PROFITS





After
provision for social welfare funds for employees and provision for taxation, the
profits, if any, of the Joint Venture will be available for distribution to the
parties in proportion to their respective capital contributions. Any such
distributions must be authorized by the Joint Venture’s Board of Directors. To
date, the Joint Venture has not distributed any profits and does not anticipate
doing so for the near term.





JV
ASSIGNMENT OF INTEREST





Any
assignment of an interest in the Joint Venture must be approved by the Chinese
government. The Chinese joint venture laws also provide for preemptive rights
and the consent of the other joint venture party for any proposed assignments by
one party to a third party.


13





JV
LIQUIDATION





Under the
Chinese joint venture laws, the Joint Venture may be liquidated in certain
limited circumstances, including expiration of the ten-year term or any term of
extension, the inability to continue operations due to severe losses, force
majeure, or the failure of a party to honor its obligations under the joint
venture agreement or the Articles Of Association in such a manner as to impair
the operations of the joint venture. The Chinese joint venture laws provide
that, upon liquidation, the net asset value (based on the prevailing market
value of the assets) of a joint venture shall be distributed to the parties in
proportion to their respective registered capital in the joint
venture.





JV
RESOLUTION OF DISPUTES





In the
event of a dispute between the parties, attempts will be made to resolve the
dispute through friendly consultation or mediation. In the absence of a friendly
resolution, the parties have agreed that the matter will first be referred to
the China International Economic and Trade Arbitration Commission in Beijing,
whose decisions are final and enforceable in Chinese courts.





JV
EXPROPRIATION





The
Chinese joint venture laws provide that China will not nationalize or
requisition enterprises in which foreign funds have been invested. However,
under special circumstances, when public interest requires, enterprises with
foreign capital may be legally requisitioned and appropriate compensation will
be made.





ITEM
1A. RISK FACTORS





Our
business faces many risks. The risks described below may not be the only risks
we face. Additional risks that we do not yet know of, or that we currently think
are immaterial, may also impair our business operations or financial results. If
any of the events or circumstances described in the following risks actually
occurs, our business, financial condition or results of operations could suffer
and the trading price of our common stock could decline.





If
intensification of the current financial crisis and slowdown of global economies
continues, it may promote trade protectionism which would negatively affect our
export sales.





As a
result of global economic conditions and little or no growth in many countries,
there is a risk of increased international trade protectionism. Many countries
set trade barriers which could negatively affect our export sales, as well as
create potential risks for litigation in the countries to which our products are
exported.





Our
ability to effectively implement our business strategy depends upon, among other
factors, the successful recruitment and retention of additional highly skilled
and experienced management and other key personnel and we cannot assure that we
will be able to hire or retain such employees.





We must
attract recruit and retain a sizeable workforce of technically competent
employees. Our ability to effectively implement our business strategy will
depend upon, among other factors, the successful recruitment and retention of
additional highly skilled and experienced management and other key personnel.
These individuals are difficult to find in China and as the economy in China
expands, there is increasing competition for skilled workers. We cannot assure
that we will be able to find, hire or retain such employees, or even if we are
able to so hire such employees, that the cost of these employees will not
adversely affect our net income.


14


Certain
of our officers and directors have existing responsibilities to other businesses
in addition to our Company and as a result, conflicts of interest between us and
the other activities of those persons may occur from time to time.





Certain
persons serving as our officers and directors have existing responsibilities
and, in the future, may have additional responsibilities, to provide management
and services to other entities in addition to us. In particular, Mr. Xiao Ping
Zhang, our Chief Executive Officer is an officer and a principal
stockholder of Ruili Group Co. Ltd. which is engaged in the development,
production and sale of various kinds of automotive parts as well as operating a
hotel property and investing in the development of real property in China. The
management of our joint venture is shared with the Ruili Group and therefore
there may exist conflicts of interest between us and the Ruili Group in
connection with its operation. Our joint venture agreement provides that the
Board of Directors of the Joint Venture is comprised of three persons, two of
whom are appointed by us. However, at the present time our Chief Executive
Officer, Mr., Xiao Ping Zhang, is the founder of and employed at the Ruili
Group. There can be no assurance that in the event of a conflict between us and
the Ruili Group, our interests in the Joint Venture will not be adversely
affected, or that our Company’s interests will always be fairly represented. The
Ruili Group also provides certain services to the Company in the form of bank
guaranties and licensing of certain technology. The Ruili Group also sells to us
certain non-valve products which allow us to fill out our product lines which in
2009 represented approximately 13.6% of our sales. As a result, conflicts of
interest between us and the other activities of those persons may occur from
time to time. Our officers and directors are accountable to us and our
shareholders as fiduciaries, which requires that such officers and directors
exercise good faith and integrity in handling our affairs. However, the existing
responsibilities limit the amount of time such officers and directors can spend
on our affairs.





We
are and will continue to be under downward pricing pressures on our products
from our customers and competitors which may adversely affect our growth, profit
margins and net income.





We face
continuing downward pricing pressure from our customers and competitors,
especially in the sales of replacement parts. To retain our existing customers
and gain new ones, we must continue to keep our unit prices low. In view of our
need to maintain low prices on our products, our growth, profit margins and net
income will suffer if we cannot effectively continue to control our
manufacturing and other costs.





Our
contracts with our customers are generally short-term and do not require the
purchase of a minimum amount, which may result in periods of time during which
we have limited orders for our products.





Our
customers generally do not provide us with firm, long-term volume purchase
commitments. Although we enter into manufacturing contracts with certain of our
customers who have continuing demand for a certain product, these contracts
state terms such as payment method, payment period, quality standards and
inspection and similar matters rather than provide firm, long-term commitments
to purchase products from us. As a result of the absence of long-term contracts,
we could have periods during which we have no or only limited orders for our
products, but will continue to have to pay the costs to maintain our work force
and our manufacturing facilities and to meet other fixed costs, without the
benefit of current revenues.





We
consistently face short lead times for delivery of products to customers.
Failure to meet delivery deadlines in our production agreements could result in
the loss of customers and damage to our reputation and goodwill.





We enter
into production agreements with our customers prior to commencing production,
which reduces our risk of cancellations. However, these production agreements
typically contain short lead times for delivery of products, leading to
production schedules that can strain our resources and reduce our profit margins
on the products produced. Although we have increased our manufacturing capacity,
we may lack sufficient capacity at any given time to meet all of our customers’
demands if they exceed production capacity levels. We strive for rapid
response to customer demand, which can lead to reduced purchasing efficiency and
increased material costs. If we are unable to sufficiently meet our customers’
demands, we may lose our customers. Moreover, failure to meet customer demands
may impair our reputation and goodwill.


15





Because
of the short lead times in our production agreements, we may not be able to
accurately or effectively plan our production or supply needs.





We make
significant decisions, including determining the levels of business that we will
seek and accept, production schedules, component procurement commitments,
facility requirements, personnel needs, and other resource requirements, based
on our production agreements with our customers. Short lead times of our
customers’ commitments to their own customers and the possibility of rapid
changes in demand for their products reduce our ability to estimate accurately
the future requirements of those customers for our products. Because many of our
costs and operating expenses are fixed, a reduction in customer demand can harm
our sales, margins and operating results. We may also occasionally acquire raw
materials without having customer orders based on a customer’s forecast or in
anticipation of an order and to secure more favorable pricing, delivery or
credit terms in view of the short lead times we often have under our customers’
orders. These purchases can expose us to losses from inventory carrying costs or
inventory obsolescence.





Our
operations depend highly on Messrs. Xiao Ping Zhang, our Chief Executive
Officer, and Bao Jian Tao, our Chief Operating Officer, and a small number of
other executives and the loss of any such executive could adversely affect our
ability to conduct our business.





The
success of our operations depends greatly on a small number of key managers,
particularly, Messrs. Xiao Ping Zhang and Bao Jian Tao. The loss of the service
of Mr. Zhang, or any of the other senior executives could adversely affect our
ability to conduct our business. Even if we are able to find other managers to
replace any of these managers, the search for such managers and the integration
of such managers into our business will inevitably occur only over an extended
period of time. During that time the lack of senior leadership could affect
adversely our sales and manufacturing, as well as our research and development
efforts.





We
may not be able to respond effectively to rapid growth in demand for our
products and of our manufacturing operations which could adversely affect our
customer relations and our growth prospects.





If we
continue to be successful in obtaining rapid market penetration of our products,
we will be required to deliver large volumes of quality products to customers on
a timely basis at a reasonable cost to those customers. Meeting such increased
demands will require us to expand our manufacturing facilities, to increase our
ability to purchase raw materials, to increase the size of our work force, to
expand our quality control capabilities and to increase the scale upon which we
produce products. Such demands would require more capital and working capital
than we currently have available.





We
may not be able to finance the development of new products which could
negatively impact our competitiveness.





Our
future operating results will depend to a significant extent on our ability to
continue to provide new products that compare favorably on the basis of cost and
performance with the products of our competitors. Some of our competitors have
design and manufacturing capabilities and technologies that compete well with
our products, particularly in markets outside of China. We are currently
conducting research and development on a number of new products, activities
requiring a substantial outlay of capital. To remain competitive, we must
continue to incur significant costs in product development, equipment,
facilities and invest in research and development of new products. These costs
may increase, resulting in greater fixed costs and operating expenses. All of
these factors create pressures on our working capital and ability to fund our
current and future manufacturing activities and the expansion of our
business.


16





We
receive a significant portion of our revenues from a small number of customers
which may make it difficult to negotiate attractive prices for our products and
exposes us to risks of substantial losses if we lose certain of these
customers.





Although
no customer individually accounted for more than 10% of our revenues for
the fiscal year ended December 31, 2009, our three largest customers accounted
for approximately 19.2% of our revenues in each of 2009 and 2008.
Dependence on a few customers could make it difficult to negotiate attractive
prices for our products and could expose us to the risk of substantial losses if
a single major customer stops purchasing our products.





Our
business depends on our ability to protect and enforce our intellectual property
effectively which may be difficult particularly in China.





The
success of our business depends in substantial measure on the legal protection
of proprietary rights in technology we hold. We hold 22 patents in China
and one in the United States, and have filed applications for
26 others in China and an additional two in the United States. We claim
proprietary rights in various unpatented technologies, know-how, trade secrets
and trademarks relating to products and manufacturing processes. We protect our
proprietary rights in our products and operations through contractual
obligations, including nondisclosure agreements. If these contractual measures
fail to protect our proprietary rights, any advantage those proprietary rights
provide us would be negated. Monitoring infringement of intellectual property
rights is difficult, and we cannot be certain that the steps we have taken
will prevent unauthorized use of our intellectual property and know-how,
particularly in China and other countries in which the laws may not protect our
proprietary rights as fully as the laws of the United States. Accordingly, other
parties, including competitors, may improperly duplicate our products using
our proprietary technologies. Pursuing legal remedies against persons infringing
our patents or otherwise improperly using our proprietary information is a
costly and time consuming process that would divert management’s attention and
other resources from the conduct of our other business, and could cause delays
and other problems with the marketing and sales of our products, as well as
delays in deliveries.





It
may be difficult to find or integrate acquisitions which could have an adverse
effect on our expansion plans.





An
important component of our growth strategy is to invest in or acquire companies
such as other automotive parts manufacturers and distribution companies. We may
be unable to identify suitable investment or acquisition candidates, or to make
these investments or acquisitions on a commercially reasonable basis, if at all.
If we complete an investment or acquisition, we may not realize the anticipated
benefits from the transaction.





Integrating
an acquired company is complex, distracting and time consuming, as well as a
potentially expensive process. The successful integration of an acquisition
would require us to:





·
            integrate and retain key
      management, sales, research and development, and other
      personnel;





·
            incorporate the acquired products
      or capabilities into our offerings both from an engineering and sales and
      marketing perspective;





·
            coordinate research and
      development
      efforts;





·
            integrate and support
      pre-existing supplier, distribution and customer relationships;
      and


17





·
            consolidate duplicate facilities
      and functions and combine back office accounting, order processing and
      support functions.





The
geographic distance between the companies, the complexity of the technologies
and operations being integrated and the disparate corporate cultures being
combined may increase the difficulties of combining an acquired company.
Acquired businesses are likely to have different standards, controls, contracts,
procedures and policies, making it more difficult to implement and harmonize
company-wide financial, accounting, billing, information and other systems.
Management’s focus on integrating operations may distract attention from our
day-to-day business and may disrupt key research and development, marketing or
sales efforts.





With
the automobile parts markets being highly competitive and many of our
competitors having greater resources than we do, we may not be able to compete
successfully.





The
automobile parts industry is a highly competitive business. Criteria for our
customers and potential customers include:





·
            Quality;





·
            Price/cost
      competitiveness;





·
            Product
      performance;





·
            Reliability and timeliness of
      delivery;





·
            New product and technology
      development capability;





·
            Degree of global and local
      presence;





·
            Effectiveness of customer
      service; and





·
            Overallmanagement
      capability.





Depending
on the particular product market (OEM or aftermarket) and geographic market, the
number of our competitors varies significantly. Many of our competitors have
substantially greater revenues and financial resources than we do, as well as
stronger brand names, consumer recognition, business relationships with vehicle
manufacturers, and geographic presence than we have, especially where we intend
to enter a new geographic market. We may not be able to compete favorably and
increased competition may substantially harm our competitive
position.


18


Internationally,
we face different market dynamics and competition. We may not be as successful
as our competitors in generating revenues in international markets due to the
lack of recognition of our brands, products or other factors. Developing product
recognition overseas is expensive and time-consuming and our international
expansion efforts may be more costly and less profitable than we expect. If we
are not able to execute our business expansion in our target markets, our sales
could decline, our margins could be negatively impacted and we could lose market
share.





A
disruption at our sole manufacturing site would significantly interrupt our
production capabilities, which could have drastic consequences to us, including
threatening our financial viability.





We
currently manufacture all of our products at our sole commercial manufacturing
facility, which is located near Ruian City, Wenzhou, Zhejiang Province, People’s
Republic of China. Accordingly, we face risks inherent in operating a single
manufacturing facility, since any disruption, such as a fire, or natural
disaster, could significantly interrupt our manufacturing capability. We
currently do not have alternative production plans in place or
disaster-recovery facilities available. In case of a disruption, we will have to
establish alternative manufacturing sources. This would require substantial
capital on our part, which we may not be able to obtain on commercially
acceptable terms or at all. Additionally, we would likely experience months or
years of production delays as we build or locate replacement facilities and seek
and obtain necessary regulatory approvals. If this occurs, we will be unable to
satisfy customer orders on a timely basis, if at all. Also, operating any new
facilities may be more expensive than operating our current facility. For these
reasons, a significant disruptive event at our manufacturing facility could have
drastic consequences on us, including threatening our financial
viability.





The
cyclical nature of commercial vehicle production and sales could result in a
reduction in automotive sales, which could adversely affect our financial
liquidity.





Our sales
to OEMs depend on automotive commercial vehicle production and sales by our
customers, which are highly cyclical and affected by general economic conditions
and other factors, including consumer spending and preferences. They also can be
affected by government policies, labor relations issues, regulatory
requirements, and other factors. In addition, in the last two years, the price
of commercial vehicles in China has generally declined. As a result, the volume
of commercial vehicle production in China has fluctuated from year to year,
which has caused fluctuations in the demand for our products.





Increasing
costs for manufactured components and raw materials may adversely affect our
profitability.





We use a
broad range of manufactured components and raw materials in our products,
including castings, electronic components, finished sub-components, molded
plastic parts, fabricated metal, aluminum and steel, and resins. Because it may
be difficult to pass increased prices for these items on to our customers, a
significant increase in the prices of our components and materials could
materially increase our operating costs and adversely affect our profit margins
and profitability.





Longer
product life of parts may reduce aftermarket demand for some of our
products.





In 2009,
approximately 49.5% of our sales were to the aftermarket. The average useful
life of original equipment parts has been steadily increasing in recent years
due to improved quality and innovations in products and technologies. The longer
product lives allow vehicle owners to replace parts of their vehicles less
often. Additional increases in the average useful life of automotive parts are
likely to adversely affect the demand for our aftermarket
products.


19


We
may be subject to product liability and warranty and recall claims, which may
increase the costs of doing business and adversely affect our financial
condition and liquidity.





We face
an inherent business risk of exposure to product liability and warranty claims
if our products actually or allegedly fail to perform as expected or the use of
our products results, or is alleged to result, in bodily injury and/or property
damage. We have not obtained product liability insurance and therefore may be
exposed to potential liability without any insurance. We cannot ensure you that
we will not incur significant costs to defend these claims or that we will not
experience any product liability losses in the future. In addition, if any of
our designed products are or are alleged to be defective, we may be required to
participate in a recall of such products. We cannot assure you that the future
costs associated with providing product warranties and/or bearing the cost of
repair or replacement of our products will not have an adverse effect on our
financial condition and liquidity.





We
are subject to environmental and safety regulations, which may increase our
compliance costs.





We are
subject to the requirements of environmental and occupational safety and health
laws and regulations in China and other countries where we sell our products. To
the extent that we expect to expand our operations into other geographic areas,
we will become subject to such laws and regulations of those countries as well.
We cannot provide assurance that we have been or will be at all times in full
compliance with all of these requirements, or that we will not incur material
costs or liabilities in connection with these requirements. The capital
requirements and other expenditures that may be necessary to comply with
environmental requirements could increase and become a material expense of doing
business.





Non-performance
by our suppliers may adversely affect our operations by delaying delivery or
causing delivery failures, which may negatively affect demand, sales and
profitability.





We
purchase various types of equipment, raw materials and manufactured component
parts from our suppliers. We would be materially and adversely affected by the
failure of our suppliers to perform as expected. We could experience delivery
delays or failures caused by production issues or delivery of non-conforming
products if our suppliers failed to perform, and we also face these risks in the
event any of our suppliers becomes insolvent or bankrupt.





Our
commercial viability depends significantly on our ability to operate without
infringing the patents and other proprietary rights of third
parties.





