**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,
                2006





OR




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





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 REGISTEREDNONE
            NONE





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





TITLE
                OF EACH CLASS
            COMMON
                STOCK








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





Indicate
                by check mark if no 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, or a non-accelerated filer. See definition of
                “accelerated filer and large accelerated filer” in Rule 12b-2 of the
                Exchange Act.
              Large
                accelerated filer o         
                Accelerated filer o       
                Non-accelerated x





Indicate
                by check mark whether the registrant is a shell company (as defined
                in
                Rule 12b-2 of the Exchange Act).
              Yes
                o No x




State
      issuer’s revenues for its most fiscal year December 31, 2006:
      $84,898,000




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, 2006, the value was approximately $13,871,000.




State
      the
      number of shares outstanding of each of the issuer’s classes of common equity:
      18,275,126 as of March 23, 2007.









**TABLE
      OF CONTENTS**




PART
                  IITEM
                  1.
              DESCRIPTION
                  OF BUSINESS
              
              2ITEM
                  1.A.
              RISK
                  FACTORS
              
              15ITEM
                  1B.
              UNRESOLVED
                  STAFF COMMENTS
              
              26ITEM
                  2.
              DESCRIPTION
                  OF PROPERTY
              
              27ITEM
                  3.
              LEGAL
                  PROCEEDINGS
              
              27ITEM
                  4.
              SUBMISSION
                  OF MATTERS TO A VOTE OF SECURITY HOLDERS
              
              27PART
                  IIITEM
                  5.
              MARKET
                  FOR COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS AND ISSUER PURCHASES
                  OF
                  EQUITY SECURITIES
              
              27ITEM
                  6.
              CONSOLIDATED
                  SELECTED FINANCIAL DATA
              
              29ITEM
                  7.
              MANAGEMENT’S
                  DISCUSSION AND ANALYSIS OR FINANCIAL PLAN OF OPERATION
              
              31ITEM
                  7A.
              QUANTITATIVE
                  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
              
              42ITEM
                  8.
              FINANCIAL
                  STATEMENTS AND SUPPLEMENTARY DATE
              
              43ITEM
                  9.
              CHANGES
                  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
                  DISCLOSURE
              
              61ITEM
                  9A.
              CONTROLS
                  AND PROCEDURES
              
              62ITEM
                  9B.
              OTHER
                  INFORMATION
              
              62PART
                  IIIITEM
                  10.
              DIRECTORS
                  AND EXECUTIVE OFFICERS OF THE REGISTRANT
              
              62ITEM
                  11.
              EXECUTIVE
                  COMPENSATION
              
              65ITEM
                  12.
              SECURITY
                  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
                  STOCKHOLDER MATTERS
              
              71ITEM
                  13.
              CERTAIN
                  RELATIONSHIPS AND RELATED TRANSACTIONS
              
              72ITEM
                  14.
              PRINCIPAL
                  ACCOUNTANT FEES AND SERVICES
              
              73ITEM
                  15.
              EXHIBITS,
                  AND FINANCIAL STATEMENT SCHEDULES
              
              74SIGNATURES
              
              
              75




-i-


**PART
      I**




**ITEM
      1. DESCRIPTION OF BUSINESS**




SORL
      Auto
      Parts, Inc. (the “Registrant” or the “Company”) is engaged in the business of
      manufacturing and distributing automotive air brake valves and related
      components for commercial vehicles weighing more than three tons, such as trucks
      and buses. The Company distributes products both in China and internationally
      under the SORL trademarks. The Company’s product range includes 40 categories of
      brake valves with over 800 different specifications. According to an
      announcement of National Bureau of Statistics of China and China Association
      of
      Automobile Manufacturers (“CAAM”) in June 2006, the Company ranks among the top
      100 automotive component suppliers in China.




**COMPANY
      HISTORY**




**GENERAL**




The
      Company was incorporated in Delaware in March 1982 under the name The Enchanted
      Village, Inc. As of May 2004, prior to the acquisition of Fairford Holdings
      Limited, the Company had no revenues and limited assets. In July 2004, the
      Registrant changed its name from The Enchanted Village, Inc. to SORL Auto Parts,
      Inc. The Registrant also effected a one (1) for fifteen (15) reverse stock
      split.




**ACQUISITION
      OF FAIRFORD**




In
      May
      2004, pursuant to the terms of a Share Exchange Agreement (the “Exchange
      Agreement”) dated as of April 4, 2004, among the Registrant, Keating Reverse
      Merger Fund, LLC, Xiao Ping Zhang, Xiao Feng Zhang and Shuping Chi
      (collectively, the “Fairford Sellers”); and Fairford Holdings Limited, a Hong
      Kong corporation (“Fairford”), the Registrant acquired from the Sellers (the
“Acquisition”) all of the issued and outstanding equity interests of Fairford
      (the “Fairford Shares”). As consideration for the Fairford Shares, the
      Registrant issued 1,000,000 shares of its Series A Convertible Preferred Stock,
      which were convertible into an aggregate of the 194,305,800 shares of common
      stock. In July 2004, the Fairford Sellers converted their shares of Preferred
      Stock into shares of common stock. The consideration for the Acquisition was
      determined through arm’s length negotiations between the management and the
      Fairford Sellers. As a result of the Acquisition, the Fairford Sellers held
      approximately 97.5% of our common stock on an as converted basis.




Upon
      the
      closing of the Acquisition, Kevin R. Keating resigned as President, Secretary
      Chief Financial Officer and sole Director of the Registrant. Effective May
      7,
      2004, Xiao Ping Zhang, Xiao Feng Zhang, and Jung Kang Chang began serving their
      terms as members of the Registrant’s Board of Directors. The newly elected
      directors appointed Xiao Ping Zhang as the Chairman and Chief Executive Officer,
      Xiao Feng Zhang as the Chief Operating Officer and Zong Yun Zhou as the Chief
      Financial Officer.




All
      references in this report to “SORL,” the “Registrant,” the “Company,” “we,”
“our” and “us” mean, unless the context indicates otherwise, (i) our
      predecessor, the Enchanted Village, Inc., for the periods prior to May 10,
      2004,
      the date the Acquisition was consummated, and (ii) the successor and registrant,
      SORL Auto Parts, Inc. and subsidiaries that now owns and operates the automotive
      components manufacturing business of Fairford as a result of the Acquisition.
      In
      addition, when the context so requires, we use the term “predecessor” to refer
      to the historical operations of our predecessor prior to the Acquisition and
      “successor” to refer to our historical operations following the Acquisition, and
      we use the terms “we,” “our” and “us” to refer to the predecessor and the
      successor collectively.




**BUSINESS**




As
      a
      result of the Acquisition, through Fairford’s 90% ownership of the Ruili Group
      Ruian Auto Parts Co., Ltd., a sino-foreign joint venture (the “Joint Venture”),
      the Company develops, manufactures and distributes automotive air brake valves
      and related components to automotive original equipment manufacturers, or OEMs,
      and the related aftermarket both 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. The Company’s products are principally used in commercial
      vehicles weighing over three tons, such as trucks and buses. Air brake valves
      are critical components that ensure driving safety.




-2-




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. The Ruili Group was
      incorporated in the 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, SORL 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 SORL 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, SORL 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. SORL continues to hold a 90%
      controlling interest in the operating subsidiary.




The
      Joint
      Venture is located 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 weighing more than three tons such as trucks and buses. Reliable
      functioning of those valves is critical to safety both when driving and
      parking.




**The
      Company’s Products**




Through
      the Joint Venture, the Company manufactures and distributes commercial vehicle
      air brake valves and 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 brake. The products are principally used in
      commercial vehicles weighing over three tons, such as trucks and buses. Air
      brake valves are critical components that ensure driving safety.




The
      Joint
      Venture makes an extensive range of air brake valves and related products
      covering forty categories and over eight hundred specifications, which are
      widely used in different types of commercial vehicles. Additionally, the Joint
      Venture offers 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. The Joint Venture is continually engaged in introducing new products
      rapidly, maintain high quality, and provide excellent customer support. When
      working with a customer, the Joint Venture’s goal is to understand the design
      intent and brand image for each product and leverage the Joint Venture’s
      extensive experience and innovative technology to deliver products that enable
      the customer to differentiate the air brake valves and related components.
      The
      Company supports its products with a full-range of styling, design, testing
      and
      manufacturing capabilities, including just-in -time and in-sequence
      delivery.




-3-




The
      following discussion describes the major products within the operations segment
      that the Joint Venture produces as of the date of this report.




**Product**
            
            **Description**RL3530
                Series Spring Brake Chamber
            
            A
                spring brake chamber executes the service, parking and emergency
                braking,
                when the brake system malfunctions, the products can automatically
                provide
                emergency braking force. In 2006, the Joint Venture produced 786,900
                units
                of spring brake chambers, the largest output in China, which were
                supplied
                to OEM customers such as FAW Qingdao and Dongfeng
                Group.Clutch
                Servo
            
            Clutch
                Servo, which are innovative clutch empower devices developed by the
                Joint
                Venture, was awarded a patent in China. They are used for controlling
                the
                performance of brake system clutches by means of a pneumatic-driven
                hydraulic operation. The features of this product are simpler structure,
                smaller size, higher durability and improved effectiveness. With
                an output
                of 465,900 units in 2006, clutch servo are currently supplied to
                OEM
                customers such as FAW Qingdao.RL351
                Series Air Dryer
            
            Air
                dryers dry and purify the compressed air. Combined with unloader
                valves
                and the heating components, this new type of air dryer requires no
                separate installation of certain other components. The product has
                a
                compact structure and multiple functions. Furthermore, it improves
                the
                reliability of the use of other air brake system components, enhancing
                safe driving. Annual output of these series of products reached 191,400
                units in 2006. The products are supplied to OEM customers such as
                FAW
                Qingdao and Dongfeng Group.Relay
                Valves
            
            Electric
                control exhaust relay valves greatly shorten the length of pipeline
                between the air storing tank and the brake chamber, and, as a result,
                enhance the speed to operate the brake system. They are widely used
                in
                different types of commercial vehicles. Annual output is approximately
                401,500 units.Hand
                Brake Valves
            
            Hand
                brake valves serve as an auxiliary device for parking brakes. Current
                annual output is about 287.7 thousand units. They are supplied to
                many OEM
                customers including FAW Qingdao.




We
      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 2006 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.




**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. Mr. Changming Xu, head of Economic Consulting
      Center under the State Information Center, predicted that the continued growth
      of the Chinese economy will in turn result in the growth of the Chinese
      automotive industry for at least another decade. It is expected that, during
      the
      Eleventh “Five-Year Plan” period (2006 - 2010), China’s GDP will maintain a high
      growth rate of at least 7% per annum. Per CAAM’s statistics, in 2006, China’s
      automobile output and sales volume hit their record high, reaching 7.28 million
      and 7.22 million units, and increasing by 27.3% and 25.1% year over year,
      respectively. It is expected that China’s automobile output and sales volume
      would reach 8 million units in 2007. In 2006, total automobile purchases in
      China accounted for over 10% share of the overall global consumption, more
      than
      twice of that in 2001, in which year China joined WTO. To date, China has become
      world’s third largest automobile manufacturing country and the second largest
      automobile consumption country.




-4-




By
      the
      end of 2010, annual production of all types of trucks in China is forecasted
      to
      reach 2.2 million units, out of which approximately 0.65 million units for
      heavy
      duty trucks, representing a compounded annual growth rate (CAGR) between 10%
      and
      15% during the period. This forecast was based on the prediction that Chinese
      government will continue its active fiscal policy, development plan for western
      China, restoration of the northeastern China traditional industrial base,
      investment in infrastructure projects, and strict enforcement of the ban on
      truck overloading.




In
      2006,
      China’s worldwide automotive parts sales was approximately $74.4 billion. It is
      forecasted that the total China auto parts global sales would expand to about
      $187 billion in 2010, of which $82.5 billion will be for sales to original
      equipment manufacturers (“OEM’s”).




The
      overall 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.




·
            To
                meet the requirements from increasingly 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 groups capable of competing with
                international manufacturers.




**MARKET
      AND CUSTOMERS**




The
      Joint
      Venture is the largest commercial vehicle air brake system manufacturer in
      China. In general, customers are divided into three groups: OEM in China,
      aftermarket distributors in China, and international customers, accounting
      for
      approximately 32%, 28% and 40%, respectively, of the Company’s annual sales for
      2006.




**OEM
      Market -** The
      Joint Venture has established long-term business relationships with most of
      the
      major automobile manufacturers in China. The Joint Venture sells its products
      to
      thirty-nine (39) vehicle manufacturers, including all of the key truck
      manufacturers in China. In addition to heavy-duty trucks, the valves are also
      widely used in air brake systems for buses. Typically, bus manufacturers
      purchase a chassis from truck chassis manufacturers which already have the
      Joint
      Venture’s air brake valves incorporated.




The
      table
      below presents comparative information for 2005 and 2006 on the Company’s top 5
      OEM customers.




**Ranking**
            
            **Customer**
            
            **%
                of**
              **2006**
              **Sales**
            
            **Customer**
            
            **%
                of**
              **2005**
              **Sales**1
            
            FAW
                Qingdao Automobile Works
            
            4.56%
            
            FAW
                Qingdao Automobile Works
            
            5.07%2
            
            First
                Auto Group Purchase Dept.
            
            4.39%
            
            First
                Auto Group Purchase Dept.
            
            4.38%3
            
            Dongfeng
                Axle Co., Ltd.
            
            3.43%
            
            Dongfeng
                Axle Co., Ltd.
            
            3.25%4
            
            Beiqi
                Foton Motor Co., Ltd. Zhucheng Automobile Works
            
            2.07%
            
            Liuzhou
                Special Auto
              Manufacturing
                Co., Ltd.
            
            3.04%5
            
            Liuzhou
                Special Auto
              Manufacturing
                Co., Ltd.
            
            1.71%
            
            Beiqi
                Foton Motor Co., Ltd. Beijing Auman Heavy-Duty Vehicle Works
            
            2.65%




-5-


Our
      principal OEM customers are:




FAW
      Qingdao Automobile Works: It is a subsidiary of FAW Group (a.k.a. First Auto
      Group). Established in 1953, FAW is the largest automobile manufacturer in
      China. During the past 50 years, its product line has expanded from a single
      product for trucks to a full range of light, medium and heavy vehicles, sedans
      and buses, with output reaching 6.4 million units. FAW has established joint
      ventures with major international firms such as Volkswagen and Toyota, while
      expanding within China through a merger with Tianjin Automobile Industry (Group)
      Co., Ltd.




Dongfeng
      Axle Co., Ltd.: It is a subsidiary of Dongfeng Motors Group. Established in
      1969, Dongfeng ranks among the top three groups in China’s automotive industry.
      Its main products include commercial vehicles, passenger cars and automotive
      parts.




Beiqi
      Foton Motor Co., Ltd.: Headquartered in Chang Ping District, Beijing, Foton
      was
      founded in 1996. It is a public listed company with majority of state-owned
      shares. It possesses total assets exceeding 5 billion RMB and has about 28,000
      employees. As China’s largest commercial vehicle manufacturer with a complete
      range of types, Foton sells under the brand names of Auman, AUV, View, Saga,
      Aumark, Ollin, Sup and Forland.