In the
event that our technologies infringe or violate the patent or other proprietary
rights of third parties, we may be prevented from pursuing product development,
manufacturing or commercialization of our products that utilize such
technologies. There may be patents held by others of which we are unaware that
contain claims that our products or operations infringe. In addition, given the
complexities and uncertainties of patent laws, there may be patents of which we
know that we may ultimately be held to infringe, particularly if the claims of
the patent are determined to be broader than we believe them to be. As a result,
avoiding patent infringement may be difficult.





If
a third party claims that we infringe its patents, any of the following may
occur:





·
            we may become liable for
      substantial damages for past infringement if a court decides that our
      technologies infringe upon a competitor’s
  patent;





·
            a court may prohibit us from
      selling or licensing our product without a license from the patent holder,
      which may not be
      available on commercially acceptable terms or at all, or which may require
      us to pay substantial royalties or grant cross-licenses to our patents;
      and





·
            we may have to redesign our
      product so that it does not infringe upon others’patent rights, which may not be possible
      or could require substantial funds or
  time.


20


In
addition, employees, consultants, contractors and others may use the trade
secret information of others in their work for us or disclose our trade secret
information to others. Either of these events could lead to disputes over the
ownership of inventions derived from that information or expose us to potential
damages or other penalties. If any of these events occurs, our business will
suffer and the market price of our common stock will likely
decline.





Our
international expansion plans subject us to risks inherent in doing business
internationally.





Our
long-term business strategy relies on the expansion of our international sales
outside China by targeting markets, such as Europe and the United States. Risks
affecting our international expansion include challenges caused by distance,
language and cultural differences, conflicting and changing laws and
regulations, international import and export legislation, trading and investment
policies, foreign currency fluctuations, the burdens of complying with a wide
variety of laws and regulations, protectionist laws and business practices that
favor local businesses in some countries, foreign tax consequences, higher costs
associated with doing business internationally, restrictions on the export or
import of technology, difficulties in staffing and managing international
operations, trade and tariff restrictions, and variations in tariffs, quotas,
taxes and other market barriers. These risks could harm our international
expansion efforts, which could in turn materially and adversely affect our
business, operating results and financial condition.





If
we cannot continue to satisfy the Nasdaq Global Market’s listing maintenance
requirements and other Nasdaq rules, our common stock could be delisted, which
could negatively affect the price of our ordinary shares and your ability to
sell them.





In order
to maintain our listing on the Nasdaq Global Market, we will be required to
comply with Nasdaq rules which include rules regarding minimum shareholders’
equity, minimum share price, and certain corporate governance requirements. We
may not be able to continue to satisfy the listing maintenance requirements of
the Nasdaq Global Market and other applicable Nasdaq rules. If we are
unable to satisfy the Nasdaq criteria for maintaining listing, our common stock
could be subject to delisting. If our common stock is delisted, trading, if any,
of our common stock would thereafter be conducted in the over-the-counter
market, in the so-called “pink sheets” or on the National Association of
Securities Dealers, Inc.’s “electronic bulletin board.” As a consequence of any
such delisting, our share price could be negatively affected and our
stockholders would likely find it more difficult to dispose of, or to obtain
accurate quotations as to the prices of, our common stock.





We
do not intend to pay dividends on shares of our common stock in the foreseeable
future.





We have
never paid cash dividends on our common stock. Our current Board of Directors
does not anticipate that we will pay cash dividends in the foreseeable future.
Instead, we intend to retain future earnings for reinvestment in our business
and/or to fund future acquisitions. Determination of net income under PRC
accounting standards and regulations may differ from determination under U.S.
GAAP in significant aspects, such as the use of different principles for
recognition of revenues and expenses. Under PRC law, our PRC joint venture is
required to set aside a portion of its net income each year to fund designated
statutory reserve funds.





Risks
Related to Doing Business in China





We
operate from facilities that are located in China. Our principal operating
subsidiary, Ruili Group Ruian Auto Parts Co., Ltd., is a Sino-foreign joint
venture organized under the laws of the PRC.


21


Changes
in China’s political and economic policies and conditions could cause a
substantial decline in the demand for our products and services.





Historically,
we have derived a substantial portion of our revenues from China. We anticipate
that China will continue to be our primary production location and an important
sales base in the near future and currently almost all of our assets are located
in China. While the PRC government has pursued economic reforms to transform its
economy from a planned economy to a market-oriented economy since 1979, a large
part of the PRC economy is still being operated under varying degrees of control
by the PRC government. By imposing industrial policies and other economic
measures, such as restrictions on lending to certain sectors of the economy,
control of foreign exchange, taxation and restrictions on foreign participation
in the domestic market of various industries, the PRC government exerts
considerable direct and indirect influence on the development of the PRC
economy. Many of the economic reforms carried out by the PRC government are
unprecedented or experimental and are expected to be refined and improved. Other
political, economic and social factors may also lead to further adjustments of
the PRC reform measures. This refining and adjustment process may not
necessarily have a positive effect on our operations and our future business
development. For example, the PRC government has in the past implemented a
number of measures intended to slow down certain segments of the PRC economy
that the government believed to be overheating, including placing additional
limitation on the ability of commercial banks to make loans by raising bank
reserve-against-deposit rates. Historically, this restrictive policy on loans
had the effect of decreasing infrastructure projects resulting in a decrease in
demand for heavy trucks, thus adversely impacting our product sales to our OEM
Customers. Because of the negative impact of the Chinese government policies on
the truck manufacturers, we also were required to extend our normal credit terms
to certain of these manufacturers. Our operating results may be materially and
adversely affected by changes in the PRC economic and social conditions and
by changes in the policies of the PRC government, such as measures to control
inflation, changes in the rates or method of taxation and the imposition of
additional restrictions on currency conversion.





Changes
in foreign exchange regulation in China may affect our ability to pay dividends
in foreign currencies.





Currently,
the RMB is not a freely convertible currency and the restrictions on currency
exchanges in China may limit our ability to use revenues generated in RMB to
fund our business activities outside China or to make dividends or other
payments in U.S. dollars. The PRC government strictly regulates conversion of
RMB into foreign currencies. Over the years, the PRC government has
significantly reduced its control over routine foreign exchange transactions
under current accounts, including trade-and service-related foreign exchange
transactions, foreign debt service and payment of dividends. In accordance with
the existing foreign exchange regulations in China, our PRC joint venture may
pay dividends in foreign currencies, without prior approval from the PRC State
Administration of Foreign Exchange, or SAFE, by complying with certain
procedural requirements. The PRC government may, however, at its discretion,
restrict access in the future to foreign currencies for current account
transactions and prohibit us from converting our RMB-denominated earnings into
foreign currencies. If this occurs, our PRC joint venture may not be able to pay
us dividends in foreign currency without prior approval from SAFE. In addition,
conversion of RMB for most capital account items, including direct investments,
is still subject to government approval in China and companies are required to
open and maintain separate foreign exchange accounts for capital account
items.





Fluctuation
in the value of RMB could adversely affect the value of, and dividends payable
on, our shares in foreign currency terms.





The value
of RMB is subject to changes in PRC government policies and depends to a large
extent on China’s domestic and international economic, financial and political
developments, as well as the currency’s supply and demand in the local market.
For over a decade from 1994, the conversion of RMB into foreign currencies,
including the U.S. dollar, was based on exchange rates set and published daily
by the People’s Bank of China, the PRC central bank, based on the previous day’s
interbank foreign exchange market rates in China and exchange rates on the world
financial markets. The official exchange rate for the conversion of RMB into
U.S. dollars remained stable until RMB was revalued in July 2005 and allowed to
fluctuate by reference to a basket of foreign currencies, including the U.S.
dollar. Under the new policy, RMB will be permitted to fluctuate within a band
against a basket of foreign currencies. There remains significant international
pressure on the PRC government to adopt a substantially more liberalized
currency policy, which could result in a further and more significant
appreciation in the value of RMB against the U.S. dollar. Further revaluations
of RMB against the U.S. dollar may also occur in the future.


22


The
uncertain legal environment in China could limit the legal protections available
to you.





The PRC
legal system is a civil law system based on written statutes. Unlike the
common-law system, the civil law system is a system in which decided legal cases
have little precedential value. In the late 1970s, the PRC government began to
promulgate a comprehensive system of laws and regulations to provide general
guidance on economic and business practices in China and to regulate foreign
investment. Our PRC joint venture is a Sino-foreign joint venture and is subject
to laws and regulations applicable to foreign investment in China in general and
laws and regulations applicable to foreign-invested enterprises in particular.
China has made significant progress in the promulgation of laws and regulations
dealing with economic matters such as corporate organization and governance,
foreign investment, commerce, taxation and trade. However, the promulgation of
new laws, changes of existing laws and abrogation of local regulations by
national laws may have a negative impact on our business and prospects. In
addition, as these laws, regulations and legal requirements are relatively
recent and because of the limited volume of published cases and their
non-binding nature, the interpretation and enforcement of those laws,
regulations and legal requirements involve significant uncertainties.
These uncertainties could limit the legal protections available to
foreign investors, including you. For example, it is not clear if a PRC court
would enforce in China a foreign court decision brought by you against us in
shareholders’ derivative actions.





Moreover,
the enforceability of contracts in China, especially with governmental entities,
is relatively uncertain. If counterparties repudiated our contracts or defaulted
on their obligations, we might not have adequate remedies. Such uncertainties or
inability to enforce our contracts could materially and adversely affect our
revenues and earnings.





Our
primary source of funds for dividend and other distributions from our operating
subsidiary in China is subject to various legal and contractual restrictions and
uncertainties as well as the practice of such subsidiary in declaring dividends,
and our ability to pay dividends or make other distributions to our shareholders
is negatively affected by those restrictions, uncertainties and dividend
practices.





We
conduct our core business operations through our PRC joint venture. As a result,
our profits available for distribution to our shareholders are dependent on the
profits available for distribution from our PRC joint venture. Under current PRC
law, our PRC joint venture is regarded as a foreign-invested enterprise in
China. Although dividends paid by foreign invested enterprises are not subject
to any PRC corporate withholding tax, PRC law permits payment of dividends only
out of net income as determined in accordance with PRC accounting standards and
regulations. Determination of net income under PRC accounting standards and
regulations may differ from determination under U.S. generally accepted
accounting principles in significant aspects, such as the use of different
principles for recognition of revenues and expenses. Under PRC law, our PRC
joint venture is required to set aside 10% of its net income each year to fund a
designated statutory reserve fund until such funds reach 50% of registered share
capital. These reserves are not distributable as cash dividends. As a result,
our primary internal source of funds for dividend payments is subject to these
and other legal and contractual restrictions and uncertainties, which in turn
may limit or impair our ability to pay dividends to our shareholders
although we do not presently anticipate paying any dividends. Moreover, any
transfer of funds from us to our PRC joint venture, either as a shareholder loan
or as an increase in registered capital, is subject to registration with or
approval by PRC governmental authorities. These limitations on the flow of funds
between us and our PRC joint venture could restrict our ability to act in
response to changing market conditions. Additionally to date, our PRC Joint
Venture has not distributed any profits and does not anticipate doing so for the
near term.





PRC’s
economic reform policies, nationalization or domestic or global economic
conditions could result in a total investment loss in our common
stock.





Since
1979, the Chinese government has reformed its economic systems. Because many
reforms are unprecedented or experimental, they are expected to be refined and
improved. Other political, economic and social factors, such as political
changes, changes in the rates of economic growth, unemployment or
inflation, or in the disparities in per capita wealth between regions within
China, could lead to further readjustment of the reform measures. This refining
and readjustment process may negatively affect our operations.


23





Although
the Chinese government owns the majority of productive assets in China, in the
past several years the government has implemented economic reform measures that
emphasize decentralization and encourage private economic activity. Because
these economic reform measures may be inconsistent or ineffectual, there
are no assurances that:





·
            We will be able to capitalize on
      economic reforms;





·
            The Chinese government will
      continue its pursuit of economic reform
  policies;





·
            The
      economic policies, even if pursued, will be
  successful;





·
            Economic policies will not be
      significantly altered fromtime to time;
      and





·
            Business operations in China will
      not become subject to the risk of
  nationalization.





There can
be no assurance that the reforms to China’s economic system will continue or
that we will not be adversely affected by changes in China’s political,
economic, and social conditions and by changes in policies of the Chinese
government, such as changes in laws and regulations, measures which may be
introduced to control inflation, changes in the rate or method of taxation,
changes affecting currency conversion and remittance abroad, and changes in
tariffs and other import controls. A material change in reforms on economic
policy could cause instability or other harmful results.





Because
our principal operating company is organized under the laws of China, and
substantially all of our assets are located in China, you may experience
difficulties in effecting service of legal process, enforcing foreign judgments
or bringing original actions in China based on U.S. or other foreign law against
our management and us.





Our joint
venture operating company is incorporated under the laws of China and
substantially all of our assets are located in China. In addition, all of our
directors and executive officers reside within China, and substantially all of
the assets of these persons are located within China. As a result, it may not be
possible to effect service of process within the United States or elsewhere
outside China upon certain directors or executive officers, including with
respect to matters arising under U.S. federal securities laws or applicable
state securities laws. Moreover, China does not have treaties providing for the
reciprocal recognition and enforcement of judgments of courts with the United
States, the United Kingdom, Japan or many other countries. As a result,
recognition and enforcement in China of judgments of a court in the United
States and any of the other jurisdictions mentioned above in relation to any
matter may be difficult or impossible. Furthermore, an original action may be
brought in China against us, our directors, managers, or executive officers only
if the actions are not required to be arbitrated by Chinese law and only if the
facts alleged in the complaint give rise to a cause of action under PRC law. In
connection with any such original action, a Chinese court may award civil
liability, including monetary damages.





Any
occurrence of serious infectious diseases, such as recurrence of severe acute
respiratory syndrome (SARS) causing widespread public health problems, could
adversely affect our business operations.





A renewed
outbreak of SARS or other widespread public health problems in China, where a
substantial portion of our revenue is derived, and in Ruian City, where our
operations are headquartered, could have a negative effect on our operations.
Our operations may be impacted by a number of public health-related factors,
including the following:


24





·
            quarantines or closures of our
      factories or subsidiaries which would severely disrupt its
      operations;





·
            the sickness or death of the key officers and
      employees; and





·
            general slowdown in the Chinese
      economy resulting from an
outbreak.





Any of
the foregoing events or other unforeseen consequences of public health problems
could result in reduction in net sales of our products.





It
is likely that China will adopt additional environmental regulations and
additional or modified regulations relating to the manufacture, transportation,
storage, use and disposal of materials used to manufacture our products or
restricting disposal of waste, which would likely increase our operating
costs.





National,
provincial and local laws impose various environmental controls on the
manufacture of automotive parts and/or of certain materials used in the
manufacture of automotive parts. Although we believe that our operations are in
substantial compliance with current environmental regulations, there can be no
assurance that changes in such laws and regulations will not impose costly
compliance requirements on us or otherwise subject us to future liabilities. In
addition, China is experiencing substantial problems with environmental
pollution. Accordingly, it is likely that the national, provincial and local
governmental agencies will adopt stricter pollution controls. Any such
regulation relating to the manufacture, transportation, storage, use and
disposal of materials used to manufacture our products or restricting disposal
of any waste would likely increase our operating costs.





Risks
Related to Our Common Stock





The
market price for our common stock may be volatile which could result in a
complete loss of your investment.





The
market price for our common stock may be volatile and subject to
fluctuations in response to factors including the following:





·
            actual or anticipated
      fluctuations in our quarterly operating
  results,





·
            announcements of new products by
      us or our competitors,





·
            changes in financial estimates by
      securities analysts,





·
            conditions in the automotive
      market,


25





·
            changes in the economic performance or market
      valuations of other companies involved in the production of automotive
      parts,





·
            announcements by our competitors
      of significant acquisitions, strategic partnerships, joint ventures or
      capital commitments,





·
            additions or
      departures of key
      personnel, or





·
            potential
      litigation.





In
addition, the securities markets have from time to time experienced significant
price and volume fluctuations that are not related to the operating performance
of particular companies. These market fluctuations may also materially and
adversely affect the market price of our common stock.





We
may issue additional shares of our capital stock to raise additional cash for
working capital. If we issue additional shares of our capital stock, our
stockholders will experience dilution in their respective percentage ownership
in us.





We may
seek to further expand our operations and therefore we may issue additional
shares of our capital stock to raise additional cash for working capital. If we
issue additional shares of our capital stock, our stockholders will experience
dilution in their respective percentage ownership in us.





A
large portion of our common stock is controlled by a small number of
stockholders and as a result, these stockholders are able to influence the
outcome of stockholder votes on various matters.





A large
portion of our common stock is held by a small number of stockholders. Mr. Xiao
Ping Zhang, our Company’s Chief Executive Officer, and his brother, Xiao Feng
Zhang, a member of our Board of directors, hold approximately 49.7% and
6.2% as of December 31, 2009, respectively, of the Company’s common stock. As a
result, these stockholders are able to control the outcome of stockholder votes
on various matters, including the election of directors and other corporate
transactions including business combinations.





The
occurrence of sales of a large number of shares of our common stock, or the
perception that these sales could occur, may affect our stock price and could
impair our ability to obtain capital through an offering of equity
securities.





The
occurrence of sales of a large number of shares of our common stock, or the
perception that these sales could occur, may affect our stock price and could
impair our ability to obtain capital through an offering of equity securities.
This would have an adverse affect on our business by restricting access to
working capital to fund growth and operations. Furthermore, the comparatively
small public float of our common stock could adversely affect the market price
of our common stock.





We
are responsible for the indemnification of our officers and directors which
could result in substantial expenditures, which we may be unable to
recoup.





Our
Bylaws provide for the indemnification of our directors, officers, employees,
and agents, under certain circumstances, against attorney’s fees and other
expenses incurred by them in any litigation to which they become a party arising
from their association with or activities on behalf of us. This indemnification
policy could result in substantial expenditures, which we may be unable to
recoup.


26





Compliance
with the Sarbanes-Oxley act costs hundreds of thousands of dollars, requires
additional personnel and requires hundreds of man hours of effort, and there can
be no assurance that we will have the personnel, financial resources or
expertise to continue to meet requirements of these regulations.





The US
Public Company Accounting Reform and Investor Protection Act of 2002, better
known as Sarbanes-Oxley, was the most sweeping legislation to affect US
publicly traded companies in 70 years. Sarbanes-Oxley created a set of complex
and burdensome regulations. Compliance with such regulations imposes substantial
burdens in terms of financial expense and commitment of personnel. There can be
no assurance that we will have the personnel, financial resources or expertise
to continue to meet requirements of these regulations.





ITEM
1B. UNRESOLVED STAFF COMMENTS





None.





ITEM
2. PROPERTIES





Our
facilities are located in the Ruian District of Wenzhou City in Zhejiang
Province, which is the center of automotive parts production in China. The
facilities include a manufacturing plant and office building with a total floor
area of 712,333 square feet, which we purchased from Ruili Group Co. Ltd., a
related party, for an aggregate purchase price of approximately RMB152 million
(approximately US$20.2 million). Before the transaction, we occupied
271,713 square feet of factory and warehouse, leased from the Ruili Group
under a ten year lease. At the production facility, the Company has production
equipment, imported from the United States, Korea, and Taiwan, as well as
manufactured in mainland China.





ITEM
3. LEGAL PROCEEDINGS





None.





PART
II





ITEM
5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDERS MATTERS AND ISSUERS PURCHASES
OF EQUITY SECURITIES





Price
Range of Common Stock





On April
18, 2006, SORL Auto Parts, Inc. was approved for listing its common shares on
the NASDAQ Capital Market and commenced trading its shares on NASDAQ under the
symbol “SORL”. The Company was further approved for listing on the NASDAQ Global
Market on November 21, 2006. High and low sales prices per share of our Common
Shares for each quarter ended during 2009 and 2008 are as
follows:


27





QuarterEnded
                  
                  High
                  
                  Low2009First
      Quarter
                  
                  
                  2.20
                  
                  1.14Second
      Quarter
                  
                  
                  4.54
                  
                  1.68Third
      Quarter
                  
                  
                  5.39
                  
                  3.12Fourth
      Quarter
                  
                  
                  9.16
                  
                  4.652008First
      Quarter
                  
                  
                  7.40
                  
                  4.70Second
      Quarter
                  
                  
                  7.10
                  
                  4.83Third
      Quarter
                  
                  
                  6.45
                  
                  3.32Fourth
      Quarter
                  
                  
                  3.89
                  
                  1.39





During
February 2010, we sold one million shares of our common stock in a registered
direct offering to selected institutional investors, at an offering price of
$10.00 per share. Gross proceeds were $10 million, and net proceeds to us, after
expenses and underwriting compensation, were $9.4 million. The proceeds of the
offering will be used for general corporate purposes.





Stockholders





At March
17, 2010, we had approximately 518 registered stockholders of record of our
common stock. This number does not include shares beneficially owned by
investors through brokerage clearing houses, depositories or otherwise held in
“street name”.





Dividends





We have
not historically declared or paid any cash dividends on our common stock and do
not anticipate paying any cash dividends in the foreseeable future. Payment of
cash dividends, if any, in the future will be at the discretion of our board of
directors and will depend upon our debt and equity structure, earnings and
financial condition, need for capital in connection with possible future
acquisitions and other factors including economic conditions, regulatory
restrictions and tax considerations. Additionally, amounts available for
dividends are dependent on the profits available for distribution from our PRC
joint venture. Under current PRC law, our PRC joint venture is regarded as a
foreign invested enterprise in China. Although dividends paid by foreign
invested enterprises are not subject to any PRC corporate withholding tax, PRC
law permits payment of dividends only out of net income as determined in
accordance with PRC accounting standards and regulations. Determination of net
income under PRC accounting standards and regulations may differ from
determination under U.S. GAAP in significant aspects, such as the use of
different principles for recognition of revenues and expenses. Under PRC law,
our PRC joint venture is required to set aside a portion of its net income each
year to fund designated statutory reserve funds. These reserves are
not distributable as cash dividends. As a result, our primary internal
source of funds for dividend payments is subject to these and other legal and
contractual restrictions and uncertainties, which in turn may limit or impair
our ability to pay dividends to our shareholders although we do not presently
anticipate paying any dividends. Moreover, any transfer of funds from us to our
PRC joint venture, either as a shareholder loan or as an increase in registered
capital, is subject to registration with or approval by PRC governmental
authorities. These limitations on the flow of funds between us and our PRC joint
venture could restrict our ability to act in response to changing market
conditions. Additionally to date, our PRC Joint Venture has not distributed
any profits and does not anticipate doing so for the near
term.





ITEM
6. SELECTED FINANCIAL DATA.





Not
applicable.


28


ITEM
7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS





The
following is management’s discussion and analysis of certain significant factors
that have affected our financial position and operating results during the
periods included in the accompanying consolidated financial statements, as well
as information relating to the plans of our current management. This report
includes forward-looking statements. Generally, the words “believes,”
“anticipates,” “may,” “will,” “should,” “expect,” “intend,” “estimate,”
“continue,” and similar expressions or the negative thereof or comparable
terminology are intended to identify forward-looking statements. Such
statements are subject to certain risks and uncertainties, including the matters
set forth in this report and other reports or documents we file with the
Securities and Exchange Commission from time to time, which could cause actual
results or outcomes to differ materially from those presented. Undue reliance
should not be placed on these forward-looking statements, which speak only as of
the date hereof. We undertake no obligation to update these forward-looking
statements.





The
following discussion and analysis should be read in conjunction with our
consolidated financial statements and the related notes thereto and other
financial information contained elsewhere in this Form 10K.





OVERVIEW





On May
10, 2004, we acquired all of the issued and outstanding equity interests of
Fairford Holdings Limited, a Hong Kong limited liability company (“Fairford”).
Until we acquired Fairford, we had only nominal assets and liabilities and
limited business operations. Although Fairford became a wholly-owned subsidiary
following the acquisition, because the acquisition resulted in a change of
control, the acquisition was recorded as a “reverse merger” whereby Fairford is
considered to be the accounting acquirer. As such, the following results of
operations are those of Fairford.





Fairford
was organized in Hong Kong as a limited liability company on November 3, 2003.
Fairford owns 90% of the equity interest of Ruili Group Ruian Auto Parts Co.,
Ltd., a Sino-foreign joint venture (the “Joint Venture”) established pursuant to
the laws of the People’s Republic of China (“PRC” or “China”). The Joint Venture
is a joint venture between our wholly-owned subsidiary, Fairford, and Ruili
Group Co., Ltd. (the “Ruili Group”).





The Ruili
Group was incorporated in the PRC in 1987 to specialize in the development,
production and sale of various kinds of automotive parts. Its headquarters are
located in Ruian City of Wenzhou Area, one of the leading automotive parts
manufacturing centers of China with more than 1400 auto parts manufacturing
companies. Its major product lines include valves for air brake systems, auto
metering products, auto electric products, anti-lock brake systems and
retarders. Some of those products were developed and are manufactured through
affiliated companies of Ruili Group. Due to its leading position in the
industry, the Chairman of the Ruili Group, Mr. Xiao Ping Zhang, has been elected
as the Chairman of Wenzhou Auto Parts Association, one of the leading auto parts
trade associations in China. Mr. Zhang is also Chairman and Chief Executive
Officer of the Company. The Joint Venture was established in the PRC as a
Sino-foreign joint venture company with limited liability by the Ruili Group and
Fairford. Fairford and Ruili Group contributed 90% and 10%, respectively, of the
paid-in capital in the aggregate amount of approximately $43.4
million.





In
connection with its formation, effective January 19, 2004 the Joint Venture
acquired the business of the Ruili Group relating to the manufacture and sale of
various kinds of valves for automotive brake systems and related operations (the
“Transferred Business”). This was accomplished by the transfer from the Ruili
Group to Fairford of the relevant assets and liabilities of the Transferred
Business including trade receivables, inventories and machinery, and the
assumption of short and long term borrowings, at a consideration of
approximately $6.39million.





The
consideration was based on a valuation by an independent PRC valuation firm.
Fairford then contributed these assets and liabilities as a capital contribution
for its 90% interest in the Joint Venture. The Ruili Group also transferred
inventory as its capital contribution for its 10% interest in the Joint Venture.
The assets and liabilities transferred to the Joint Venture by Fairford and the
Ruili Group represented all the relevant assets and liabilities of the
Transferred Business.


29


Pursuant
to the formation of the Joint Venture, on January 17, 2004, the Ruili Group and
Fairford signed a binding Joint Venture agreement (the “JV Agreement”). Pursuant
to the JV Agreement, the Board of Directors consists of three directors;
Fairford has the right to designate two members of the board and the Ruili Group
has the right to designate one member. The majority of the Board has decision
making authority with respect to operating matters. As a result, Fairford
maintains operating control over the Joint Venture.





The
transactions were accounted for as a reverse spin-off in accordance with EITF
02-11 “Accounting for Spin-offs.” Accordingly SORL Auto Parts, Inc. was deemed
to be the “spinnor” for accounting purposes.





In
December 2006, through Fairford, SORL invested a further approximately $32.67
million in its operating subsidiary- the Joint Venture. To maintain its 10%
shareholding in the Joint Venture, the Ruili Group increased its capital
investment by approximately $3.63 million. SORL Auto Parts, Inc. continues
to hold a 90% controlling interest in the operating subsidiary.





As a
result of the foregoing, through Fairford’s 90% interest in the Joint Venture,
the Company manufactures and distributes automotive air brake systems, air
controlling systems and other related components in China and internationally
for use primarily in different types of vehicles, such as trucks and buses.
There are forty categories of valves with over one thousand different
specifications in air brake systems, air controlling systems and others.
Management believes that it is the largest manufacturer of automotive air brake
systems for commercial vehicles in China.





On
November 11, 2009, we entered into a joint venture agreement with MGR,
a Hong Kong-based global auto parts distribution specialist firm, and with a
Taiwanese investor. The new joint venture was named SORL International Holding,
Ltd. (the "SIH"). SORL holds a 60% interest in the joint venture. SIH was
primarily devoted to expanding SORL's international sales network in
Asia-Pacific and creating a larger footprint in Europe, the Middle East and
Africa with a target to create a truly global distribution network. Based
in Hong Kong, SIH seeks to open up and establish channels of distribution
in international markets with SORL's primary products, including spring brake
chambers, clutch servos, air dryers, relay valves and hand brake
valves.





CRITICAL
ACCOUNTING POLICIES AND ESTIMATES





Our
discussion and analysis of our financial condition and results of operations are
based upon our consolidated financial statements, which have been prepared in
accordance with U.S. generally accepted accounting principles. The preparation
of financial statements in conformity with those accounting principles requires
us to make judgments and estimates that affect the amounts reported in the
consolidated financial statements and accompanying notes. Those judgments and
estimates have a significant effect on the consolidated financial statements
because they result primarily from the need to make estimates about the effects
of matters that are inherently uncertain. Actual results could differ from those
estimates. We periodically re-evaluate our judgments and estimates that are
based upon historical experience and on various other assumptions that we
believe to be reasonable under the circumstances.





We
believe that the following critical accounting policies set forth below involve
the most significant judgments and estimates used in the preparation of our
consolidated financial statements. We evaluate these policies on an ongoing
basis, based upon historical results and experience, consultation with experts,
trends and other methods we consider reasonable in the particular circumstances,
as well as our forecasts as to how these might change in the
future.





WARRANTIES





Estimated
product warranty expenses are accrued in cost of goods sold at the time the
related sales are recognized. We base our estimate on historical trends of units
sold and payment amounts, combined with our current understanding of the status
of existing claims and discussions with our customers.


30





INVENTORIES





Inventories
are stated at the lower of cost or net realizable value. Cost is calculated on
the weighted-average basis and includes all costs to acquire and other costs
incurred in bringing the inventories to their present location and condition.
The Company evaluates the net realizable value of its inventories on a regular
basis and records a provision for loss to reduce the computed weighted-average
cost if it exceeds the net realizable value.





INCOME
TAXES





Taxes are
calculated in accordance with taxation principles currently effective in the
PRC. Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized as income or loss
in the period that includes the enactment date. A valuation allowance is
provided for the amount of deferred tax assets and liabilities that, based on
available evidence, are not expected to be realized.





Under a
Tax Holiday in PRC, the Company is granted an exemption from income taxes for
two years commencing from the first cumulative profit-making year and a 50%
reduction in the income tax rates for the following three years. Fiscal year
ended December 31, 2004 was the first cumulative profit-making year. As a result
of the Joint Venture obtaining its Sino-foreign joint venture status in 2004, in
accordance with applicable PRC tax regulations, the Joint Venture was exempted
from PRC income tax in both fiscal 2004 and 2005. Thereafter, the Joint Venture
is entitled to a tax concession of 50% of the applicable income tax rate of
26.4% for the two years ended December 31, 2006 and 2007. With the new PRC
Enterprise Income Tax Law, effective on 1st January 2008, the China’s
enterprises are generally subject to a PRC income tax rate of 25% and the
Joint Venture is entitled to a tax concession of 50% of the applicable income
tax rate of 25% for the year ended December 31, 2008.





Additionally,
the Company increased its investment in the Joint Venture as a result of its
financing in December, 2006. In accordance with the Income Tax Law of the
People's Republic of China on Foreign-invested Enterprises and Foreign
Enterprises, the Joint Venture is eligible for additional preferential tax
treatment. For the years 2007 and 2008, the Joint Venture entitled to an income
tax exemption on all pre-tax income generated by the company above its pre-tax
income generated in the fiscal year 2006. Thereafter, the Joint Venture will
enjoy a 50% exemption from the applicable income tax rate of 25% on any pre-tax
income above its 2006 pre-tax income, to be recognized in the years 2009, 2010
and 2011.




The above
taxation exemption was superceded, because the Joint Venture has been
awarded the Chinese government's "High-Tech Enterprise" designation. The
High-Tech Enterprise certificate is valid for three years and provides for a
reduced tax rate of 15% for years 2009 through 2011. So, the effective
income tax rate will be 15% for years 2009 through 2011.




REVENUE
RECOGNITION





In
accordance with the provisions of Staff Accounting Bulletin No. 103, revenue
from the sale of goods is recognized when the risks and rewards of ownership of
the goods have transferred to the buyer including factors such as when
persuasive evidence of an arrangement exits, delivery has occurred, the sales
price is fixed and determinable, and collection is probable. The Company
generally records sales upon shipment of product to customers and transfer of
title under standard commercial terms. Revenue consists of the invoice
value for the sale of goods and services net of value-added tax (“VAT”), rebates
and discounts and returns. The Company nets sales return in gross revenue, i.e.,
the revenue shown in the income statement is the net sales. The Company is
subject to the following surtaxes, which are recorded as deductions from gross
sales: Education Tax.


31





The
Company does not receive revenue for shipping and handling costs to customers.
Shipping and handling expenses incurred by the Company are included in selling
and administrative expenses in the accompanying consolidated statements of
income.





CONCENTRATION
OF CREDIT RISK





Financial
instruments that potentially subject the Company to significant concentrations
of credit risk consist primarily of accounts receivable. The Company performs
ongoing credit evaluations with respect to the financial condition of its
creditors, but does not require collateral. In order to determine the value of
the Company’s accounts receivable, the Company records a provision for doubtful
accounts to cover probable credit losses. Management reviews and adjusts this
allowance periodically based on historical experience and its evaluation of the
collection of outstanding accounts receivable.





RESULTS
OF OPERATIONS





Year
ended December 31, 2009 as compared to year ended December 31,
2008:





Years Ended December 31,Sales
                                      
                                      2009
                                      
                                      
                                      %
                                      
                                      
                                      2008
                                      
                                      
                                      %(U.S. 
      dollars in million)Air
      brake systems & related components
                                      
                                      $
                                      108.0
                                      
                                      
                                      
                                      86.4
                                      %
                                      
                                      $
                                      99.7
                                      
                                      
                                      
                                      76.2
                                      %Non-valve
      products
                                      
                                      $
                                      17.0
                                      
                                      
                                      
                                      13.6
                                      %
                                      
                                      $
                                      31.2
                                      
                                      
                                      
                                      23.8
                                      %Total
                                      
                                      $
                                      125.0
                                      
                                      
                                      
                                      100
                                      %
                                      
                                      $
                                      130.9
                                      
                                      
                                      
                                      100
                                      %





Sales
consisted of air brake systems and related components manufactured by SORL and
sold to Chinese domestic OEM and Chinese aftermarket customers and
international customers; as well as distribution of non-valve auto parts sourced
from related parties.





Total
net sales were $124,979,741 and $130,893,422 for the fiscal years ended December
31, 2009 and 2008, respectively, representing a decrease of $5.9 million
or 4.5% year over year. A breakdown of net sales revenue for our three
principal markets, Chinese domestic OEM market, Chinese domestic
aftermarket and international markets, in 2009 and 2008 is as
follows:


Years Ended December 31,Percentof2009
                            
                            
                            Total
                              sales
                            
                            
                            2008
                            
                            
                            Percent
      ofTotal
      sales
                            
                            
                            PercentageChange(U.S.
      dollars in million)China
      OEM market
                            
                            $
                            63.1
                            
                            
                            
                            50.5
                            %
                            
                            $
                            49.0
                            
                            
                            
                            37.4
                            %
                            
                            
                            28.8
                            %China
      Aftermarket
                            
                            $
                            31.5
                            
                            
                            
                            25.2
                            %
                            
                            $
                            35.5
                            
                            
                            
                            27.1
                            %
                            
                            
                            -11.3
                            %International
      market
                            
                            $
                            30.4
                            
                            
                            
                            24.3
                            %
                            
                            $
                            46.4
                            
                            
                            
                            35.5
                            %
                            
                            
                            -34.5
                            %Total
                            
                            $
                            125.0
                            
                            
                            
                            100
                            %
                            
                            $
                            130.9
                            
                            
                            
                            100
                            %
                            
                            
                            -4.5
                            %


32





With the
approaching of implementation of the China III emission standard beginning July
1, 2008, the consumption of trucks equipped with China II engines was
significantly spurred before the policy was enforced. This increased the
output and sales volume of vehicles made in China in the first half of 2008. As
a result, our Chinese OEM sales achieved a strong growth in the first half year
of 2008. With the worsening financial crisis, our OEM sales sharply
decreased in the second half year of 2008.