**Aftermarket
      -** Together
      with the Ruili Group, the Joint Venture has established the sales networks
      of
      twenty-eight authorized distributors covering the following seven regions
      nationwide:




·
            Northeast
                Region (Harbin, Changchun,
                Shenyang)




·
            North
                Region (Beijing, Shijiazhuang, Datong,
                Tianjin)




·
            Northwest
                Region (Urumchi, Xi’an)




·
            Southwest
                Region (Chongqing, Liuzhou, Kunming,
                Chengdu)




·
            Central
                Region (Zhengzhou, Wuhan, Shiyan)




·
            East
                Region (Ji’nan, Qingdao, Hefei, Hangzhou, Nanchang, Quanzhou, Shanghai,
                Najing, Xuzhou)




·
            South
                Region (Guangzhou, Changsha)




The
      28
      distributors sell only “SORL” products and in turn channel the products through
      over 800 sub-distributors.




**International
      Market -** Management views the export market as the most important growth area. We have
      signed agreements with three distributors in UAE, Australia and US. We also
      actively participate in international trade shows such as those held in Paris,
      Frankfurt, Dubai and Las Vegas, through which the Company has been able to
      expand its export business. In 2006, export sales accounted for 40% of total
      revenue. With the exception of OEM sales to TATA in India, export sales are
      to
      the overseas aftermarket. Products are exported to more than 72 countries and
      regions in the world. Total export sales in 2006 increased by 45% compared
      to
      that in 2005.




-6-




**Ranking**
            
            **Country**
            
            **Customer
                Name**
            
            **%
                of 2006 Sales**
            
            **Country**
            
            **Customer
                Name**
            
            **%
                of 2005 Sales**1
            
            United
                Arab Emirates
            
            GOLDEN
                DRAGAN AUTO SPARE PARTS
            
            6.24%
            
            United
                Arab Emirates
            
            GOLDEN
                DRAGAN AUTO SPARE PARTS
            
            6.46%2
            
            USA
            
            ITM
            
            4.50%
            
            South
                Africa
            
            MICO
            
            1.57%3
            
            South
                Africa
            
            MICO
            
            1.83%
            
            Canada
            
            F.P.
            
            1.21%4
            
            Nigeria
            
            LIL/MILA
            
            1.35%
            
            Taiwan,
                China
            
            MITA
            
            0.94%5
            
            Poland
            
            MAKROTECH
            
            0.87%
            
            South
                Africa
            
            POLMO
            
            0.77%6
            
            South
                Africa
            
            POLMO
            
            0.73%
            
            Spain
            
            AIR-FREN
            
            0.66%7
            
            Poland
            
            FOTA
            
            0.70%
            
            USA
            
            KTC
            
            0.61%





**COMPETITION**




The
      Joint
      Venture conducts its 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 current global automotive industry,
      it
      is a trend that vehicle manufacturers 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 who 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, the Joint Venture
      has
      established long-term business relationships with most of the major automobile
      manufacturers in China, such as FAW Group (a.k.a. First Auto Group), Dongfeng
      Motors Group, Liuzhou Special Auto Manufacturing Co., Ltd., Beiqi Foton Motor
      Co., Ltd., etc. In 2006, the Joint Venture maintained an increasing market
      share
      in all sales segments, especially in overseas sales. In terms of revenues,
      the
      Company ranks among the top 100 automotive component suppliers in China.
      Management believes that the key success factors in the commercial vehicle
      air
      brake valves segment are product quality, price competitiveness, technical
      expertise and development capability, new product innovation, reliability and
      timeliness of delivery, product design capability, facilities condition,
      operational flexibility, customer service and overall management.




**Domestic
      Competition -** The
      Joint Venture has three major competitors in China: 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 portion for aftermarket and
                export.




·
            China
                Shandong Weiming Automotive Products Co. Ltd.: This is a joint venture
                with WABCO of Germany, and mainly produces spring brake chambers,
                air
                dryers, and ABS, primarily supplying to truck and bus OEM’s such as FAW
                and North-Benz.




·
            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.




-7-


Management
      believes the Company has the following advantages:




·
            Brand
                Name: As China’s largest commercial vehicle air brake valves manufacturer,
                the Joint Venture’s “SORL” brand is widely known in the
                country.




·
            Technology:
                The Joint Venture views technological innovation and leadership as
                the
                critical means to enhance its core competence. It owns a technology
                center, including a laboratory specializing in the research of automotive
                brake controlling technologies and development of air brake system
                products.




·
            Product
                Development: Through its international sales offices in the US, Australia
                and the Middle East, the Joint Venture is able to promptly collect
                information about the current trends in automotive technologies,
                which in
                turn is applied to our new product development. 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.




·
            Sales
                Networks: The Joint Venture has contracted with 28 authorized distributors
                covering 7 regions of China, who in turn channel “SORL” products through
                over 800 sub-distributors throughout
                China.




**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. The Joint Venture’s competitive advantages over other competitors
      in the world market are:




·
            Performance-Cost
                Ratio: “SORL” products enjoy a much lower production costs leveraging on
                the low labor costs in China. Through the Company’s improved product line
                as a result of technology and manufacturing improvements, the Joint
                Venture products’ performance-cost advantage is
                increasing.




·
            Quick
                Adaptation to Local Market: Through its international sales channels
                in
                the US, Australia and Middle East, the Joint Venture has been able
                to
                respond to local market needs.




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




**SALES
      AND MARKETING**




To
      further increase our market share, in 2006, the JV expanded its sales force
      to
      strengthen its sales and marketing efforts. As a result, the headcount for
      domestic (PRC) sales and international sales increased to twenty-seven and
      thirty, respectively, from twenty-two and twenty-three. Products are sold under
      the “SORL” trademark, which the Joint Venture licenses on a royalty free basis
      from the Ruili Group. The license expires in 2019.




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




**OEM
      Market -** The
      Joint Venture sells its products to thirty nine (39) vehicle manufacturers,
      with
      most of which it has established long-term relationships. Normally, annual
      sales
      contracts with key customers are signed at the beginning of the calendar year
      and are revised as needed.




After
      experiencing a market slump in 2005, China’s heavy duty trucks output and sales
      volume increased by 15.4 % year over year in 2006. With the rebound of the
      Chinese heavy duty truck markets, the Joint Venture’s sales to the OEM market
      increased by $6.5 million or 31.6% for the year ended December 31, 2006, as
      compared to the year ended December 31, 2005. The Joint Venture expanded its
      OEM
      market share basically from its existing major customers.




-8-




**Aftermarket
      -** The
      Joint Venture’s products are also sold 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, demand for parts has become
      stronger. Currently, SORL has 28 authorized distributors covering 7 regions
      nationwide. These distributors sell only the Joint Ventures and the Ruili
      Group’s products under the “SORL” trademark to over 800 distributors. The Joint
      Venture provides product technical services to these distributors. The Joint
      Venture also conducts periodic performance evaluations, and reserves the right
      to terminate the distributorship of those with frequent delinquencies or poor
      sales records, and to replace them by other selected firms. For 2006, the
      Company achieved total revenue of $23.9 million in domestic aftermarket sales,
      an increase of 18.3% from 2005.




**International
      Markets -** Export
      expansion is the focus of our marketing strategy. The Joint Venture sells
      products to over 72 countries and has signed agreements with three distributors
      in UAE, Australia and the U.S. as SORL’s sales centers in their regions. It also
      actively participates in international trade shows at Paris, Frankfurt, Dubai
      and Las Vegas, to update its knowledge on automobile technology and local market
      trends and to acquire new customers and new orders. To further penetrate the
      Indian market, in early 2007, the Joint Venture set up a sales office in Pune,
      India. In addition to supplying products to TATA Motors, the Joint Venture
      also
      focused on establishing relationships with other major OEMs and with
      participants in the replacement market in India.




In
      2006,
      the Middle East segment had the largest share of overseas sales. The American
      segment experienced the fastest growth, followed by the European segment. Export
      sales grew by approximately 44.9%, from $23.4 million in 2005 to $33.9 million
      in 2006.




**DISTRIBUTION**




The
      Joint
      Venture ships finished products directly to OEM customers. The 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 Capability**




The
      Joint
      Venture currently employs 56 technical staff members, including 38 holding
      Engineer or Senior Engineer qualifications. Among which, 3 staff members are
      for
      intelligence, 35 for new product development and technique designing, 6 for
      testing, 5 for MIS and the remaining for on-site quality
      management.




In
      addition to its in-house technical force, the Joint Venture has cooperation
      arrangements with leading universities in automotive engineering industry,
      including:




·
            Harbin
                Institute of Technology: Contract for co-development of electronic
                control
                products for automotive 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.




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
      Changchun Automotive Research Institute of FAW Group and Dongfeng Automotive
      Research Institute of the Dongfeng Group.




Capitalizing
      on these resources, we have successfully developed innovative products and
      technologies such as a new type of clutch servo for automatic transmissions;
      a
      combined air dryer with build-in temperature-control device and unloader; and
      an
      inner-breath spring chamber which enables internal air circulation, thus
      reducing dirt collection and therefore enhancing the product’s reliability and
      durability.




-9-




In
      2006,
      we successfully developed a number of new products and started
      production:




·
            **Clutch
                Servo with Inductive Displacement Transducer:**The special transducer triggers an automatic alarm before the clutch
                gets
                burned, and also prevents shifting of the transmission without
                separateness of the clutch, thereby enabling harmonious
                shifting.




·
            **Automatic
                Slack Adjuster:**It
                automatically adjusts the abrasion clearance between the brake shoe
                and
                the brake drum, thereby keeping the clearance of different wheels
                within
                prescribed limits and ensuring the highest level balance of braking
                force
                among wheels.




·
            **Loading
                Sensor Proportion Valve:**It
                automatically adjusts the input air pressure in the brake chamber
                in line
                with changes in load, hence matching braking strength with auto
                load.




·
            **New
                Type Foot Brake Valve:**The alarming switch and braking switch added give new features to
                the
                traditional foot brake valves.




The
      Joint
      Venture owns a full range of processing equipment required for development
      of
      new auto part products, including machines for molding, die casting and cutting
      processes. Furthermore, the Joint Venture is capable of 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 savings in the cycle time
      for
      new product development.




**Patented
      Technologies**




Currently
      the Joint Venture owns 11 utility patents and has filed applications for another
      in China and additional three in the U.S.




**Know-how**




Based
      on
      the many years of manufacturing experience, the Joint Venture has accumulated
      a
      substantial amount of know-how. For instance, the special formula for aluminum
      alloy acquired over years of repeating tests considerably improves the
      compactness of alloy, hence the strength of casting. The Joint Venture also
      keeps a confidential “protection film” processing technique to enhance the
      sealability of products.




The
      Joint
      Venture has taken numerous steps to protect its proprietary technologies.
      Specific staff is assigned to safe keep documents and filings. Critical
      employees are required to sign a confidentiality agreement with the Joint
      Venture.




**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.




**PRODUCTION**




The
      Joint
      Venture owns the largest commercial vehicle air brake valve products
      manufacturing base in China, consisting of fifteen (15) production / assembly
      lines. In 2006, the Joint Venture re-deployed and streamlined its production
      /
      assembly lines, enabling it to rapidly adjust its production plan to meet
      increasing market demands for new types. The production process includes
      fixture, jig and die making, aluminum alloy die casting, metal sheet stamping,
      numerical control cutting, melding, numerical control processing, surface
      treatment, filming, rubber/plastic processing, final assembly and packaging.
      The
      Joint Venture possesses state-of-the-art manufacturing and testing facilities
      sourced from the US, Korea, Taiwan as well as mainland China, including CNC
      processing centers, CNC lathes, casting, stamping and cutting machines,
      automatic spraying and electroplating lines, cleaning machines, automatic
      assembly lines and 3D COMERO and projectors, etc.




-10-




There
      are
      currently 1,425 production staff, most of whom are experienced and skilled
      workers and mechanics.




The
      Joint
      Venture leases from Ruili Group the plant building as its production facility
      and warehouse, for a total area of approximately 271,713 square feet. The lease
      began in March 2004 for a term of ten years. Annual rental is approximately
      $457,845.




**ENVIRONMENT**




The
      Joint
      Venture carries out staff training to enhance awareness of environment
      protection. It effects controls from the beginning to adopt environment friendly
      production, reducing or preventing pollution, as well as saving energy
      consumption and manufacturing costs. For example, intensity of noise 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 disposal of aluminum and steel scraps, thereby saving both storage
      space
      and power consumption.




**RAW
      MATERIALS**




Raw
      materials used by the Joint Venture in the manufacture of its products primarily
      include steel, aluminum, other metals, rubber and various
      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. The Joint Venture
      maintains relationships with over twenty material suppliers. In 2006, the three
      largest suppliers are Shanghai Jinshi Materials Co,. Ltd, Shanghai Tongzai
      International Trade Co,. Ltd and Shanghai Dechen Materials Co,. Ltd, which
      accounted for 41.7% of the aggregate of raw materials we purchased.




Over
      the
      past two years we have experienced price increases for aluminum but no supply
      delays or shortages. The increases have had an adverse impact on gross profit,
      since some of the increases cannot be passed onto the customers. To reduce
      the
      impact of these price increases, we have taken some measures, such as selecting
      the suppliers which are physically close to the Joint Venture to reduce the
      cost
      of transportation, not to carrying inventories of raw material in excess of
      those required to meet production when the market price is volatile, having
      short-term pricing agreements with some of our suppliers that reduce our
      exposure to aluminum pricing increases, and optimizing production technique
      to
      reduce raw material consumption. Furthermore, with the increase of production,
      we believe that the negative affect on gross margin was largely offset by
      economy of scale.




When
      planning a purchase order, with such other terms as quality, delivery and credit
      terms being substantially the same, the Joint Venture compares prices quoted
      by
      different suppliers in an attempt to receive the lowest price. In order to
      secure a purchase price and subsequently a predictable cost of sales, the Joint
      Venture generally makes 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. Such 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 the 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.




**STRATEGIC
      PLAN**




The
      Joint
      Venture’s strategic plan is to enhance its core competences, maintain steady
      business growth and increase its market share both in China and internationally
      through the following:




·
            FOCUS
                ON QUALITY CONTROL AND COST REDUCTION. We believe that our products
                offer
                higher quality compared with our competitors in the commercial vehicle
                air
                brake valve market in China, and a superior performance-cost advantage
                in
                the international market. To sustain this competitive advantage and
                at the
                same time obtain higher profit margins, the Joint Venture plans,
                based on
                its efficient manufacturing base in China, to continue focusing on
                quality
                control and cost reduction, including, for example, reduction in
                spoilage
                and improvement in manufacturing
                techniques.




-11-


·
            IMPLEMENT
                THE BRAND STRATEGY. The Joint Venture plans to focus efforts on promotion
                of the “SORL” brand name based on technological
                innovation.




·
            INVEST
                IN THE NEXT GENERATION VALVE TECHNOLOGY. We have passed the final
                testing
                for the newly developed clutch servo with inductive displacement
                transducer, and placed the product in mass production in 2006. We
                have
                also completed the development of other new products such as automatic
                slack adjusters, loading sense proportion valves and a new type foot
                brake
                valve. Additionally, we have 102 new products in the process of
                developing.




·
            EXPAND
                PRODUCTION FACILITIES TO MEET FURTHER DEMANDS. Anticipating the increasing
                demands for our products, management plans to acquire new facilities
                and
                procure new equipment, and also to increase the Joint Venture’s sales
                force.