Global
financial conditions, involving a worldwide macroeconomic decline and weak
global auto market, caused the demand for our products to decline during the
first half of 2009. However, the Chinese’s government’s 4 trillion RMB stimulus
package, which positively affected the development of China’s automobile
industry, materially benefited our results in the second half of
2009. Further, we promoted our integrated system and modular supplies of
air brake systems to our OEM customers and we increasingly focused on the
light duty, bus and agricultural vehicle market in 2009. As a result of
these positive factors, our sales to the Chinese OEM market increased
by $14.1 million or 28.8% for the fiscal year ended December 31, 2009, as
compared with the fiscal year ended December 31, 2008.





During
the year ended December 31, 2009, we generated revenues of $31.5 million
from Chinese domestic aftermarket sales, a decrease of $4.0 million,
or 11.3% from the year ended December 31, 2008. Accelerated replacement of
medium-duty and heavy-duty trucks, and rising new vehicle usage in recent years
resulted in the decreased sales in aftermarket in the short term.





The
global financial crisis has negatively affected our international customers, and
caused local currencies to depreciate against the US dollar, while the lack of
confidence in the growth of the world macro-economy has made our customers
decrease their inventories in order to lower their risk. Consequently, our
export sales decreased by $16.0 million or approximately 34.5% for the fiscal
year ended December 31, 2009, from $46.4 million for 2008.





COST
OF SALES





Cost of
sales for the fiscal year ended December 31, 2009 decreased to
$89.5 million from $97.2 million for the fiscal year ended December 31,
2008, a $7.7 million or 7.9 % decrease, consistent with the decrease in
revenues.





GROSS
PROFIT





Gross
profit for the fiscal year ended December 31, 2009, increased by approximately
$1.8 million or 5.3% to $35.5 million from $33.7 million for the
fiscal year ended December 31, 2008. Gross margin increased by
approximately 2.7 percentage points, from 25.7% in 2008 to 28.4%
in 2009.





We
believe that the improvements in gross profits and gross margin reflect our
focus in 2009 on increasing production efficiency, improving the technologies of
products, and improving our product portfolio. We believe that our continued
expansion to higher-profit new products will also help us to maintain or
increase our gross profit margins.





SELLING
EXPENSES





Selling
expenses were $8,137,377 for the fiscal year ended December 31, 2009, as
compared to $8,423,124 for the fiscal year ended December 31, 2008, a decrease
of $285,747 or 3.4%. The decrease was mainly due to the decreased
transportation expense as a result of decreased international sales. As a
percentage of sales revenue, selling expenses increased to 6.5% for the fiscal
year ended December 31, 2009, as compared to 6.4% for the same period in
2008.


33


GENERAL
AND ADMINISTRATIVE EXPENSES





General
and administrative expenses were $7,282,110 for the fiscal year ended
December 31, 2009, as compared to $6,075,404 for the fiscal year ended December
31, 2008, an increase of $1,206,706 or 19.9%. As a percentage of sales
revenue, general and administrative expenses increased to 5.8% for the fiscal
year ended December 31, 2009, as compared to 4.6% for the same period in 2008.
The increase was mainly due to increased staff salary and welfare costs, rent
expenses, travel expenses and business entertainment expenses, which together
increased by $987,777 as compared with the total for these items during the
fiscal year ended December 31, 2008.





RESEARCH
AND DEVELOPMENT EXPENSE




Research
and development expense was $4,335,464 for the fiscal year ended December
31, 2009, as compared with $3,219,895 for the fiscal year ended December 31,
2008, an increase of $1,115,569. The Company will continue to invest in new
product development, particularly in upgrading traditional valve products and in
developing electronically controlled products.





DEPRECIATION
AND AMORTIZATION





Depreciation
and amortization expense increased to $3.0 million for the fiscal year ended
December 31, 2009, compared with depreciation and amortization expense of $2.71
million for the fiscal year ended December 31, 2008.





The
increase in depreciation and amortization expense was primarily due to the
addition of purchased production equipment.





FINANCIAL
EXPENSE





Financial
expense mainly consists of foreign exchange loss. Financial expense for the
fiscal year ended December 31, 2009 decreased by $721,560 to $131,080 from
$852,640 for the fiscal year ended December 31, 2008, which was mainly due
to the lesser exchange loss incurred as compared to the fiscal year ended
December 31, 2008.




OTHER
INCOME




For the
fiscal year ended December 31, 2009, other income included subsidy income of
$190,167 compared with $307,520 for the fiscal year ended December 31,
2008. Through local governments, these subsidies were provided to the Company as
economic incentives to secure business commitments and no repayment is
required.





INCOME
TAX





The Joint
Venture is registered in the PRC, and is therefore subject to state and local
income taxes within the PRC at the applicable tax rate on taxable income as
reported in the PRC statutory financial statements in accordance with relevant
income tax laws. According to applicable tax laws regarding Sino-Foreign Joint
Ventures, the Joint Venture was exempt from income taxes in the PRC for each of
the fiscal years ended December 31, 2005 and 2004. Thereafter, the Joint Venture
was entitled to a 50% income tax deduction for each of the three years ended
December 31, 2008. Thus, the Joint Venture was exempted from PRC income tax in
both fiscal 2004 and 2005, and entitled to a tax concession of 50% of the
applicable income tax rate of 26.4% for the two years ended December 31, 2006
and 2007. With the new PRC Enterprise Income Tax Law, effective on 1st January
2008, China’s enterprises are generally subject to a PRC income tax rate of
25% and the Joint Venture was entitled to a tax concession of 50% of the
applicable income tax rate of 25% for the year ended December 31,
2008.





The
Company increased its investment in the Joint Venture as a result of its
financing in December, 2006. In accordance with the Income Tax Law of the
People's Republic of China on Foreign-invested Enterprises and Foreign
Enterprises, the Joint Venture was eligible for additional preferential tax
treatment for the years 2007 and 2008. In those years, the Joint Venture
was entitled to an income tax exemption on all pre-tax income generated by the
Company above its pre-tax income generated in the fiscal year 2006. In
2009, 2010 and 2011, the Joint Venture will enjoy a 50% exemption from the
applicable income tax rate of 25% on any pre-tax income above its 2006 pre-tax
income. The above taxation exemption was superceded, because the Joint Venture
has been awarded the Chinese government's "High-Tech Enterprise" designation.
The High-Tech Enterprise certificate is valid for three years and provides for a
reduced tax rate of 15% for years 2009 through 2011. So, the effective
income tax rate will be 15% for years 2009 through 2011.


34


In
addition, the Joint Venture was entitled to a PRC tax credit equal to 40% of the
additional investment in the Joint Venture used to purchase eligible domestic
equipment, subject to certain limitations.





During
the fiscal year ended December 31, 2009 and December 31, 2008, the Joint Venture
received an abovementioned income tax benefit of $694,746 and
$377,147 respectively, which has been reflected as a reduction to current
income tax expense. As a result of the factors discussed above, income tax
expense was $1,796,622 for the fiscal year ended December 31, 2009 compared
with $1,586,503 for the fiscal year ended December 31, 2008,
an increase of $210,119.





STOCK—BASED
COMPENSATION




On March
1, 2006, the Board of Directors approved a total of 60,000 options to be issued
to the four independent members of the Board of Directors. The contractual term
of the options is three years. Total deferred stock-based compensation expenses
related to stock options amounted to $178,904. This amount is amortized over the
three year vesting period in a manner consistent with FASB ASC 505-50. The
amortization of deferred stock-based compensation for these equity arrangements
were $9,935 and $59,636 for the fiscal years ended December 31,
2009 and 2008, respectively. As of December 31, 2009, the 60,000
options had expired unexercised.





On June
20, 2007, the Company granted to its previous senior manager of investor
relations, David Ming He, options to purchase 4,128 shares of its common stock
with an exercise price of $7.25 per share. In accordance with the agreement, the
option became vested and exercisable immediately on the date thereof. Total
deferred stock-based compensation expenses related to the 4,128 stock options
granted amounted to $23,201. This amount was charged to G&A during the
fiscal year ended December 31, 2007. On November 13, 2009, David Ming He
exercised the options on a cashless basis and received 460 shares of common
stock, based on a formula provided for in the initial grant.





On
January 5, 2006, the Company issued 100,000 warrants for financial services to
be provided by Maxim Group LLC and Chardan Capital Markets, LLC, with an
exercise price of $6.25 per share. In accordance with the common stock purchase
warrant agreement, the warrants became vested and exercisable immediately on the
date thereof. As set forth in the agreement, the Company retained Maxim Group
LLC and Chardan Capital Markets, LLC as its exclusive financial advisors and
investment bankers for a period of twelve months from the date of January 5,
2006. The agreement has now expired. Total expense associated with the 100,000
warrants amounted to $299,052, which, consistent with FASB ASC 505-50, was
recognized during the fiscal year ended December 31, 2006.





On
November 9, 2009, Maxim Group LLC transferred 35,000 warrants to OTA LLC and
35,000 warrants to Maxim Partners, LLC respectively. OTA LLC exercised the
warrants on a cashless basis on November 12, 2009 and received 6,609 shares of
common stock, based on a formula provided for in the initial grant. Maxim
Partners, LLC and Chardan Capital Markets, LLC transferred 35,000 warrants and
30,000 warrants to OTA LLC on December 15, 2009 and December 11, 2009,
respectively. OTA LLC exercised the warrants on a cashless basis on December 18,
2009 and received 18,598 shares of common stock, based on a formula provided for
in the initial grant.





There
were no options or warrants outstanding as of December 31, 2009.





Although
the Company anticipates future issuances of stock awards could have a
material impact on reported net income in future financial statements, we do not
expect them to have a material impact on future cash flow.


35


NET
INCOME ATTRIBUTABLE TO NON-CONTROLLING INTEREST IN
SUBSIDIARIES





Non-controlling
interest in subsidiaries represents a 10% non-controlling interest in the
Chinese located Joint Venture and 40% non-controlling interest in the Hong Kong
located Joint Venture. Net income attributable to non-controlling interest in
subsidiaries amounted to $1,376,791and
$1,381,230 for the fiscal year ended December 31, 2009 and 2008,
respectively.





NET
INCOME ATTRIBUTABLE TO STOCKHOLDERS





The net
income attributable to stockholders for the fiscal year ended December 31,
2009 increased by $385,206, to $12,756,066 from $12,370,860 for
the fiscal year ended December 31, 2008 due to the factors discussed above.
Earnings per share (“EPS”), both basic and diluted, for 2009 and 2008, were
$0.70 and $0.68 per share, respectively.




FINANCIAL
CONDITION




LIQUIDITY
AND CAPITAL RESOURCES




OPERATING
- Net cash provided from operating activities was $9,703,198 for the fiscal
year ended December 31, 2009, as compared to $9,673,487 of net
cash provided by operating activities for the fiscal year ended
December 31, 2008, an increase of $29,711.


.


Our
primary cash flows from net income were realized through the sale of automotive
parts. Net income after deducting non-cash items provided cash inflows at
approximately $17.2 million for the fiscal year ended December 31,
2009 as compared to $16.6 million for the fiscal year ended December
31, 2008, an increase of $0.6 million. Cash flows from accounts receivable and
notes receivable decreased by approximately $13.7 million for the fiscal year
ended December 31, 2009 as compared with the fiscal year ended December 31,
2008, as a result of the high level of accounts receivable and notes receivable
at December 31, 2009. The increase in accounts receivable was
primarily due to the increase of the sales for the OEM market. The ending
balance of accounts receivable as of December 31, 2009 was consistent with our
normal practice. Additionally, most of accounts receivable were collected
through bank acceptance during the fiscal year ended December 31,
2009, causing the increase in notes receivable. The Company
established more distribution warehouses close to major OEM customers and
maintained more stock in those warehouses to ensure timely deliveries at the
request of major OEM customers. As a result, the Company maintained a high
inventory level as of the end of fiscal year ended December 31, 2008. Because we
normally require certain overseas and after-market customers to pay in
advance before delivering goods, and due to the decreased sales in the overseas
and after-market segments, cash flow generated from deposits received from
customers decreased approximately $6.6 million for the fiscal year ended
December 31, 2009 as compared with the fiscal year ended December 31,
2008. These declines in cash flow from operations were largely
offset by cash flows in 2009 associated with inventory and other current assets
reductions, and changes in liabilities.





At
December 31, 2009, the Company had cash and cash equivalents of $10,255,259, as
compared to cash and cash equivalents of $7,795,987 at December 31,
2008. The Company had working capital of $75,909,745 at December 31, 2009,
as compared to working capital of $61,586,125 at December 31, 2008, reflecting
current ratios of 5.05:1 and 5.36:1, respectively.





INVESTING
- During the fiscal year ended December 31, 2009, the Company expended net cash
of $7,252,359 in investing activities, mainly including the funds for
acquisition of new equipment to support the growth of business. For the
fiscal year ended December 31, 2008, the Company utilized $3,136,574 in
investing activities.





FINANCING
–Net cash used by financing activities was $3,482,360 for the fiscal year
ended December 31, 2008, while cash flow from financing activities
were positive, in an immaterial amount, for the fiscal year ended December
31, 2009, due to the fact that during fiscal year ended December 31, 2008, the
Company repaid all its outstanding debt.


36


The
Company’s management has taken a number of steps to restructure its customer
base and phase out accounts that failed to make prompt payment. The Company also
placed more emphasis on accounts receivable collection. In addition, the Company
maintains good relationships with local banks. We believe that our current cash
and cash equivalents, including the proceeds of our February 2010 stock
offering, and anticipated cash flow generated from operations and our bank lines
of credit, will be sufficient to finance our working capital requirements for
the foreseeable future.





OFF-BALANCE
SHEET AGREEMENTS





At
December 31, 2009 and December 31, 2008, we did not have any material
commitments for capital expenditures or have any transactions, obligations or
relationships that could be considered off-balance sheet
arrangements.





ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





The
Company did not have any material market risk with respect to such factors
as commodity prices, equity prices, and other market changes that affect market
risk sensitive investments.





Although
our reporting currency is the U.S. dollar, the functional currency of Joint
Venture is RMB. As a result, we are exposed to foreign exchange risk as our
revenues and results of operations may be affected by fluctuations in the
exchange rate between U.S. dollars and RMB. If the RMB depreciates against the
U.S. dollar, the value of our Renminbi revenues, earnings and assets as
expressed in our U.S. dollar financial statements will decline. In recent years,
the RMB has been appreciating against the U.S. dollar.





Assets
and liabilities of our operating subsidiaries are translated into U.S. dollars
at the exchange rate at the balance sheet date, their equity accounts are
translated at historical exchange rate and their income and expenses items are
translated using the average rate for the period. Any resulting exchange
differences are recorded in accumulated other comprehensive income or loss. The
Company is adopting such steps as the diversification of currencies used in
export sales, and the negotiation of export contracts with fixed exchange rates
to reduce the risk of foreign exchange changes.





As the
Company is currently free of indebtedness for borrowed money, we are not
presently exposed to interest rate risk. However, to the extent that the Company
borrows money in the future, an increase in market interest rate would cause a
commensurate increase in the interest expense related to such
borrowings.





ITEM
8 FINANCAL STATEMENTS AND SUPPLEMENTARY DATA




37











38





SORL
Auto Parts, Inc. and Subsidiaries


Consolidated
Balance Sheets


December
31, 2009 and 2008





December 31,
                      2009
                    
                    
                    December 31,
                      2008AssetsCurrent
      AssetsCash
      and Cash Equivalents
                    
                    US$
                    10,255,259
                    
                    
                    US$
                    7,795,987Accounts
      Receivable, Net of Provision
                    
                    
                    44,546,107
                    
                    
                    
                    35,797,824Notes
      Receivable
                    
                    
                    13,083,691
                    
                    
                    
                    7,536,534Inventory
                    
                    
                    18,760,724
                    
                    
                    
                    19,105,845Prepayments,
      including $0 and $187,813 from related parties at December 31, 2009 and
      December 31, 2008, respectively.
                    
                    
                    7,558,140
                    
                    
                    
                    1,013,440Other
      current assets, including $0 and $1,906,070 from related parties at
      December 31, 2009 and December 31, 2008, respectively.
                    
                    
                    444,281
                    
                    
                    
                    4,445,778Total
      Current Assets
                    
                    
                    94,648,202
                    
                    
                    
                    75,695,408Fixed
      AssetsProperty,
      Plant and Equipment
                    
                    
                    35,335,958
                    
                    
                    
                    32,927,306Less:
      Accumulated Depreciation
                    
                    
                    (11,608,920
                    )
                    
                    
                    (8,951,886
                    )Property,
      Plant and Equipment, Net
                    
                    
                    23,727,038
                    
                    
                    
                    23,975,420Leasehold
      Improvements in Progress
                    
                    
                    477,681
                    
                    
                    
                    ―Land
      Use Rights, Net
                    
                    
                    14,198,392
                    
                    
                    
                    14,514,983Other
      AssetsDeferred
      compensation cost-stock options
                    
                    
                    ―
                    
                    
                    
                    9,935Intangible
      Assets
                    
                    
                    161,499
                    
                    
                    
                    161,347Less:
      Accumulated Amortization
                    
                    
                    (54,380
                    )
                    
                    
                    (39,018
                    )Intangible
      Assets, Net
                    
                    
                    107,119
                    
                    
                    
                    122,329Deferred
      tax assets
                    
                    
                    220,577
                    
                    
                    
                    189,228Total
      Other Assets
                    
                    
                    327,696
                    
                    
                    
                    321,492Total
      Assets
                    
                    US$
                    133,379,009
                    
                    
                    US$
                    114,507,303Liabilities and Shareholders'
      EquityCurrent
      LiabilitiesAccounts
      Payable, including $1,985,291 and $0 due to related parties at December
      31, 2009 and December 31, 2008, respectively.
                    