·
            FURTHER
                EXPANSION IN THE INTERNATIONAL MARKET. During 2006, the Joint Venture
                achieved approximately 44.9% growth in export sales, which accounted
                for
                40% of total sales for the year. Management believes our products
                are
                competitive in the international market. We plan to set up additional
                authorized sales distributors internationally. We also plan to actively
                seek strategic partnerships with international distributors and
                manufacturers.




·
            EXPAND
                THROUGH STRATEGIC ALLIANCES AND ACQUISITIONS. We are exploring
                opportunities to create long-term growth through new joint ventures
                or
                acquisitions of other automotive parts manufacturers in China, and
                of auto
                parts distributors or repair factories with established sales networks
                outside of China. We will seek synergistic acquisition targets which
                can
                be easily integrated into our product manufacturing and corporate
                management, or companies that have strong joint-venture partners
                that
                would become major customers.




**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 2004, 2005 and 2006 was 9.5%, 9.4% and 10.7%
      respectively.




Looking
      forward, GDP growth in the region is forecasted about 10% in 2007. Over the
      long
      term, China’s accession to the World Trade Organization (WTO) has accelerated
      the capital flow to China from other developed countries.




**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 People’s Republic of China accounting laws
      mandate accounting practices, which are not consistent with US Generally
      Accepted Accounting Principles. 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.




-12-




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 from time 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.




**EMPLOYEES
      AND EMPLOYMENT AGREEMENTS**




The
      Company currently employs 1621 employees, all of whom are employed full time:
      41
      for quality control, 56 technical staff, 57 sales and marketing staff, 1425
      production workers and 42 administrative staff. There are employment agreements
      with all of the employees whereby administrative staff workers agree to five
      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.




-13-




**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.




**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.




-14-




**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.




***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 financial costs therefrom will not
      adversely affect our net income.




***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, and Mr. Xiao Feng Zhang, our Chief Operating
      Officer, are officers and principal stockholders 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 two senior executives, Messrs, Xiao Ping Zhang and Xiao Feng
      Zhang are the founders of and employed at the Ruili Group. Therefore, the Ruili
      Group exercises considerable control over the Joint Venture. There can be no
      assurance that in the event of a conflict between us and the Ruili Group that
      the operations of the Joint Venture and 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, licensing of certain technology, and is the
      landlord of our existing factory and warehouse space. The Ruili Group also
      sells
      to us certain non-valve products which allow us to fill out our product lines
      which in 2006 represented approximately 26% 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 service our indebtedness without the
      benefit of current revenues.




-15-




***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 the production capacity of 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 damage our reputation and goodwill.




***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 gross 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 Xiao Feng Zhang, 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 Xiao Feng Zhang. The loss of the
      services of either 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 effectively respond 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 growth 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
      extend relatively long payment terms for accounts receivable which can adversely
      affect our cash flow.***




As
      is
      customary in China, we currently extend relatively long payment terms to certain
      of our China based customers (generally 90-180 days for our OEM customers and
      60-90 days for our aftermarket customers). As a result of the size of many
      of
      our orders, these extended terms adversely affect our cash flow and our ability
      to fund our operations out of our operating cash flow. In addition, the reserves
      we establish for our receivables may not prove to be adequate in view of actual
      levels of bad debts. The failure of our customers to pay us timely would
      negatively affect our working capital, which could in turn adversely affect
      our
      cash flow.




-16-




Our
      customers often place large orders for products, requiring fast delivery, which
      impacts our working capital. If our customers do not incorporate our products
      into their products and sell them in a timely fashion, for example, due to
      excess inventories, sales slowdowns or other issues, they may not pay us in
      a
      timely fashion, even on our extended terms. This failure to pay timely may
      defer
      or delay further product orders from us, which may adversely affect our cash
      flows, sales or income in subsequent periods.




***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.




***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 7% of our revenues for the
      fiscal year ended December 31, 2006, our three largest customers accounted
      for
      approximately 15.2% and 16% of our revenues in 2006 and 2005, respectively.
      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 dominant 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 eleven patents in China,
      and have filed applications for another in China and additional three in the
      U.S.. 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 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.




-17-




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




·
            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




·
            Overall
                management 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.




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.




-18-




***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.




As
      described below, we are currently planning to establish a second manufacturing
      facility, also to be located in China. Even with both facilities operational,
      we
      would still be subject to a material risk to our operations if either facility
      experiences a significant disruption.




***If
      we are unable to expand our manufacturing capacity as planned, we may be unable
      to satisfy demand for our products.***




We
      believe we will have to expand our manufacturing capacity to meet anticipated
      demand for our products. We are currently constructing a new facility in Ruian
      City, approximately five miles from our existing facility, to meet our
      manufacturing demands. The construction commenced in December 2006, and as
      of
      December 31, 2006, we have spent approximately $6.1 million out of the net
      proceeds received from the follow-on public offering closed in November 2006.
      While we believe that our new facility will be completed in approximately one
      year, we may not be able to complete the construction of this facility within
      our anticipated time frame or budget. If we cannot complete the planned
      construction, in a timely manner, our ability to meet demand for our products
      would be adversely affected.




***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 cause 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
      2006,
      approximately 68% 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.
  ***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 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 1978, 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.
  -21-
  ***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. This change in policy resulted initially
        in an approximately 5.7% appreciation in the value of Renminbi against the
        U.S.
        dollar. 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.
  ***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
  -22-
  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
        economic reform policies or nationalization 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.
  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;
  -23-
  ·
              Economic
                  policies will not be significantly altered from time to time;
                  and
  ·
              Business
                  operations in China will not become subject to the risk of
                  nationalization.
  Over
        the
        last few years, China’s economy has registered a high growth rate. Recently,
        there have been indications that rates of inflation have increased. In response,
        the Chinese government recently has taken measure to curb this excessively
        expansive economy. These measures have included restrictions on the availability
        of domestic credit, reducing the purchasing capability of certain of its
        customers, and limited re-centralization of the approval process for purchases
        of some foreign products. These austere measures alone may not succeed in
        slowing down the economy’s excessive expansion or control inflation, and may
        result in severe dislocations in the Chinese economy.
  The
        Chinese government may adopt additional measure to further combat inflation,
        including the establishment of freezes or restraints on certain projects
        or
        markets. These measures may adversely affect our operations. For example,
        we
        believe that certain macroeconomic measures adopted by the Chinese government
        negatively impacted the demand for trucks in 2005, thus decreasing the demand
        from Chinese truck manufacturers for our products.
  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.
        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:
  ·
              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.
  -24-
  Any
        of
        the foregoing events or other unforeseen consequences of public health problems
        could result in reduction in net sales of our products.
  ***Because
        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 any waste will 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 will increase our operating costs.
  ***Changes
        in tax and other benefits may adversely impact our results of
        operations.***
  The
        legal
        authorities in China are in the process of evaluating tax and fee benefits
        previously provided to foreign investors and companies to encourage development
        within the country. These benefits may be lessened or removed with the
        consequence that expenses may rise impacting margins and net
        income.
  The
        legal
        authorities are evaluating tax and fee benefits that have been available
        to
        foreign investors and companies operating in China and tax holidays for new
        enterprises. It is anticipated, in the near term, there will be changes that
        substantially reduce or eliminate many, if not all, the tax and other
        governmental fee advantages that heretofore have been available to foreign
        entities and newly created entities whether or not such new entities are
        foreign. The goal is to institute greater equalization of tax and government
        fee
        treatment of all corporate and similar entities in China. China is being
        encouraged to create this more equal treatment because of its WTO obligations
        and public opinion within China. There may be phase-ins of various taxes
        and
        fees for entities that currently benefit from either no or lower tax rates
        and
        fees compared to wholly Chinese companies and entities, but there can be
        no
        assurance of this. Even if there are phase-in periods, the length of such
        periods is not known. Overall, it is expected that the cost of operating
        in
        China will increase for those companies and entities that have had various
        tax
        and fee advantages in the past.
  **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 is likely to be highly volatile and subject
        to
        wide 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,
  ·
              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
  -25-
  ·
              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, our Chief Operating Officer, hold approximately 49.7% and 6.2%,
        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 will have an adverse affect on the business by restricting access to
        working capital to fund growth and operations. Furthermore, the current ratios
        of ownership of our common stock reduce the public float and liquidity of
        our
        common stock which can in turn 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.
  ***Compliance
        with the Sarbanes-Oxley act could cost hundreds of thousands of dollars,
        require
        additional personnel and require hundreds of man hours of effort, and there
        can
        be no assurance that we will have the personnel, financial resources or
        expertise to meet requirements of these regulations.***
  The
        US
        Public Company Accounting Reform and Investor Protection Act of 2002, better
        known as Sarbanes-Oxley, is the most sweeping legislation to affect publicly
        traded companies in 70 years. Sarbanes-Oxley created a set of complex and
        burdensome regulations. Compliance with such regulations requires hundreds
        of
        thousands of dollars, additional personnel and hundreds of man hours of effort.
        There can be no assurance that we will have the personnel, financial resources
        or expertise to meet requirements of these regulations.
  **ITEM
        1B. UNRESOLVED STAFF COMMENTS**
  Not
        Applicable.
  -26-
  **ITEM
        2. DESCRIPTION OF PROPERTY**
  Our
        facilities are located in Ruian District of Wenzhou City in the Zhejiang
        Province, which is the center of automotive parts production in China. The
        facilities include 271,713 square feet of factory and warehouse, which we
        rent
        from the Ruili Group under a ten-year lease. The annual rent is approximately
        $457,845 the terms of which are at least as favorable as those that could
        have
        been obtained from an unrelated party. We also share office space of 10,764
        square feet with the Ruili Group which we utilize free of charge. At the
        production facility, the Company has production equipment, which is imported
        from the United States, Korea, Taiwan as well as manufactured in mainland
        China.
  **ITEM
        3. LEGAL PROCEEDINGS**
  We
        are
        not a party to any pending litigation.
  **ITEM
        4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**
  There
        were no matters submitted to the stockholders in the fourth quarter of
        2006.
  **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 to list its common shares on
        the
        NASDAQ Capital Market and commence trading its shares on NASDAQ under the
        symbol
“SORL”. The Company was further approved to be listed on NASDAQ Global Market on
        November 21, 2006. Before April 18, 2006, our shares were quoted on the
        Over-The-Counter Bulletin Board. The following table sets forth, for the
        periods
        indicated, the high and low prices per share of our common stock.
  **Quarter
                  Ended**
              
              **High**
              
              **Low****2005**March
                  31
              
              
              8.00
              
              
              6.50June
                  30
              
              
              7.50
              
              
              2.75September
                  30
              
              
              7.00
              
              
              5.25December
                  31
              
              
              6.60
              
              
              5.00**2006**March
                  31
              
              
              5.95
              
              
              4.16June
                  30
              
              
              12.00
              
              
              5.65September
                  30
              
              
              8.21
              
              
              5.81December
                  31
              
              
              12.00
              
              
              5.77
 
 **Stockholders**
  At
        March
        12, 2007, we had approximately 828 registered stockholders of record of our
        common stock. This number does not include shares held by brokerage clearing
        houses, depositories or otherwise in unregistered form.
  **Dividend**
  We
        have
        never 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.
  -27-
  **Securities
        Authorized For Issuance Under Equity Compensation Plans**
  The
        following table summarizes the securities authorized for issuance under our
        2005
        Stock Compensation Plan, the number of shares of our common stock issuable
        upon
        the exercise of outstanding options, warrants and rights, the weighted average
        exercise of such options and the number of additional shares of our common
        stock
        remaining available for issuance.
  **Plan
                  Category**
              
              **Number
                  of securities to be issued upon exercise of outstanding options,
                  warrants
                  and rights**
              
              **Weighted
                  average exercise price of outstanding option warrants and
                  rights**
              
              **Number
                  of securities available for future issuance under equity compensation
                  plans**Equity
                  Compensation plans not approved by security holders
              
              
              60,000
              
              
              
              
              
              1,590,500Total
              
              
              60,000
              
              
              
              
              
              1,590,500
 
 Our
        2005
        Stock Compensation Plan was adopted by our board of directors in July 2005.
        We
        have reserved 1,700,000 shares for issuance under the 2005 Stock Compensation
        Plan of which options to purchase 60,000 shares have been granted and 49,500
        shares have been awarded to date.
  **Recent
        Sales of Registered Securities; Use of Proceeds from Registered
        Securities.**
  On
        November 30, 2006, SORL completed its follow-on public offering of 4,285,714
        shares of common stock at $7.25 per share. Maxim Group LLC and Chardan Capital
        Markets, LLC acted as representatives of the underwriters. 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 the follow-on offering, exercised the
        over-allotment option in full to purchase an additional 642,857 shares of
        common
        stock. After deduction of the underwriter’s discount of $0.3 million,
        approximately $4.3 million was received by the Company. The aggregate net
        proceeds to the Company of this offering were approximately US$32.5 million,
        which included $4.3 million as a result of the exercise of the over-allotment
        option.
  As
        of
        December 31, 2006, the Company used approximately $22.7 million out of the
        net
        offering proceeds for working capital or new projects, including approximately
        $16.6 million for temporary repayment of short-term bank loans and $6.1 million
        as capital expenditures for the purchase of the land use right from the Ruili
        Group (a related party) and for construction of the new plant. The Company
        has
        reached agreement with local banks to temporarily repay its outstanding
        obligations when it has sufficient cash in account before spending the funds
        according to its business plan. In subsequent periods, the remaining net
        offering proceeds will be invested in new plant construction, new machinery
        and
        equipment purchase, R&D efforts, international sales and marketing
        activities, as well as to meet additional working capital requirements. Other
        than the payments to Ruili Group as mentioned above, none of the net offering
        proceeds were paid, directly or indirectly, to directors, officers and persons
        who beneficially own ten percent or more of our equity securities.
  -28-
  **ITEM
        6. CONSOLIDATED SELECTED FINANCIAL DATA**
  The
        following selected consolidated financial data should be read in conjunction
        with the Consolidated Financial Statements and Notes thereto and “Management’s
        Discussion and Analysis of Financial Condition and Results or Operation”
appearing elsewhere in this report.
  **Years
                  ended December 31,****(in
                  thousands, of US dollars except per share data)**
              
              **2006**
              
              **2005**
              
              **2004**
              
              **2003**
              
              **2002****RESULTS
                  OF OPERATIONS**Revenues
              
              
              84,898
              
              
              64,183
              
              
              46,815
              
              
              33,121
              
              
              24,250Income
                  before income tax provision
              
              
              9,748
              
              
              5,500
              
              
              5,341
              
              
              3,844
              
              
              1,807Income
                  tax provision
              
              
              (1,253
              )
              
              —
              
              
              —
              
              
              (546
              )Net
                  income before minority interest
              
              
              8,495
              
              
              5,500
              
              
              5,341
              
              
              1,150
              
              
              1,626Minority
                  interest
              
              
              (797
              )
              
              (550
              )
              
              (534
              )
              
              —
              
              
              —Net
                  income attributable to shareholders
              
              
              7,698
              
              
              4,950
              
              
              4,807
              
              
              1,150
              
              
              1,626Earnings
                  per share:Basic
              
              
              0.56
              
              
              0.37
              
              
              0.37
              
              
              0.09
              
              
              0.12Diluted
              
              
              0.56
              
              
              0.37
              
              
              0.37
              
              
              0.09
              
              
              0.12**FINANCIAL
                  POSITION**Cash,
                  cash equivalents and restricted cash
              