                    US$
                    9,724,715
                    
                    
                    US$
                    4,623,850Deposit
      Received from Customers
                    
                    
                    3,670,369
                    
                    
                    
                    6,295,857Income
      tax payable
                    
                    
                    551,900
                    
                    
                    
                    340,138Accrued
      Expenses
                    
                    
                    4,206,297
                    
                    
                    
                    2,389,314Other
      Current Liabilities, including $200,762 and $0 from related parties at
      December 31, 2009 and December 31, 2008, respectively.
                    
                    
                    585,176
                    
                    
                    
                    460,124Total
      Current Liabilities
                    
                    
                    18,738,457
                    
                    
                    
                    14,109,283Non-Current
      LiabilitiesDeferred
      tax liabilities
                    
                    
                    115,481
                    
                    
                    
                    106,826Total
      Liabilities
                    
                    
                    18,853,938
                    
                    
                    
                    14,216,109Stockholders'
      EquityPreferred
      Stock - No Par Value; 1,000,000 authorized; none issued and outstanding as
      of December 31, 2009 and December 31, 2008
                    
                    
                    ―
                    
                    
                    
                    ―Common
      Stock - $0.002 Par Value; 50,000,000 authorized, 18,304,921 and 18,279,254
      issued and outstanding as of December 31, 2009 and December 31,
      2008
                    
                    
                    36,609
                    
                    
                    
                    36,558Additional
      Paid In Capital
                    
                    
                    37,498,401
                    
                    
                    
                    37,498,452Reserves
                    
                    
                    4,425,784
                    
                    
                    
                    3,126,086Accumulated
      other comprehensive income
                    
                    
                    10,939,100
                    
                    
                    
                    10,848,248Retained
      Earnings
                    
                    
                    50,231,052
                    
                    
                    
                    38,774,684Total
      SORL Auto Parts, Inc. stockholders' equity
                    
                    
                    103,130,946
                    
                    
                    
                    90,284,028Noncontrolling
      Interest In Subsidiaries
                    
                    
                    11,394,125
                    
                    
                    
                    10,007,166Total
      Equity
                    
                    
                    114,525,071
                    
                    
                    
                    100,291,194Total
      Liabilities and Stockholders' Equity
                    
                    US$
                    133,379,009
                    
                    
                    US$
                    114,507,303





The
accompanying notes are an integral part of these financial
statements


39




SORL
Auto Parts, Inc. and Subsidiaries


Consolidated
Statements of Income and Comprehensive Income


For
Years Ended on December 31, 2009 and 2008





2009
                    
                    
                    2008Sales
                    
                    US$
                    124,979,741
                    
                    
                    
                    130,893,422Include:
      sales to related parties
                    
                    
                    569,621
                    
                    
                    
                    2,816,816Cost
      of Sales
                    
                    
                    89,516,540
                    
                    
                    
                    97,225,582Gross
      Profit
                    
                    
                    35,463,201
                    
                    
                    
                    33,667,840Expenses:Selling
      and Distribution Expenses
                    
                    
                    8,137,377
                    
                    
                    
                    8,423,124General
      and Administrative Expenses
                    
                    
                    7,282,110
                    
                    
                    
                    6,075,404Research
      and development expenses
                    
                    
                    4,335,464
                    
                    
                    
                    3,219,895Financial
      Expenses
                    
                    
                    131,080
                    
                    
                    
                    852,640Total
      Expenses
                    
                    
                    19,886,031
                    
                    
                    
                    18,571,063Operating
      Income
                    
                    
                    15,577,170
                    
                    
                    
                    15,096,777Other
      Income
                    
                    
                    488,123
                    
                    
                    
                    683,104Non-Operating
      Expenses
                    
                    
                    (135,814
                    )
                    
                    
                    (441,288
                    )Income
      Before Provision for Income Taxes
                    
                    
                    15,929,479
                    
                    
                    
                    15,338,593Provision
      for Income Taxes
                    
                    
                    1,796,622
                    
                    
                    
                    1,586,503Net
      Income
                    
                    US$
                    14,132,857
                    
                    
                    
                    13,752,090Other
      Comprehensive Income - Foreign Currency Translation
    Adjustment
                    
                    
                    100,968
                    
                    
                    
                    6,017,843Total
      Comprehensive Income
                    
                    
                    14,233,825
                    
                    
                    
                    19,769,933Less:Net
      income Attributable to Non-controlling Interest In
      Subsidiaries
                    
                    
                    1,376,791
                    
                    
                    
                    1,381,230Other
      Comprehensive Income Attributable to Non-controlling Interest's
      Share
                    
                    
                    10,116
                    
                    
                    
                    601,784Total
      Comprehensive Income Attributable to Non-controlling Interest's
      Share
                    
                    
                    1,386,907
                    
                    
                    
                    1,983,014Net
      Income Attributable to Stockholders
                    
                    
                    12,756,066
                    
                    
                    
                    12,370,860Other
      Comprehensive Income Attributable to Stockholders
                    
                    
                    90,852
                    
                    
                    
                    5,416,059Total
      Comprehensive Income Attributable to Stockholders
                    
                    
                    12,846,918
                    
                    
                    
                    17,786,919Weighted
      average common share - Basic
                    
                    
                    18,280,865
                    
                    
                    
                    18,279,254Weighted
      average common share - Diluted
                    
                    
                    18,280,865
                    
                    
                    
                    18,279,254EPS
      – Basic
                    
                    
                    0.70
                    
                    
                    
                    0.68EPS
      – Diluted
                    
                    
                    0.70
                    
                    
                    
                    0.68





The
accompanying notes are an integral part of these financial
statements


40





SORL
Auto Parts, Inc. and Subsidiaries


Consolidated
Statements of Cash Flows


For
Years Ended on December 31,2009 and 2008





2009
                                              
                                              
                                              2008Cash
      Flows from Operating ActivitiesNet
      Income
                                              
                                              US$
                                              12,756,066
                                              
                                              
                                              
                                              12,370,860Adjustments
      to reconcile net income (loss) to net cash from operating
      activities:Noncontrolling
      Interest In Subsidiaries
                                              
                                              
                                              1,376,791
                                              
                                              
                                              
                                              1,381,230Bad
      Debt Expense
                                              
                                              
                                              18,943
                                              
                                              
                                              
                                              32,674Depreciation
      and Amortization
                                              
                                              
                                              3,017,677
                                              
                                              
                                              
                                              2,706,053Stock-Based
      Compensation Expense
                                              
                                              
                                              9,935
                                              
                                              
                                              
                                              59,636Loss
      on disposal of Fixed Assets
                                              
                                              
                                              11,835
                                              
                                              
                                              
                                              24,892Changes
      in Assets and Liabilities:Account
      Receivables
                                              
                                              
                                              (8,743,435
                                              )
                                              
                                              
                                              (3,000,167
                                              )Notes
      Receivables
                                              
                                              
                                              (5,537,498
                                              )
                                              
                                              
                                              2,437,182Other
      Currents Assets
                                              
                                              
                                              3,808,215
                                              
                                              
                                              
                                              111,707Inventory
                                              
                                              
                                              362,858
                                              
                                              
                                              
                                              (9,977,123
                                              )Prepayments
                                              
                                              
                                              (2,179,237
                                              )
                                              
                                              
                                              400,877Deferred
      tax assets
                                              
                                              
                                              (31,185
                                              )
                                              
                                              
                                              (182,938
                                              )Accounts
      Payable and Notes Payable
                                              
                                              
                                              5,062,595
                                              
                                              
                                              
                                              (1,011,371
                                              )Income
      Tax Payable
                                              
                                              
                                              211,344
                                              
                                              
                                              
                                              (33,631
                                              )Deposits
      Received from Customers
                                              
                                              
                                              (2,630,156
                                              )
                                              
                                              
                                              3,937,491Other
      Current Liabilities and Accrued Expenses
                                              
                                              
                                              2,179,900
                                              
                                              
                                              
                                              312,840Deferred
      tax liabilities
                                              
                                              
                                              8,550
                                              
                                              
                                              
                                              103,275Net
      Cash Flows from Operating Activities
                                              
                                              
                                              9,703,198
                                              
                                              
                                              
                                              9,673,487Cash
      Flows from Investing ActivitiesAcquisition
      of Property and Equipment
                                              
                                              
                                              (6,817,073
                                              )
                                              
                                              
                                              (3,063,458
                                              )Leasehold
      Improvements in Progress
                                              
                                              
                                              (477,876
                                              )
                                              
                                              
                                              ―Sales
      proceeds of disposal of fixed assets
                                              
                                              
                                              42,590
                                              
                                              
                                              
                                              4,187Investment
      in Intangible Assets
                                              
                                              
                                              ―
                                              
                                              
                                              
                                              (77,303
                                              )Net
      Cash Flows from Investing Activities
                                              
                                              
                                              (7,252,359
                                              )
                                              
                                              
                                              (3,136,574
                                              )Cash
      Flows from Financing ActivitiesProceeds
      from (Repayment of) Bank Loans
                                              
                                              
                                              ―
                                              
                                              
                                              
                                              (3,482,360
                                              )Capital
      contributed by Minority S/H
                                              
                                              
                                              52
                                              
                                              
                                              
                                              ―Net
      Cash flows from Financing Activities
                                              
                                              
                                              52
                                              
                                              
                                              
                                              (3,482,360
                                              )Effects
      on changes in foreign exchange rate
                                              
                                              
                                              8,381
                                              
                                              
                                              
                                              401,223Net
      Change in Cash and Cash Equivalents
                                              
                                              
                                              2,459,272
                                              
                                              
                                              
                                              3,455,776Cash
      and Cash Equivalents- Beginning of the year
                                              
                                              
                                              7,795,987
                                              
                                              
                                              
                                              4,340,211Cash
      and cash Equivalents - End of the year
                                              
                                              US$
                                              10,255,259
                                              
                                              
                                              
                                              7,795,987Supplemental
      Cash Flow Disclosures:Interest
      Paid
                                              
                                              
                                              ―
                                              
                                              
                                              
                                              182,385Tax
      Paid
                                              
                                              
                                              2,302,527
                                              
                                              
                                              
                                              2,106,992Non-Cash
      Financing Activities:Cashless
      exercise of options and warrants and issuance of common
      stock
                                              
                                              
                                              51
                                              
                                              
                                              
                                              —


41





SORL
Auto Parts, Inc. and Subsidiaries


Consolidated
Statements of Changes in Shareholders' Equity


For
Years Ended on December 31, 2009 and 2008





Additional
                          
                          
                          
                          
                          
                          Retained
                          
                          
                          Accumu. OtherNumber
                          
                          
                          Common
                          
                          
                          Paid-in
                          
                          
                          
                          
                          
                          Earnings
                          
                          
                          Comprehensive
                          
                          
                          Shareholders’
                          
                          
                          Noncontrollingof Share
                          
                          
                          Stock
                          
                          
                          Capital
                          
                          
                          Reserves
                          
                          
                          (Deficit)
                          
                          
                          Income
                          
                          
                          Equity
                          
                          
                          Interest
                          
                          
                          Total EquityBeginning
      Balance - January 1, 2008
                          
                          
                          18,279,254
                          
                          
                          
                          36,558
                          
                          
                          
                          37,498,452
                          
                          
                          
                          1,882,979
                          
                          
                          
                          27,646,931
                          
                          
                          
                          5,432,189
                          
                          
                          
                          72,497,109
                          
                          
                          
                          8,024,152
                          
                          
                          
                          80,521,261Net
      Income
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          12,370,860
                          
                          
                          
                          ―
                          
                          
                          
                          12,370,860
                          
                          
                          
                          1,381,230
                          
                          
                          
                          13,752,090Other
      Comprehensive Income
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          5,416,059
                          
                          
                          
                          5,416,059
                          
                          
                          
                          601,784
                          
                          
                          
                          6,017,843Transfer
      to reserve
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          1,243,107
                          
                          
                          
                          (1,243,107
                          )
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―Ending
      Balance - December 31, 2008
                          
                          
                          18,279,254
                          
                          
                          
                          36,558
                          
                          
                          
                          37,498,452
                          
                          
                          
                          3,126,086
                          
                          
                          
                          38,774,684
                          
                          
                          
                          10,848,248
                          
                          
                          
                          90,284,028
                          
                          
                          
                          10,007,166
                          
                          
                          
                          100,291,194Beginning
      Balance - January 1, 2009
                          
                          
                          18,279,254
                          
                          
                          
                          36,558
                          
                          
                          
                          37,498,452
                          
                          
                          
                          3,126,086
                          
                          
                          
                          38,774,684
                          
                          
                          
                          10,848,248
                          
                          
                          
                          90,284,028
                          
                          
                          
                          10,007,166
                          
                          
                          
                          100,291,194Net
      Income
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          12,756,066
                          
                          
                          
                          ―
                          
                          
                          
                          12,756,066
                          
                          
                          
                          1,376,791
                          
                          
                          
                          14,132,857Other
      Comprehensive Income(Loss)
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          90,852
                          
                          
                          
                          90,852
                          
                          
                          
                          10,116
                          
                          
                          
                          100,968Stock
      options and warrants - cashless exercise, net
                          
                          
                          25,667
                          
                          
                          
                          51
                          
                          
                          
                          (51
                          )
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―Capital
      contributed by Minority S/H
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          52
                          
                          
                          
                          52Transfer
      to reserve
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          1,299,698
                          
                          
                          
                          (1,299,698
                          )
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―Ending
      Balance - December 31, 2009
                          
                          
                          18,304,921
                          
                          
                          
                          36,609
                          
                          
                          
                          37,498,401
                          
                          
                          
                          4,425,784
                          
                          
                          
                          50,231,052
                          
                          
                          
                          10,939,100
                          
                          
                          
                          103,130,946
                          
                          
                          
                          11,394,125
                          
                          
                          
                          114,525,071




The
accompanying notes are an integral part of these financial
statements


42





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
1 - DESCRIPTION OF BUSINESS





SORL Auto
Parts, Inc. (“the Company”) is principally engaged in the manufacture and
distribution of automotive air brake systems, air controlling systems and other
related components for different types of commercial vehicles, such as
trucks, and buses, through its 90% ownership of Ruili Group Ruian Auto Parts
Company Limited (“Ruian”) in the People’s Republic of China (“PRC” or “China”).
The Company distributes products both in China and internationally under SORL
trademarks. The Company’s product range includes 40 categories of brake systems
with over 1000 different specifications.




On
November 11, 2009, the Company entered into a joint venture agreement with MGR,
a Hong Kong-based global auto parts distribution specialist firm and a
Taiwanese investor. The new joint venture was named SORL International Holding,
Ltd. ("SIH"). SORL holds a 60% interest in the joint venture, MGR holds a 30%
interest, and the Taiwanese investor holds a 10% interest. SIH is primarily
devoted to expanding SORL's international sales network in Asia-Pacific and
creating a larger footprint in Europe, the Middle East and Africa with a target
to create a truly global distribution network. Based in Hong Kong, SIH is
expanding and establishing channels of distribution in international markets
with SORL's primary products, including spring brake chambers, clutch servos,
air dryers, relay valves and hand brake valves.




NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





a.
            ACCOUNTING
      METHOD





The
Company uses the accrual method of accounting for financial statement and tax
return purposes.





b.
            PRINCIPLES
      OF CONSOLIDATION





The
consolidated financial statements include the accounts of SORL Auto Parts, Inc.
and its majority owned subsidiaries. All significant inter-company balances and
transactions have been eliminated in the consolidation.





c.
            USE
      OF ESTIMATES





The
preparation of financial statements in conformity with U.S generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Management makes its best estimate of the outcome for these items based on
historical trends and other information available when the financial statements
are prepared. Changes in estimates are recognized in accordance with the
accounting rules for the estimate, which is typically in the period when new
information becomes available to management. Actual results could differ from
those estimates.





d.
            FAIR
      VALUE OF FINANCIAL INSTRUMENTS





For
certain of the Company’s financial instruments, including cash and cash
equivalents, trade receivables and payables, prepaid expenses, deposits and
other current assets, short-term bank borrowings, and other payables and
accruals, the carrying amounts approximate fair values due to their short
maturities.





e.
            RELATED
      PARTY TRANSACTIONS





A related
party is generally defined as (i) any person that holds 10% or more of the
Company’s securities and their immediate families, (ii) the Company’s
management, (iii) someone that directly or indirectly controls, is controlled by
or is under common control with the Company, or (iv) anyone who can
significantly influence the financial and operating decisions of the Company. A
transaction is considered to be a related party transaction when there is a
transfer of resources or obligations between related parties. The Company
conducts business with its related parties in the ordinary course of business.
All transactions have been recorded at fair market value of the goods and
services exchanged.





f.
            FINANCIAL
      RISK FACTORS AND FINANCIAL RISK
MANAGEMENT





The
Company is exposed to the following risk factors:


43





(i) Credit
risks - The Company has policies in place to ensure that sales of products are
made to customers with an appropriate credit history. The Company performs
ongoing credit evaluations with respect to the financial condition of its
creditors, but does not require collateral. In order to determine the value of
the Company’s accounts receivable, the Company records a provision for doubtful
accounts to cover probable credit losses. Management reviews and adjusts this
allowance periodically based on historical experience and its evaluation of the
collection of outstanding accounts receivable. The Company has
two customers that each respectively account for more than 5.5% of its
total revenues for the period. The Company also has a concentration of credit
risk due to geographic sales as a majority of its products are marketed and sold
in the PRC.


(ii)
Liquidity risks - Prudent liquidity risk management implies maintaining
sufficient cash, the availability of funding through an adequate amount of
committed credit facilities and ability to close out market
positions.


(iii)
Interest rate risk - The interest rate and terms of repayments of short-term and
long-term bank borrowings are approximately 5.4% per annum. The Company’s income
and cash flows are substantially independent of changes in market interest
rates. The Company has no significant interest-bearing assets. The Company’s
policy is to maintain all of its borrowings in fixed rate
instruments.





g.
            CASH
      AND CASH EQUIVALENTS





The
Company considers all highly liquid instruments purchased with an original
maturity of three months or less to be cash equivalents.





h.
            INVENTORIES





Inventories
are stated at the lower of cost or net realizable value, with cost computed on a
weighted-average basis. Cost includes all costs of purchase, cost of conversion
and other costs incurred in bringing the inventories to their present location
and condition. Net realizable value is the estimated selling price in the
ordinary course of business less the estimated costs of completion and the
estimated costs necessary to make the sale. The Company has made salability
evaluation and did not find material impairment as December 31,
2009.





i.
            PROPERTY,
      PLANT AND EQUIPMENT





Property,
plant and equipment are stated at cost less accumulated depreciation and
impairment losses. The initial cost of the asset comprises its purchase price
and any directly attributable costs of bringing the asset to its working
condition and location for its intended use. Depreciation is provided using the
straight-line method over the estimated useful life of the respective assets as
follows:





Category
                
                Estimated Useful Life(Years)Buildings
                
                
                10-20Machinery
      and equipment
                
                
                5-10Electronic
      equipment
                
                
                5Motor
      Vehicles
                
                
                5-10





Significant
improvements and betterments are capitalized where it is probable that the
expenditure resulted in an increase in the future economic benefits expected to
be obtained from the use of the asset beyond its originally assessed standard of
performance. Routine repairs and maintenance are expensed when incurred. Gains
and losses on disposal of fixed assets are recognized in the income statement
based on the net disposal proceeds less the carrying amount of the
assets.


44





j.
            LAND
      USE RIGHTS





According
to the law of China, the government owns all the land in China. Companies or
individuals are authorized to possess and use the land only through land use
rights granted by the Chinese government. Land use rights are being amortized
using the straight-line method over its useful lives. The land use rights
is amortized on a straight-line basis over the estimated useful life of 45
years.





k.
            IMPAIRMENT
      OF LONG-LIVED ASSETS





Long-lived
assets, such as property, plant and equipment and other non-current assets,
including intangible assets, are reviewed periodically for impairment whenever
events or changes in circumstances indicate that the carrying value of an asset
may not be recoverable. An impairment loss is recognized when the estimated
undiscounted cash flows associated with the asset or group of assets is less
than their carrying value. If impairment exists, an adjustment is made to write
the asset down to its fair value, and a loss is recorded as the difference
between the carrying value and fair value. Fair values are determined based on
quoted market values, discounted cash flows or internal and external appraisals,
as applicable. Assets to be disposed of are carried at the lower of carrying
value or estimated net realizable value.





l.
            INTANGIBLE
      ASSETS





Intangible
assets represent mainly the patent of technology, plus the computer software.
Intangible assets are measured initially at cost. Intangible assets are
recognized if it is probable that the future economic benefits that are
attributable to the asset will flow to the enterprise and the cost of the asset
can be measured reliably. After initial recognition, intangible assets
are measured at cost less any impairment losses. Intangible assets with
definite useful lives are amortized on a straight-line basis over their useful
lives.





m.
            ACCOUNTS
      RECEIVABLES AND ALLOWANCE FOR BAD
DEBTS





The
Company presents accounts receivables, net of allowances for doubtful accounts
and returns, to ensure accounts receivable are not overstated due to
uncollection. Accounts receivables generated from credit sales have general
credit terms of 90 days for domestic aftermarket customers.





The
allowances are calculated based on a detailed review of certain individual
customer accounts, historical rates and an estimation of the overall economic
conditions affecting the Company’s customer base. The Company reviews a
customer’s credit history before extending credit. If the financial condition of
its customers were to deteriorate, resulting in an impairment of their ability
to make payments, additional allowances may be required.





The
Company will write off the uncollectible receivables once the customers are
bankrupt or there is a remote possibility that the Company will collect the
outstanding balance. The write-off must be reported to the local tax authorities
and receive official approval from them. To date, the Company has not written
off any account receivable.





n.
            NOTES
      RECEIVABLE





Notes
receivable generally due within 30 to 60 days are issued by some customers
to pay certain outstanding receivable balances to the Company with specific
payment terms and definitive due dates. Notes receivable do not bear
interest.





o.
            REVENUE
      RECOGNITION





Revenue
from the sale of goods is recognized when the risks and rewards of ownership of
the goods have transferred to the buyer including factors such as when
persuasive evidence of an arrangement exits, delivery has occurred, the sales
price is fixed and determinable, and collection is probable. Revenue consists of
the invoice value for the sale of goods and services net of value-added tax
(“VAT”), rebates and discounts and returns. The Company nets sales return in
gross revenue, i.e., the revenue shown in the income statement is the net
sales.


45





p.
            INCOME
      TAXES





The
Company accounts for income taxes under the provision of FASB ASC 740-10 (Prior
authoritative literature: Statement No. 109, “Accounting for Income
Taxes,”) whereby deferred income tax assets and liabilities are computed for
differences between the financial statements and tax bases of assets and
liabilities that will result in taxable or deductible amounts in the future,
based on enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances are
established when necessary; to reduce deferred income tax assets to the amount
expected to be realized.





q.
            FOREIGN
      CURRENCY TRANSLATION





The
Company maintains its books and accounting records in Renminbi (“RMB”), the
currency of the PRC, The Company’s functional currency is also RMB. The Company
has adopted FASB ASC 830-30 (Prior authoritative literature: SFAS No.52) in
translating financial statement amounts from RMB to the Company’s reporting
currency, United States dollars (“US$”). All assets and liabilities are
translated at the current rate. The shareholders’ equity accounts are translated
at appropriate historical rate. Revenue and expenses are translated at the
weighted average rates in effect on the transaction dates.





Translation
adjustments resulting from this process are included in accumulated other
comprehensive income in the statement of stockholders’ equity. Transaction gains
and losses that arise from exchange rate fluctuations on transactions
denominated in a currency other than the functional currency are include in the
results of operations as incurred.





r.
            STOCK-BASED
      COMPENSATION





In
December 2004, the Financial Accounting Standards Board (“FASB”) issued FASB ASC
505-50 (Prior authoritative literature: Statement No. 123R, “Share-Based
Payment”). FASB ASC 505-50 revises FASB Statement No. 123 “Accounting for
Stock-Based Compensation” and supersedes APB Opinion No. 25 “Accounting for
Stock Issued to Employees”. FASB ASC 505-50requires all public and non-public
companies to measure and recognize compensation expense for all stock-based
payments for services received at the grant-date fair value, with the cost
recognized over the vesting period (or the requisite service period). The
Company has adopted FASB ASC 505-50as of January 1, 2005. Refer to Note 20:
stock compensation plan for additional information on our stock option plan and
related stock-based compensation expense.





s.
            EMPLOYEES’
      BENEFITS





Mandatory
contributions are made to Government’s health, retirement benefit and
unemployment schemes at the statutory rates in force during the period,
based on gross salary payments. The cost of these payments is charged to the
statement of income in the same period as the related salary costs.





t.
            RESEARCH
      AND DEVELOPMENT EXPENSES





Research
and development costs are classified as general and administrative expenses and
are expensed as incurred.





u.
            SHIPPING
      AND HANDLING COSTS





Shipping
and handling cost are classified as selling expenses and are expensed as
incurred.





v.
            ADVERTISING
      COSTS





Advertising
costs are classified as selling expenses and are expensed as
incurred.


46





w.
            WARRANTY
      CLAIMS





The
Company provides for the estimated cost of product warranties when the products
are sold. Such estimates of product warranties were based on, among other
things, historical experience, product changes, material expenses, service and
transportation expenses arising from the manufactured product. Estimates will be
adjusted on the basis of actual claims and circumstances.





x.
            PURCHASE
      DISCOUNTS





Purchase
discounts, if applicable, are netted in the cost of goods sold.





y.
            LEASE
      COMMITMENTS





The
Company has adopted FASB ASC 840 (Prior authoritative literature: FASB
Statement No. 13, “Accounting for Leases”). If the lease terms meet one or
all of the following four criteria, it will be classified as a capital lease,
otherwise, it is an operating lease: (1) The lease transfers the title to the
lessee at the end of the term; (2) the lease contains a bargain purchase option;
(3) the lease term is equal to 75% of the estimated economic life of the leased
property or more; (4) the present value of the minimum lease payment in the term
equals or exceeds 90% of the fair value of the leased property.





z.
            RECENTLY
      ISSUED FINANCIAL STANDARDS





In
December 2007, the FASB issued FASB ASC 810-10-65 (Prior authoritative
literature: FASB Statement No. 160, "Noncontrolling Interests in Consolidated
Financial Statements - an amendment of ARB No.51") of which the objective is to
improve the relevance, comparability, and transparency of the financial
information that a reporting entity provides in its consolidated financial
statements by establishing accounting and reporting standards by requiring all
entities to report noncontrolling (minority) interests in subsidiaries in the
same way - as an entity in the consolidated financial statements. Moreover, FASB
ASC 810-10-65 eliminates the diversity that currently exists in accounting for
transactions between an entity and noncontrolling interests by requiring they be
treated as equity transactions.





FASB ASC
810-10-65 is effective for fiscal years beginning after December 15, 2008. The
adoption of these standards has not had any significant impact on its
consolidated financial statements.





In June
2009, the FASB issued FASB ASC 860-10-05 (Prior authoritative literature: FASB
Statement No. 166, “Accounting for Transfers of Financial Assets—an amendment of
FASB Statement No. 140”).  FASB ASC 860-10-05 improves the relevance,
representational faithfulness, and comparability of the information that a
reporting entity provides in its financial statements about a transfer of
financial assets; the effects of a transfer on its financial position, financial
performance, and cash flows; and a transferor’s continuing involvement, if any,
in transferred financial assets. FASB ASC 860-10-05 is effective as of the
beginning of each reporting entity’s first annual reporting period that begins
after November 15, 2009, for interim periods within that first annual reporting
period and for interim and annual reporting periods thereafter. As such, the
Company is required to adopt this standard in January 2010. The Company is
evaluating the impact the adoption of FASB ASC 860-10-05 will have on its
consolidated financial statements.





In June
2009, the FASB issued FASB ASC 810-10-05 (Prior authoritative literature: FASB
Statement No. 167, “Amendments to FASB Interpretation No. 46(R)”). FASB ASC
810-10-05 improves financial reporting by enterprises involved with variable
interest entities and to address (1) the effects on certain provisions of prior
authoritative literature FASB Interpretation No. 46 (revised December 2003),
“Consolidation of Variable Interest Entities”, as a result of the elimination of
the qualifying special-purpose entity concept in prior authoritative literature
SFAS 166 and (2) constituent concerns about the application of certain key
provisions of prior authoritative literature Interpretation 46(R), including
those in which the accounting and disclosures under the Interpretation do not
always provide timely and useful information about an enterprise’s involvement
in a variable interest entity. FASB ASC 810-10-05 is effective as of the
beginning of each reporting entity’s first annual reporting period that begins
after November 15, 2009, for interim periods within that first annual reporting
period, and for interim and annual reporting periods thereafter. As such, the
Company is required to adopt this standard in January 2010. The Company is
evaluating the impact of the adoption of FASB ASC 810-10-05 will have on its
consolidated financial statements.


47





In June
2009, the FASB issued FASB ASC 105-10 (Prior authoritative literature: FASB
Statement No. 168, "The FASB
Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles”). FASB ASC 105-10 replaces prior authoritative
literature SFAS 162 and establishes the FASB Accounting Standards
Codification as the source of authoritative accounting principles
recognized by the FASB to be applied by nongovernmental entities in the
preparation of financial statements in conformity with GAAP.  FASB ASC
105-10 is effective for financial statements issued for interim and annual
periods ending after September 15, 2009. The Company does not believe that the
adoption of FASB ASC 105-10 has had a material effect on its consolidated
financial statements.




NOTE
3 - RELATED PARTY TRANSACTIONS





The
Company continued to purchase non-valve automotive products, components for
valve parts and packaging materials from the Ruili Group Co., Ltd. The Ruili
Group Co., Ltd., is the minority shareholder of the Joint Venture and is
controlled by the Zhang family, who is also the controlling party of the
Company.





The
following related party transactions occurred for the fiscal year ended December
31, 2009 and 2008:





December 31,2009
                            
                            
                            2008PURCHASES
      NON-VALVE PRODUCT , COMPONENTS FOR VALVE AUTO PARTS AND PACKAGING MATERIAL
      FROM:Ruili
      Group Co., Ltd.
                            
                            $
                            18,179,641
                            
                            
                            $
                            35,344,273Total
      Purchases
                            
                            $
                            18,179,641
                            
                            
                            
                            35,344,273SALES
      TO:Ruili
      Group Co., Ltd.
                            
                            
                            569,621
                            
                            
                            
                            2,816,816Total
      Sales
                            
                            $
                            569,621
                            
                            
                            $
                            2,816,816December 31,2009
                            
                            
                            2008ACCOUNTS
      PAYABLERuili
      Group Co., Ltd.
                            
                            $
                            1,985,291
                            
                            
                            $
                            —Total
                            
                            $
                            1,985,291
                            
                            
                            $
                            —OTHER
      PAYABLESRuili
      Group Co., Ltd.
                            
                            $
                            200,762
                            
                            
                            $
                            —Total
                            
                            $
                            200,762
                            
                            
                            $
                            —PREPAYMENTSRuili
      Group Co., Ltd.
                            
                            $
                            —
                            
                            
                            $
                            187,813Total
                            
                            $
                            —
                            
                            
                            $
                            187,813OTHER  ACCOUNTS
      RECEIVABLERuili
      Group Co., Ltd.
                            
                            $
                            —
                            
                            
                            $
                            1,906,070Total
                            
                            $
                            —
                            
                            
                            $
                            1,906,070




48




The total
purchases from Ruili Group during the fiscal year ended December 31,
2009 consisted of $16.1  million of finished products for
non-valve auto parts and $2.0 million of packaging materials.





NOTE
4 - ACCOUNTS RECEIVABLE





The
changes in the allowance for doubtful accounts at December 31, 2009 and
December 31, 2008 were summarized as follows:




December31,
                      2009
                    
                    
                    December 31,
                      2008Beginning
      balance
                    
                    $
                    24,997
                    
                    
                    $
                    27,987Add:
      Increase to allowance
                    
                    
                    32,826
                    
                    
                    
                    (2,990
                    )Less:
      Accounts written off
                    
                    
                    —
                    
                    
                    
                    —Ending
      balance
                    
                    $
                    57,823
                    
                    
                    $
                    24,997December
      31,
                      2009
                    
                    
                    December
      31,
                      2008Accounts
      receivable
                    
                    $
                    44,603,930
                    
                    
                    $
                    35,822,821Less:
      allowance for doubtful accounts
                    
                    
                    57,823
                    
                    
                    
                    (24,997
                    )Account
      receivable balance, net
                    
                    $
                    44,546,107
                    
                    
                    $
                    35,797,824





NOTE
5 - INVENTORIES





On
December 31, 2009 and December 31, 2008, inventories consisted of the
following:




December 31,
                    2009
                  
                  
                  December 31,
                    2008Raw
      Material
                  
                  $
                  4,417,094
                  
                  
                  $
                  2,705,224Work
      in process
                  
                  
                  2,186,337
                  
                  
                  
                  8,074,488Finished
      Goods
                  
                  
                  12,157,293
                  
                  
                  
                  8,326,133Total
      Inventory
                  
                  $
                  18,760,724
                  
                  
                  $
                  19,105,845




49





NOTE
6 - PROPERTY, PLANT AND EQUIPMENT





Property,
plant and equipment consisted of the following, on December 31, 2009 and
December 31, 2008:




December31,
                  2009
                
                
                December31,
                  2008Machinery
                
                $
                24,283,034
                
                
                $
                22,085,672Molds
                
                
                1,276,757
                
                
                
                1,275,561Office
      equipment
                
                
                700,609
                
                
                
                618,403Vehicle
                
                
                1,092,835
                
                
                
                972,422Building
                
                
                7,982,723
                
                
                
                7,975,248Sub-Total
                
                
                35,335,958
                
                
                
                32,927,306Less:
      Accumulated depreciation
                
                
                (11,608,920
                )
                
                
                (8,951,886
                )Fixed
      Assets, net
                
                $
                23,727,038
                
                
                $
                23,975,420





Depreciation
expense charged to operations was $2,672,318 and $2,375,363 for the fiscal
year ended December 31, 2009 and 2008, respectively.





NOTE
7 – LAND USE RIGHTS





December31,
                    2009
                  
                  
                  December31,
                    2008Cost:
                  
                  $
                  14,941,331
                  
                  
                  $
                  14,927,340Less:
      Accumulated amortization:
                  
                  
                  (742,939
                  )
                  
                  
                  (412,357
                  )Land
      use rights, net
                  
                  $
                  14,198,392
                  
                  
                  $
                  14,514,983





According
to the law of China, the government owns all the land in China. Companies and
individuals are authorized to possess and use the land only through land use
rights granted by the Chinese government. The Company purchased the land use
rights from Ruili Group for approximately $13.9 million on September 28, 2007.
The Company has not yet obtained the land use right certificate. However, the
Company has appliedto
obtain the land use right certificate. The remaining balance of land
use rights as of December 31, 2009 is amortized on a straight-line basis
over 43 years, its remaining useful lives. Amortization expenses were
$330,041 and $335,192 for the fiscal years ended December 31, 2009 and
2008, respectively. The annual amortization of the land use rights is
$330,195 for each of the next five years.