              
              11,138
              
              
              961
              
              
              730
              
              
              —
              
              
              —Total
                  assets
              
              
              70,880
              
              
              39,301
              
              
              22,520
              
              
              12,903
              
              
              7,852Long
                  term debt, net of current portion
              
              
              —
              
              
              —
              
              
              —
              
              
              1,208
              
              
              605
 
 **SELECTED
        UNAUDITED QUARTERLY RESULTS OF OPERATIONS**
  In
        the
        opinion of management, the accompanying unaudited quarterly financial
        information presented below includes all adjustments which management considers
        necessary to present fairly the results of its operations for the periods
        presented below in conformity with accounting principles generally accepted
        in
        the United States of America. This quarterly financial information has been
        prepared consistently with the accounting policies described in the accompanying
        audited consolidated financial statements for the year ended December 31,
        2006.
        The results of operations for the periods presented below are not necessarily
        indicative of the results of operations to be expected in the
        future.
  -29-
  **Fiscal
                  Quarters Ended,****2006**
              
              **2005**
              
              **2004****(in
                  thousands of US dollars****except
                  per share data)**
              
              **Mar.
                  31**
              
              **Jun.
                  30**
              
              **Sep.
                  30**
              
              **Dec.
                  31**
              
              **Mar.
                  31**
              
              **Jun.
                  30**
              
              **Sep.
                  30**
              
              **Dec.
                  31**
              
              **Mar.
                  31**
              
              **Jun.
                  30**
              
              **Sep.
                  30**
              
              **Dec.
                  31**Revenues
              
              
              19,420
              
              
              20,117
              
              
              21,288
              
              
              24,073
              
              
              14,516
              
              
              14,924
              
              
              16,377
              
              
              18,366
              
              
              9,091
              
              
              11,340
              
              
              12,595
              
              
              13,789Operating
                  expenses:
              
              
              (1,965
              )
              
              (1,463
              )
              
              (2,192
              )
              
              (2,740
              )
              
              (1,481
              )
              
              (1,607
              )
              
              (1,673
              )
              
              (1,351
              )
              
              (1,196
              )
              
              (1,227
              )
              
              (1,143
              )
              
              (1,949
              )Income
                  (loss) from operations
              
              
              2,431
              
              
              3,177
              
              
              2,585
              
              
              2,714
              
              
              1,738
              
              
              1,756
              
              
              1,794
              
              
              940
              
              
              1,039
              
              
              1,427
              
              
              1,745
              
              
              1,472Interest
                  income (expense), net
              
              
              (266
              )
              
              (242
              )
              
              (260
              )
              
              (287
              )
              
              (60
              )
              
              (126
              )
              
              (145
              )
              
              (358
              )
              
              (80
              )
              
              (76
              )
              
              (78
              )
              
              (53
              )Other
                  income (expense)
              
              
              (90
              )
              
              2
              
              
              (52
              )
              
              36
              
              
              (9
              )
              
              (66
              )
              
              (13
              )
              
              49
              
              
              —
              
              
              (36
              )
              
              (13
              )
              
              (6
              )Pre-tax
                  income (loss)
              
              
              2,076
              
              
              2,936
              
              
              2,274
              
              
              2,462
              
              
              1,669
              
              
              1,563
              
              
              1,636
              
              
              631
              
              
              959
              
              
              1,314
              
              
              1,654
              
              
              1,413Income
                  tax provision
              
              
              (294
              )
              
              (294
              )
              
              (311
              )
              
              (354
              )
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —Net
                  income
              
              
              1,604
              
              
              2,378
              
              
              1,766
              
              
              1,950
              
              
              1,502
              
              
              1,407
              
              
              1,473
              
              
              568
              
              
              863
              
              
              1,183
              
              
              1,489
              
              
              1,272
 
 -30-
  **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 or 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 projected. Undue reliance should
        not be
        placed on these forward-looking statements that 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 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. Certain historical information of the Transferred Business
        is based on the operation of the Transferred Business when it was owned by
        the
        Ruili Group.
  -31-
  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 $3.63million. 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 valves and
        related
        components in China and internationally for use primarily in vehicles weighing
        over three tons, such as trucks and buses. There are forty categories of
        valves
        with over eight hundred different specifications. Management believes that
        it is
        the largest manufacturer of automotive brake valves in China.
  **CRITICAL
        ACCOUNTING POLICIES AND ESTIMATES**
  Below
        is
        a description of accounting policies, which we consider critical to the
        preparation and understanding of our financial statements. In addition, certain
        amounts included in or affecting our financial statements and related disclosure
        must be estimated, which requires us to make assumptions with respect to
        values
        or conditions which cannot be known with certainty at the time the financial
        statements are prepared. Actual results may differ from these estimates under
        different assumptions or conditions. The selection of critical accounting
        policies, the judgments and other uncertainties affecting the application
        of
        those policies and the sensitivity of reported results to changes in conditions
        and assumptions are factors to be considered when reviewing our consolidated
        financial statements.
  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.
  **ACCOUNTING
        METHOD**
  The
        Company uses the accrual method of accounting which recognizes revenues when
        earned and expenses when incurred.
  **ACCOUNTS
        RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS**
  The
        Company presents accounts receivable, net of allowance for doubtful accounts.
        The allowance is calculated based on review of individual customer
        accounts.
  -32-
  **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 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 accumulative profit-making year. SORL
        is
        entitled to a 50% income tax reduction in the fiscal years ended December
        31,
        2006, 2007 and 2008. The applicable income tax rate is 26.4% in Ruian City
        which
        is located in the coastal economic development zones.
  **REVENUE
        RECOGNITION**
  In
        accordance with the provisions of Staff Accounting Bulletin No. 103, revenue
        is
        recognized when merchandise is shipped and title passes to the customer and
        collectibility is reasonably assured. Revenues consist of the invoice value
        of
        the sale of goods and services net of value added tax, rebates and discounts.
        The Company is subject to the following surtaxes, which are recorded as
        deductions from gross sales: Education Tax.
  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
        collectibility of outstanding accounts receivable.
  **RESULTS
        OF OPERATIONS**
  Year
        ended December 31, 2006 as compared to year ended December 31,
        2005:
  -33-
  **SALES**
  **Years
                  Ended December 31,****2006**
              ****
              **%**
              ****
              **2005**
              ****
              **%****(U.S.
                  dollars in million)****Sales**Air
                  brake valves & related components
              
              $
              63.0
              
              
              74.2
              %
              $
              47.9
              
              
              74.6
              %Non-valve
                  products
              
              $
              21.9
              
              
              25.8
              %
              $
              16.3
              
              
              25.4
              %Total
              
              $
              84.9
              
              
              100.0
              %
              $
              64.2
              
              
              100.0
              %
 
 Sales
        consisted of air brake valves and related components manufactured by SORL
        and
        sold to domestic OEM and aftermarket customers and international customers;
        as
        well as distribution of non-valve auto parts sourced from related
        parties.
  Total
        net
        sales were $84,898,316 and $64,182,544 for the fiscal years ended December
        31,
        2006 and 2005, respectively, representing an increase of $20.7 million or
        32%
        year over year. The increase in sales was primarily due to the expansion
        in the
        domestic OEM market, the domestic aftermarket and international market as
        a
        result of improvement in the Company’s sales network.
  A
        breakdown of net sales revenue for our three market segments, domestic OEM
        market, domestic aftermarket and international markets, in 2006 and 2005
        is as
        follows:
  **Years
                  Ended December 31,****2006**
              