50




NOTE
8 - INTANGIBLE ASSETS





Gross
intangible assets were $161,499, less accumulated amortization of
$54,380 for net intangible assets of $107,119 as of December 31, 2009.
Gross intangible assets were $161,347, less accumulated amortization of $39,018
for net intangible assets of $122,329 as of December 31, 2008. Amortization
expenses were $12,186 and $11,770 for the fiscal years ended December 31,
2009 and 2008 respectively. Future estimated amortization expense
is as follows:





2010
                  
                  
                  2011
                  
                  
                  2012
                  
                  
                  2013
                  
                  
                  2014
                  
                  
                  Thereafter$
                  16,150
                  
                  
                  $
                  16,150
                  
                  
                  $
                  16,150
                  
                  
                  $
                  16,150
                  
                  
                  $
                  11,766
                  
                  
                  $
                  30,753





NOTE
9 - PREPAYMENT





Prepayment
consisted of the following as of December 31, 2009 and December 31,
2008:




December 31,
                  
                  
                  December 31,2009
                  
                  
                  2008Raw
      material suppliers
                  
                  $
                  3,059,449
                  
                  
                  $
                  878,374Equipment
      purchase
                  
                  
                  4,498,691
                  
                  
                  
                  135,066Total
      prepayment
                  
                  $
                  7,558,140
                  
                  
                  $
                  1,013,440




NOTE
10- DEFERRED TAX ASSETS AND DEFERRED TAX LIABILITIES





Deferred
tax assets as at December 31, 2009 and December 31, 2008 comprise
the following:




Dec 31,
    2009
                  
                  
                  Dec 31,
    2008Deferred
      tax assets - currentProvision
                  
                  
                  7,917
                  
                  
                  
                  3,990Subsidiary's
      operating loss carryforwards
                  
                  
                  33,008
                  
                  
                  
                  ―Warranty
                  
                  
                  260,295
                  
                  
                  
                  277,893Deferred
      tax assets
                  
                  
                  301,220
                  
                  
                  
                  281,883Valuation
      allowance
                  
                  
                  ―
                  
                  
                  
                  ―Net
      deferred tax assets - current
                  
                  
                  301,220
                  
                  
                  
                  281,883Deferred
      tax liabilities - currentRevenue
      (netoff
      cost)
                  
                  
                  80,643
                  
                  
                  
                  92,655Deferred
      tax liabilities - current
                  
                  
                  80,643
                  
                  
                  
                  92,655Net
      deferred tax assets - current
                  
                  
                  220,577
                  
                  
                  
                  189,228Deferred
      tax liabilities - non-currentLand
      use right
                  
                  
                  115,481
                  
                  
                  
                  106,826Deferred
      tax liabilities - non-current
                  
                  
                  115,481
                  
                  
                  
                  106,826




51


Deferred
taxation is calculated under the liability method in respect of taxation effect
arising from all timing differences, which are expected with reasonable
probability to realize in the foreseeable future. The Company and its
subsidiaries do not have income tax liabilities in U.S. as the Company had no
taxable income for the reporting period. The Company’s subsidiary registered in
the PRC is subject to income taxes within the PRC at the applicable tax
rate.





NOTE
11 - ACCRUED EXPENSES





Accrued
expenses consisted of the following as of December 31, 2009 and December 31,
2008:





December 31, 2009
                  
                  
                  December 31, 2008Accrued
      payroll
                  
                  $
                  1,536,980
                  
                  
                  $
                  617,522Other
      accrued expenses
                  
                  
                  2,669,317
                  
                  
                  
                  1,771,792Total
      accrued expenses
                  
                  $
                  4,206,297
                  
                  
                  $
                  2,389,314





NOTE
12 - INCOME TAXES





The Joint
Venture is registered in the PRC, and is therefore subject to state and local
income taxes within the PRC at the applicable tax rate on the taxable income as
reported in the PRC statutory financial statements in accordance with relevant
income tax laws. According to applicable tax laws regarding Sino-Foreign Joint
Venture, the Joint Venture is exempted from income taxes in the PRC for the
fiscal years ended December 31, 2005 and 2004. Thereafter, the Joint Venture is
entitled to a 50% income tax deduction for the following three years ended
December 31, 2006, 2007, and 2008. As a result of the Joint Venture
obtaining its Sino-foreign joint venture status in 2004, in accordance with
applicable PRC tax regulations, the Joint Venture was exempted from PRC income
tax in both fiscal 2004 and 2005. Thereafter, the Joint Venture is entitled to a
tax concession of 50% of the applicable income tax rate of 26.4% for the two
years ended December 31, 2006 and 2007. With the new PRC Enterprise Income Tax
Law, effective on 1st January 2008, the China’s enterprises are generally
subject to a PRC income tax rate of 25% and the Joint Venture is entitled to a
tax concession of 50% of the applicable income tax rate of 25% for the year
ended December 31, 2008.





Additionally,
the Company increased its investment in the Joint Venture as a result of its
financing in December, 2006. In accordance with the Income Tax Law of the
People's Republic of China on Foreign-invested Enterprises and Foreign
Enterprises, the Joint Venture is eligible for additional preferential tax
treatment. For the years 2007 and 2008, the Joint Venture entitled to an income
tax exemption on all pre-tax income generated by the company above its pre-tax
income generated in the fiscal year 2006. Thereafter, the Joint Venture
will enjoy a 50% exemption from the effective income tax rate on any pre-tax
income above its 2006 pre-tax income, to be recognized in the years 2009, 2010
and 2011. The above taxation exemption was superceded, because the Joint
Venture has been awarded the Chinese government's "High-Tech Enterprise"
designation. The High-Tech Enterprise certificate is valid for three years and
provides for a reduced tax rate of 15% for years 2009 through 2011. So, the
effective income tax rate will be 15% for years 2009 through
2011.





In
addition, in accordance with China's relevant regulations of income taxes, there
is a benefit, which 40% of the additional investment in the Joint Venture used
to purchase eligible domestic equipments can be used as a tax credit to reduce
the current income taxes to the limit of any incremental income taxes in
addition to the prior year. The Company received an income tax benefit of
$694,746 and $377,147 in 2009 and 2008, respectively.





The
reconciliation of the effective income tax rate of the Joint Venture to the
statutory income tax rate in the PRC for the fiscal year ended on December 31,
2009 and 2008 is as follows:


52





2009
                  
                  
                  2008Statutory
      tax rate
                  
                  
                  25.0
                  %
                  
                  
                  25.0
                  %Tax
      holidays and concessions
                  
                  
                  -10
                  %
                  
                  
                  -12.5
                  %Effective
      tax rate
                  
                  
                  15
                  %
                  
                  
                  12.5
                  %





2009
                          
                          
                          2008Computed
      income tax provision at the statutory rate
                          
                          $
                          2,389,422
                          
                          
                          $
                          1,917,324Tax
      refund
                          
                          
                          (694,746
                          )
                          
                          
                          (377,147
                          )Deferred
      tax provision
                          
                          
                          (22,635
                          )
                          
                          
                          (79,663
                          )Current
      year permanent differences and other reconciling items
                          
                          
                          124,581
                          
                          
                          
                          125,989Total
      income taxes
                          
                          $
                          1,796,622
                          
                          
                          $
                          1,586,503





Income
taxes are calculated on a separate entity basis. Deferred income taxes reflect
the net tax effects of temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes and the amounts used for
income tax purposes Significant components of the Company’s net deferred tax
assets and liabilities are approximately as follows at December 31,2009. No
valuation allowance is deemed necessary. There currently is no tax benefit
or burden recorded for the United States.The tax
authority may examine the tax returns of the Company three years after the year
ended. The open years are 2006 to 2008. There were no penalties and
interest, which generally are recorded in the general and administrative
expenses or in the tax expenses. The provisions for income taxes for the
years ended December 31, 2009 and 2008, respectively, are summarized as
follows:


2009
                      
                      
                      2008Current
                      
                      $
                      1,819,257
                      
                      
                      $
                      1,666,166Deferred
                      
                      
                      (22,635
                      )
                      
                      
                      (79,663
                      )Total
                      
                      $
                      1,796,622
                      
                      
                      $
                      1,586,503





The
Company adopted the provisions of FASB ASC 740-10 (Prior authoritative
literature: FIN No. 48, Accounting for Uncertainty in Income Taxes), on January
1, 2007. As the result of the implementation of the FASB ASC 740-10, Accounting
for Uncertainty in Income Taxes – In Interpretation of FASB ASC 740-10 (Prior
authoritative literature: FASB Statement No. 109), the Company recognized
no material adjustments to unrecognized tax benefits. At the adoption date of
January 1, 2007 and as of December 31, 2009 and 2008, the Company has no
unrecognized tax benefits.





NOTE13–Non-controlling interest in
subsidiaries





Non-controlling
interest in subsidiaries represents a 10% non-controlling interest in the
Chinese located Joint Venture and 40% non-controlling interest in the Hong Kong
located Joint Venture. Net income attributable to non-controlling interest in
subsidiaries amounted to $1,376,791and
$1,381,230 for the fiscal year ended December 31, 2009 and 2008,
respectively.


53





2009
                    
                    
                    200810%
      non-controlling interest in Ruian
                    
                    $
                    1,444,109
                    
                    
                    $
                    1,381,23040%
      non-controlling interest in SIH
                    
                    $
                    (67,318
                    )
                    
                    
                    ―Total
                    
                    $
                    1,376,791
                    
                    
                    
                    1,381,230





NOTE
14 - LEASES





The Joint
Venture lease office space, apartment buildings and plant under
non-cancelable operating leases with third parties and Ruili Group Co.,
Ltd.


Future
minimum rental payments for the years ended December 31, are as
follows:





2010
                
                
                2011
                
                
                2012
                
                
                2013
                
                
                2014
                
                
                ThereafterLease
      Commitments
                
                $
                639,006
                
                
                $
                628,179
                
                
                $
                397,693
                
                
                $
                329,410
                
                
                $
                329,410
                
                
                $
                988,231Total
                
                $
                639,006
                
                
                $
                628,179
                
                
                $
                397,693
                
                
                $
                329,410
                
                
                $
                329,410
                
                
                $
                988,231





NOTE
15 - ADVERTISING COSTS





Advertising
costs are expensed as incurred and are classified as selling expenses.
Advertising costs were $10,701 and $6,126 for the fiscal years ended
December 31, 2009 and 2008, respectively.





NOTE
16 - RESEARCH AND DEVELOPMENT EXPENSE





Research
and development costs are expensed as incurred and were $4,335,464 and
$3,219,895 for the fiscal years ended December 31, 2009 and 2008,
respectively.





NOTE
17 - WARRANTY CLAIMS





Warranty
claims were $1,735,301 and $1,901,974 for the fiscal year ended on
December 31, 2009 and 2008 respectively. The movement of accrued warranty
expenses for fiscal year 2009 is as follows. Accrued warranty expenses are
included in Accrued Expenses.





Beginning
      balance at January 01, 2009
                  
                  
                  1,111,569Aggregate
      reduction for payments made
                  
                  
                  (1,020,260
                  )Aggregate
      increase for new warranties issued during current period
                  
                  
                  1,643,992Aggregate
      changes in the liability related to pre-existing warranties (changes in
      estimate)
                  
                  
                  ―Ending
      balance at December 31, 2009:
                  
                  
                  1,735,301




54




NOTE
18– SEGMENT INFORMATION




The
Company produces air brake systems, air controlling systems and other related
components for different types of commercial vehicles. Although it
manufactures about 40 varieties of products of air brake systems and
related components, they are basically one general line - air brake
systems. Management does not analyze operational income based on different
features of air brake systems but on one general line of air brake systems only.
Hence, no separate segment analysis by products is presented as the Company’s
only products are air brake systems and related components.





Net sales
from the Chinese market were $94.6 million and $84.5 million for the fiscal
year ended on December 31, 2009 and 2008, respectively. Net sales from
international market were $30.4 million and $46.4 million for the fiscal year
ended on December 31, 2009 and 2008, respectively.





All of
the Company’s long-lived assets are located in the PRC and Hong Kong. The
Company and its subsidiaries do not have long-lived assets in the United
States for the reporting periods.





For the
fiscal year ended on December 31, 2009, the Company’s three biggest customers
were FAW Qingdao Automobile Works, Dongfeng Axle Co., Ltd., and Dongfeng Axle
Co., Ltd. ShiYan Automobile Works which accounted for approximately 8.6%, 5.7%
and 4.9% of total sales revenue, respectively. For the fiscal year ended on
December 31, 2008, FAW Jiefang Automotive Co., Ltd. Dongfeng Axle Co., Ltd.
ShiYan Automobile Works and FAW Qingdao Automobile Works accounted for
approximately 6.5%, 6.0% and 5.3% of total sales revenue,
respectively.





NOTE
19 – PURCHASE DISCOUNT




Purchase
discounts represent discounts received from vendors for purchasing raw
materials. The Company did not receive any purchase discounts for the
fiscal year ended on December 31, 2009 and 2008.





NOTE
20 – SHIPPING AND HANDLING COSTS




Shipping
and handling costs incurred by the Company are included in selling expenses in
the accompanying consolidated statements of income. Shipping and handling
costs were $1,878,172 and $2,269,469 for the fiscal year ended on December 31,
2009 and 2008, respectively.





NOTE
21 - STOCK COMPENSATION PLAN





(1) The
Company’s 2005 Stock Compensation Plan (the Plan) permits the grant of share
options and shares to its employees for up to 1,700,000 shares of common stock.
The Company believes that such awards better align the interests of its
employees with those of its shareholders. Option awards are generally
granted with an exercise price equal to the market price of the Company’s stock
at the date of grant.





Pursuant
to the Plan, the Company issued 60,000 options with an exercise price of $4.79
per share on March 1, 2006. The 60,000 options became fully vested and
exercisable on March 1, 2006, and expired on March 1, 2009.





The
Company accounts for stock-based compensation in accordance with FASB ASC 505-50
(Prior authoritative literature: FASB Statement No. 123R, “Share-Based
Payment”). The fair value of each option award is estimated on the date of grant
using the Black-Scholes-Merton option-pricing model that uses the assumptions
noted in the following table.





NumberofShares
                                
                                %ofSharesIssued
                                
                                InitialVestingDate60,000
                                
                                100%
                                
                                March
      1,
2006





These
60,000 options expired unexercised as of December 31, 2009.


55





The
Company accounts for stock-based compensation in accordance with FASB ASC
505-50, “Share-Based Payment.” The fair value of each option award is estimated
on the date of grant using the Black-Scholes-Merton option-pricing model that
uses the assumptions noted in the following table.





Dividend Yield
                    
                    
                    0.00
                    %Expected
      Volatility
                    
                    
                    75.75
                    %Risk-Free
      Interest Rate
                    
                    
                    4.59
                    %Contractual
      Term
                    
                    3
      yearsStock
      Price at Date of Grant
                    
                    $
                    4.79Exercise
      Price
                    
                    $
                    4.79





Total
deferred stock-based compensation expenses related to the 60,000 stock options
granted amounted to $178,904. This amount is amortized over three years in a
manner consistent with FASB ASC 505-50. The amortization of deferred
stock-based compensation for these equity arrangements was $59,636 and $9,935for
the fiscal years ended December 31, 2008 and 2009. There was no unamortized
compensation expense as of December 31, 2009.





(ii). Subject to all the terms and provisions of
the Plan, on June 20, 2007, the Company granted to its previous senior manager
of investor relations, David Ming He, options to purchase 4,128 shares of its
common stocks with an exercise price of $7.25 per share. The option became
vested and exercisable immediately on the date thereof. On November 12, 2009,
David Ming He exercised the options on a cashless basis and received 460 shares
of common stock, based on a formula provided for in the initial
grant.





NumberofShares
                    
                    %ofSharesIssued
                    
                    InitialVestingDate4,128
                    
                    100%
                    
                    June
      20, 2007





The
Company accounts for stock-based compensation in accordance with FASB ASC 505-50
(Prior authoritative literature: FASB Statement No. 123R, “Share-Based
Payment”). The fair value of each option is estimated on the date of grant using
the Black-Scholes-Merton option-pricing model that uses the assumptions noted in
the following table.





Dividend
      Yield
                  
                  
                  0.00
                  %Expected
      Volatility
                  
                  
                  66.70
                  %Risk-Free
      Interest Rate
                  
                  
                  5.14
                  %Contractual
      Term
                  
                  3
      yearsStock
      Price at Date of Grant
                  
                  $
                  7.09Exercise
      Price
                  
                  $
                  7.25





Total
stock-based compensation expenses related to the 4,128 stock options granted
amounted to $23,201. This amount was charged to G&A during
2007.





(2)
On January 5, 2006, the Company issued 100,000 warrants for financial services
to be provided by Maxim Group LLC and Chardan Capital Markets, LLC, with an
exercise price of $6.25 per share. In accordance with the common stock purchase
warrant agreement, the warrants became vested and exercisable immediately on the
date thereof. As set forth in the agreement, the Company retained Maxim Group
LLC and Chardan Capital Markets, LLC as its exclusive financial advisors and
investment bankers for a period of twelve months from the date of January 5,
2006. The agreement has now expired.





On
November 9, 2009, Maxim Group LLC transferred 35,000 warrants to OTA LLC and
35,000 warrants to Maxim Partners, LLC respectively. OTA LLC exercised the
warrants on a cashless basis on November 12, 2009 and received 6,609 shares of
common stock, based on a formula provided for in the initial grant. Maxim
Partners, LLC and Chardan Capital Markets, LLC transferred 35,000 warrants and
30,000 warrants to OTA LLC on December 15, 2009 and December 11, 2009,
respectively. OTA LLC exercised the warrants on a cashless basis on December 18,
2009 and received 18,598 shares of common stock, based on a formula provided for
in the initial grant.


56





NumberofShares
                    
                    %ofSharesIssued
                    
                    InitialVestingDate100,000
                    
                    100%
                    
                    January
      5, 2006





The
Company accounts for these warrants in accordance with FASB ASC 505-50 (Prior
authoritative literature: FASB Statement No. 123R, “Share-Based Payment”). The
fair value of each warrant is estimated on the date of grant using the
Black-Scholes-Merton option-pricing model that uses the assumptions noted in the
following table.





Dividend
      Yield
                  
                  
                  0.00
                  %Expected
      Volatility
                  
                  
                  77.62
                  %Risk-Free
      Interest Rate
                  
                  
                  4.36
                  %Contractual
      Term
                  
                  4
      yearsStock
      Price at Date of Grant
                  
                  $
                  4.70Exercise
      Price
                  
                  $
                  6.25





Total
expense associated with the 100,000 warrants amounted to $299,052, which,
consistent with FASB ASC 505-50, was recognized during the fiscal year
ended December 31, 2006.





There
were no options or warrants outstanding as of December 31, 2009.





NOTE
22- COMMITMENTS AND CONTINGENCIES





(1)  According
to the law of China, the government owns all the land in China. Companies and
individuals are authorized to possess and use the land only through land use
rights granted by the Chinese government. The Company purchased the land use
rights from Ruili Group for approximately $13.9 million on September 28, 2007.
The Company has not yet obtained the land use right certificate. However, the
Company has applied to obtain the land use right certificate.





(2)  The
information of lease commitments is provided in Note 13.





NOTE
23 - OFF-BALANCE SHEET ARRANGEMENTS





At
December 31, 2009, we do not have any material commitments for capital
expenditures or have any transactions, obligations or relationships that could
be considered off-balance sheet arrangements.





NOTE 24 - SUBSEQUENT EVENTS




The
Company sold 1,000,000 shares of its common stock to selected institutional
investors at a price per share of $10.00 pursuant to a registered direct
offering on February 8, 2010. This transaction
provided net proceeds of approximately $9.4 million.




The
Company has evaluated the subsequent events through March 29, 2010, the
consolidated financial statements issue date.


57




NOTE
25 – RESTRICTED NET ASSETS
  Relevant
PRC laws and regulations permit payments of dividends by our PRC subsidiaries
only out of their retained earnings, if any, as determined in accordance with
PRC accounting standards and regulations. In addition, PRC laws and regulations
require that annual appropriations of 10% of after-tax income should be set
aside prior to payment of dividends as a general reserve fund. As a result of
these PRC laws and regulations, our PRC subsidiaries and our affiliated PRC
entities are restricted in their ability to transfer a portion of their net
assets to us whether in the form of dividends, loans or advances. As of
December 31, 2009 and 2008, the amounts of our restricted net assets
were approximately $4.4 million and $3.1 million,
respectively.
 
 NOTE26–RECLASSIFICATION OF PRIOR
YEAR STATEMENT OF INCOME AND STATEMENT OF CASH FLOW
 
 For the
year ended December 31, 2008, the Company has reclassified Research and
Development Expenses and Deferred Tax Assets/Liabilities to facilitate a year
over year comparison with the year ended December 31, 2009.
 
 Additional
Information—Financial Statement Schedule I
  This
financial statements schedule has been prepared in conformity with accounting
principles generally accepted in the United States of America.
 
 SORL
AUTO PARTS, INC.
 
 This
financial statements schedule has been prepared in conformity with accounting
principles generally accepted in the United States of America. The parent
Company financial statements have been prepared using the same accounting
principles and policies described in the notes to the consolidated financial
statements, with the only exception being that the Company accounts for its
subsidiaries using the equity method. Please refer to the notes to the
consolidated financial statements presented above for additional information and
disclosures with respect to these financial statements.
  58




Financial
information of Parent Company





Balance
Sheets





December 31,2009
                    
                    
                    December 31,2008ASSETSCurrent
      Assets:Cash
      and cash equivalents
                    
                    $
                    32,713
                    
                    
                    $
                    32,718Other
      current assets
                    
                    
                    6,161
                    
                    
                    
                    16,161Total
      current assets
                    
                    
                    38,874
                    
                    
                    
                    48,879Deferred
      compensation cost-stock options
                    
                    
                    ―
                    
                    
                    
                    9,935Investments
      in subsidiaries
                    
                    
                    94,949,085
                    
                    
                    
                    81,952,101TOTAL
      ASSETS
                    
                    $
                    94,987,959
                    
                    
                    $
                    82,010,915LIABILITIES
      AND SHAREHOLDERS' EQUITYCurrent
      Liabilities:Other
      current liability
                    
                    
                    2,606,643
                    
                    
                    
                    2,486,566Total
      current liabilities
                    
                    
                    2,606,643
                    
                    
                    
                    2,486,566Total
      liabilities
                    
                    
                    2,606,643
                    
                    
                    
                    2,486,566Shareholders'
      equity:Preferred
      Stock - No Par Value; 1,000,000 authorized; none issued and outstanding as
      of December
      31, 2009 and December 31, 2008
                    
                    
                    ―
                    
                    
                    
                    ―Common
      Stock - $0.002 Par Value; 50,000,000 authorized, 18,304,921 and 18,279,254
      issued and outstanding as of December 31, 2009 and December 31,
      2008
                    
                    
                    36,609
                    
                    
                    
                    36,558Additional
      paid-in capital
                    
                    
                    37,498,401
                    
                    
                    
                    37,498,452Retained
      earnings
                    
                    
                    54,846,306
                    
                    
                    
                    41,989,339Total
      shareholders' equity
                    
                    
                    92,381,316
                    
                    
                    
                    79,524,349TOTAL
      LIABILITIES AND SHAREHOLDERS' EQUITY
                    
                    $
                    94,987,959
                    
                    
                    $
                    82,010,915


59


Financial
Information of Parent Company





Statement
Of Income





Year Ended Dec 31,2009
                  
                  
                  2008Equity
      in earnings of subsidiaries
                  
                  $
                  12,996,907
                  
                  
                  $
                  12,431,066General
      and administrative expenses
                  
                  
                  (139,935
                  )
                  
                  
                  59,636Financial
      expenses
                  
                  
                  5
                  
                  
                  
                  570Net
      income attributable to shareholders
                  
                  $
                  12,856,967
                  
                  
                  $
                  12,370,860Weighted
      average common share – Basic
                  
                  
                  18,280,865
                  
                  
                  
                  18,279,254Weighted
      average common share – Diluted
                  
                  
                  18,280,865
                  
                  
                  
                  18,279,254EPS
      – Basic
                  
                  
                  0.70
                  
                  
                  
                  0.68EPS
      – Diluted
                  
                  
                  0.70
                  
                  
                  
                  0.68


60





Financial
Information of Parent Company


For
Years Ended on December 31, 2009 and 2008





Additional
                          
                          
                          RetainedNumber
                          
                          
                          Common
                          
                          
                          Paid-in
                          
                          
                          Earnings
                          
                          
                          Shareholders'of Share
                          
                          
                          Stock
                          
                          
                          Capital
                          
                          
                          (Deficit)
                          
                          
                          EquityBeginning
      Balance - January 1, 2008
                          
                          
                          18,279,254
                          
                          
                          
                          36,558
                          
                          
                          
                          37,498,452
                          
                          
                          
                          29,618,479
                          
                          
                          
                          67,153,489Net
      Income
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          12,370,860
                          
                          
                          
                          12,370,860Ending
      Balance - December 31, 2008
                          
                          
                          18,279,254
                          
                          
                          
                          36,558
                          
                          
                          
                          37,498,452
                          
                          
                          
                          41,989,339
                          
                          
                          
                          79,524,349Beginning
      Balance - January 1, 2009
                          
                          
                          18,279,254
                          
                          
                          
                          36,558
                          
                          
                          
                          37,498,452
                          
                          
                          
                          41,989,339
                          
                          
                          
                          79,524,349Net
      Income
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          ―
                          
                          
                          
                          12,856,967
                          
                          
                          
                          12,856,967Stock
      options and warrants – cashless exercise, net
                          
                          
                          25,667
                          
                          
                          
                          51
                          
                          
                          
                          (51
                          )
                          
                          
                          ―
                          
                          
                          
                          ―Ending
      Balance - December 31, 2009
                          
                          
                          18,304,921
                          
                          
                          
                          36,609
                          
                          
                          
                          37,498,401
                          
                          
                          
                          54,846,306
                          
                          
                          
                          92,381,316


61





Financial
Information of Parent Company





Statements
of Changes in Stockholders' Equity





Statement
Of Cash Flows





YearEndedDec31,2009
                        
                        
                        2008Cash
      flow from operating activities:Net
      income
                        
                        $
                        12,856,967
                        
                        
                        $
                        12,370,860Adjustments
      to reconcile net income to net cash provided by operating
      activitiesEquity
      in earnings of subsidiaries
                        
                        
                        (12,996,907
                        )
                        
                        
                        (12,431,066
                        )Stock-Based
      Compensation Expense
                        
                        
                        9,935
                        
                        
                        
                        59,636Changes
      in other current assets
                        
                        
                        ―
                        
                        
                        
                        ―Changes
      in other current liabilities
                        
                        
                        130,000
                        
                        
                        
                        ―Net
      cash provided by operating activities
                        
                        $
                        (5
                        )
                        
                        $
                        (570
                        )Cash
      flows from investing activities:Investment
      in subsidiaries, net of cash acquired
                        
                        $
                        ―
                        
                        
                        $
                        ―Net
      cash (used in) provided by investing activities
                        
                        $
                        ―
                        
                        
                        $
                        ―Cash
      flows from financing activities:Proceeds
      from Share Issuance
                        
                        $
                        ―
                        
                        
                        $
                        ―Net
      cash provided by (used in) financing activities
                        
                        $
                        ―
                        
                        
                        $
                        ―Net
      change in increase in cash and cash equivalents
                        
                        $
                        (5
                        )
                        
                        $
                        (570
                        )Cash
      and cash equivalents, beginning of period
                        
                        
                        32,718
                        
                        
                        
                        33,288Cash
      and cash equivalents, end of period
                        
                        $
                        32,713
                        
                        
                        $
                        32,718


62


ITEM
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE





None.





ITEM
9A. CONTROLS AND PROCEDURES





Evaluation
of Disclosure Controls and Procedures





As of
December 31, 2009, an evaluation was performed under the supervision and with
the participation of the Company’s management, including the chief executive
officer (“CEO”) and the chief financial officer (“CFO”), of the effectiveness of
the design and operation of the Company’s disclosure controls and procedures.
Based on that evaluation, the Company’s management, including the CEO and CFO,
conclude that the Company’s disclosure controls and procedures were effective as
of December 31, 2009.





Changes
in Internal Control over Financial Reporting





There was
no change in our internal controls over financial reporting that occurred during
the fourth fiscal quarter of the fiscal year covered by this Annual Report on
Form 10-K that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.





Management’s
Report on Internal Control over Financial Reporting





The
Company’s management is responsible for establishing adequate internal control
over financial reporting, as such item is defined in Exchange Act Rule 13a-15(f)
and 15d-15(f). In evaluating the Company’s internal control over financial
reporting, management has adopted the framework in Internal Control-Integrated
Frameworkissued by the Committee of Sponsoring Organization of the
Treadway Commission. Under the supervision and with the participation of our
management, including the principal executive officer and principal financial
officer, we conducted an evaluation of the effectiveness of our internal control
over financial reporting, as of December 31, 2009. Based on our evaluation under
the framework in Internal
Control-Integrated Framework, our management has concluded that our
internal control over financial reporting was effective as of December 31,
2009.





Because
of inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projection of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with policies and procedure may deteriorate.





This
report does not include an attestation report of the Company’s registered public
accounting firm regarding internal control over financial reporting. The
management’s report was not subject to attestation by the Company’s registered
public accounting firm pursuant to temporary roles of the Securities and
Exchange Commission that permit the Company to provide only a management’s
report in this Annual Report.





ITEM
9B. OTHER INFORMATION





None.


PART
III





ITEM
10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE





The
following table sets forth our executive officers and key employees, their ages
and the positions they held as of December 31, 2009.


63





Name
            
            Age
            
            PositionXiao
      Ping Zhang
            
            47
            
            Chief
      Executive Officer and ChairmanXiao
      Feng Zhang
            
            42
            
            Chief
      Operating Officer and DirectorZong
      Yun Zhou
            
            55
            
            Chief
      Financial Officer





Information
about our directors is presented under the caption “Election of Directors” in
our definitive Proxy Statement for the Annual Meeting of Stockholders to be held
on May 27, 2010 and is incorporated herein by reference.





Information
about our Audit Committee is presented under the caption “Election of
Directors–Committees of the Board of Directors–Audit Committee” in our
definitive Proxy Statement for the Annual Meeting of Stockholders to be held on
May 27, 2010 and is incorporated herein by reference.





Information
about our Code of Business Conduct is presented under the caption “Where You Can
Find More Information” in Part I, Item 1 of this report.





Information
about our compliance with Section 16 of the Exchange Act of 1934, as amended, is
presented under the caption “Section 16(a) Beneficial Ownership Reporting
compliance” in our definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on May 27, 2010 and is incorporated herein by
reference.





Item
11. EXECUTIVE COMPENSATION





Information
about executive compensation is presented under the captions “Compensation to
Executive Officers,” “Compensation of Directors,” “Report of the Compensation
Committee” and “Compensation Committee Interlocks and Insider Participation” in
our definitive Proxy Statement for the Annual Meeting of Stockholders to be held
on May 27, 2010 and is incorporated herein by reference.





ITEM
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS





Information
about security ownership is presented under the caption “Beneficial Ownership of
Common Stock” in our definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on May 27, 2010 and is incorporated herein by
reference.





Information
about our equity compensation plans is presented under the caption “Equity
Compensation Plans” in our definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on May 27, 2010 and is incorporated herein by
reference.





ITEM
13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS, AND DIRECTOR
INDEPENDENCE





Information
about transactions with related persons is presented under the caption “Related
Person Transactions” in our definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on May 27, 2010 and is incorporated herein by
reference.





Information
about director independence is presented under the caption “Election of
Directors–Director Independence” in our definitive Proxy Statement for the
Annual Meeting of Stockholders to be held on May 27, 2010 and is
incorporated herein by reference.


64





ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.





Information
about aggregate fees billed to us by our principal accountant is presented under
the caption “Principal Accounting Firm Fees” in our definitive Proxy Statement
for the Annual Meeting of Stockholders to be held on May 27, 2010 and is
incorporated herein by reference.





PART
IV





ITEM
15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES


3.           List
of Exhibits.  See the Exhibit Index for a list of the exhibits
incorporated by reference or filed with this report.





(a)           1.           Financial
Statements.





See Item 8 for the financial
statements filed with this report.





2.           Financial
Statement Schedules.





See Item 8 of this report





(b)          Exhibits
required by Item 601 of Regulation S-K.





1.           Financial
Statements.





See Item 8 for the financial
statements filed with this report.





2.           Financial
Statement Schedules.





See Item 8 of this report





EXHIBIT
INDEX





EXHIBIT NO.
            
            DOCUMENT DESCRIPTION3.1
            
            Articles
      of Incorporation (1)3.2
            
            Bylaws
      (2)10.1
            
            Share
      Exchange Agreement and Plan of Reorganization (3)10.2
            
            Joint
      Venture Agreement (revised)(4)10.3
            
            Employment
      Agreement—Xiao Ping Zhang (5)10.4
            
            Employment
      Agreement—Xiao Feng Zhang (5)


65





10.5
                
                Employment
      Agreement—Zong Yun Zhou (5)23
                
                Consent
      of EFP Rotenberg LLP31.1
                
                Certification
      of Principal Executive Officer pursuant to Rule 13a-14 and Rule 15d-14(a),
      promulgated under the Securities and Exchange Act of 1934, as
      amended.31.2
                
                Certification
      of Principal Financial Officer pursuant to Rule 13a-14 and Rule 15d-14(a),
      promulgated under the Securities and Exchange Act of 1934, as
      amended.32
                
                Certification
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 (Chief Executive Officer and Chief
      Financial Officer).







(1)
            Incorporated
      herein by reference from the Registrant’s Form 10-QSB filed with the
      Securities and Exchange Commission, on May 28,
  2003.





(2)
            Incorporated
      herein by reference from the Registrant’s Form 8-K Current Report as filed
      with the Securities and Exchange Commission, on March 17,
      2009.





(3)
            Incorporated
      herein by reference from Registrant’s Form 8-K Current Report, and
      amendment thereto, as filed with the Securities and Exchange Commission on
      May 24, 2004.(4)
            Incorporated
      by reference to Exhibit 10.2 to the Registrant’s Annual Report on Form
      10-K for the fiscal year ended December 31, 2007, as filed with the
      Securities and Exchange Commission on March 27,
  2008.





(5)
            Incorporated
      herein by reference from the Registrant’s Form S-1 as filed with the
      Securities and Exchange Commission on August 31,
  2006.


66


SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized, on this 29th day
of March 2010.


SORL
      AUTO PARTS, INC.By:
            /s/ Xiao Ping
      ZhangXiao
      Ping ZhangChief
      Executive Officer and Chairman





Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following person on behalf of the Registrant and in the
capacities.





Name
              
              Position
              
              Date/s/ Xiao Ping Zhang
              
              Chief
      Executive Officer, and Chairman
              
              March
      29, 2010Xiao
      Ping Zhang/s/ Xiao Feng Zhang
              
              Chief
      Operating Officer and Director
              
              March
      29, 2010Xiao
      Feng Zhang/s/ Zong Yun Zhou
              
              Chief
      Financial Officer
              
              March
      29, 2010Zong
      Yun Zhou/s/ Li Min Zhang
              
              Director
              
              March
      29, 2010Li
      Min Zhang/s/ Zhi Zhong Wang
              
              Director
              
              March
      29, 2010Zhi
      Zhong Wang




67




/s/ Yi Guang Huo
              
              Director
              
              March
      29, 2010Yi
      Guang Huo/s/ Jiang Hua Feng
              
              Director
              
              March
      29, 2010Jiang
      Hua Feng/s/ Jung Kang Chang
              
              Director
              
              March
      29, 2010Jung
      Kang Chang


68