              **%**
              
              **2005**
              
              **%****(U.S.
                  dollars in million)**China
                  OEM market
              
              $
              27.1
              
              
              32
              %
              $
              20.6
              
              
              32
              %China
                  Aftermarket
              
              $
              23.9
              
              
              28
              %
              $
              20.2
              
              
              32
              %International
                  market
              
              $
              33.9
              
              
              40
              %
              $
              23.4
              
              
              36
              %Total
              
              $
              84.9
              
              
              100
              %
              $
              64.2
              
              
              100
              %
 
 After
        experiencing a market decline in 2005, China’s heavy duty trucks output and
        sales volume increased by 15.4 % year over year in 2006. With the Chinese
        heavy
        duty truck market’s rebounding gradually, the Joint Venture’s sales for the OEM
        market increased by $6.5 million or 31.6% for the year ended December 31,
        2006,
        as compared to the year ended December 31, 2005. The Joint Venture expanded
        its
        OEM market share basically from its existing major customers. The Company
        has
        been able to quickly respond to customers’ requirements for new products.
  With
        one
        new distributor’s joining in 2006, we now have 28 authorized distributors
        covering nearly all regions in China. Those distributors are responsible
        for
        selling our products through over 800 sub-distributors in turn. With the
        rapid
        growth of commercial vehicles output in recent years and the increasing amount
        of vehicles on the road, demand for parts has increased. Based on our well
        established sales networks, SORL achieved revenue of $23.9 million in domestic
        aftermarket sales, an increase of $3.7 million, or 18.3% from 2005.
  In
        2006,
        the Middle East segment had the largest share of overseas sales. The American
        segment experienced the fastest growth, followed by the European segment.
        Export
        sales grew by approximately 44.9%, from $23.4 million in 2005 to $33.9 million
        in 2006. The increase reflects our continued focus on sales and marketing
        efforts. Moreover, the Company has been able to 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. Those accounted for
        approximately 25.8 % and 25.4% of total sales in 2006 and 2005, respectively.
        To
        penetrate the India OEM market, in 2006, the Joint Venture set up a sales
        office
        in Pune, India.
  -34-
  **COST
        OF SALES**
  Cost
        of
        sales for the fiscal year ended December 31, 2006 increased to $65.6 million
        from $49.9 million for the fiscal year ended December 31, 2005, $15.7 million
        or
        a 31.6% increase, consistent with the increase in revenues.
  **GROSS
        PROFIT**
  Gross
        profit for the fiscal year ended December 31, 2006 increased by approximately
        $5.0 million or 34.6% to $19.3 million from $14.3 million for the fiscal
        year
        ended December 31, 2005. Gross margin increased by approximately 0.4% from
        22.3%
        in 2005 to 22.7% in 2006. The improvement in gross profit margin was primarily
        attributable to economies of scale, shift of products mix and the introduction
        of new valve products with higher profit margins and continuing efforts in
        production technique optimization.
  We
        purchase various components and raw materials for use in our manufacturing
        processes. The principal raw materials are aluminum and steel. Aluminum and
        steel accounted for 33% and 17% of our total raw material purchases in 2006,
        respectively. For the fiscal year ended December 31, 2006, the price of steel
        plate decreased by approximately 22%, as compared with 2005.However, the
        average
        price of aluminum still continued to increase as it had in the past two years.
        The average price of aluminum increased by approximately 14 % in 2006 compared
        to 2005. The increased price of raw material has had an adverse effect on
        our
        profit, but the decrease in the price of steel partly offset the negative
        impact
        of the increase of aluminum. Additionally, we took several steps to lower
        our
        production cost. For example, we replaced the machining approach with a molding
        process, thereby reducing processing steps and materials consumption and
        increasing productivity. In addition, in the process of removing impurities
        from
        liquid aluminum, historically we have used the high-temperature method. The
        adoption of the new technique of using a low-temperature method helped save
        power consumption.
  **SELLING,
        GENERAL AND ADMINISTRATIVE EXPENSES**
  Selling,
        general and administrative expenses for the fiscal year ended December 31,
        2006
        were $8.4 million or 9.85% of net sales compared to $8.1 million or 12.6%
        of net
        sales for the fiscal year ended December 31, 2005. The increase in expenses
        is
        primarily due to the effect of the following factors:
  (1)  Increased
        product warranty expenses. The Company recorded $1,867,514 of product warranty
        expenses for the fiscal year ended December 31, 2006, as compared to $778,763
        for the fiscal year ended December 31, 2005, an increase of $1,088,751, mainly
        attributed to a specific “3-R Warranties” service charge (for repair,
        replacement and refund) paid to an OEM customer.
  (2)  Professional
        fees increased by $303,534 compared with 2005. The professional fees include
        auditing and legal fees associated with SEC filings, director’s fees and related
        consulting fees, stock transfer fees and other items associated with the
        costs
        of being a public entity.
  (3)  R&D
        expense, which is included in general and administrative expenses, increased
        by
        $412,129, as compared to the fiscal year ended 2005, as discussed
        below.
  (4)  The
        aforementioned increases were largely offset by the reversing of a bad debt
        provision of $ 911,000, which was mainly due to the collection of a significant
        portion of account receivables with aging over one year during
        2006.
  -35-
  **DEPRECIATION
        AND AMORTIZATION**
  Depreciation
        and amortization expense increased to $1.06 million for the fiscal year ended
        December 31, 2006, compared with depreciation and amortization expense of
        $0.86
        million for the fiscal year ended December 31, 2005.
  The
        increase in depreciation expense was primarily due to new investment in fixed
        assets, mainly production equipment and tools in 2006 in the amount of $4.4
        million, to upgrade the processing techniques and increase output.
  **FINANCIAL
        EXPENSE**
  Financial
        expense for the fiscal year ended December 31, 2006 increased by $366,426
        to
        $1,055,237 from $688,811 for the fiscal year ended December 31, 2005. Financial
        expense mainly consist of interest expense and exchange loss. The interest
        expense increased by approximately $0.26 million to approximately $0.78 million
        for 2006, compared with $0.52 million for 2005. The increase was mainly due
        to
        higher average borrowing levels. Additionally, accounts receivable and deposits
        received from customers, associated with overseas sales, are denominated
        in US
        dollars. The appreciation of the RMB against the U.S. dollar resulted in
        larger
        exchange loss during 2006. The Company recognized the exchange loss of $0.26
        million and $0.15 million for the fiscal year ended December 31, 2006 and
        2005,
        respectively, an increase of $0.11 million.
  **OTHER
        INCOME**
  For
        the
        fiscal year ended December 31, 2006, other income included subsidy income
        of
        $139,308 compared with $52,592 for the fiscal year ended December 31, 2005.
        Through local governments, these subsidies were provided to the Company as
        economic incentives to secure business commitments and no repayment is
        required.
  **INCOME
        TAX**
  There
        was
        no income tax expense for the fiscal year ended December 31, 2005 and 2004.
        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 three years ended December 31, 2006, 2007, and 2008. Income
        taxes expense of $1,252,858 was recorded for the fiscal year ended December
        31,
        2006.
  **STOCK-BASED
        COMPENSATION**
  On
        January 5, 2006 the Company issued 100,000 warrants for the financial services
        to be provided by Maxim Group LLC and Chardan Capital Markets, LLC, with
        an
        exercise price of $6.25 per share and a contractual term of four years. In
        accordance with the common stock purchase warrant agreement, the warrants
        became
        vested and exercisable immediately on the date thereof. Total deferred
        stock-based compensation expenses related to the 100,000 warrants granted
        was
        $299,052. This amount is amortized over one year in a manner consistent with
        Financial Accounting Standards Board Interpretation No. 123 (R). The
        amortization of deferred stock-based compensation for these equity arrangements
        was $ 299,052 for the fiscal year ended December 31, 2006.
  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 Financial Accounting
        Standards Board Interpretation No. 123R. The amortization of deferred
        stock-based compensation for these equity arrangements was $49,697 for the
        fiscal year ended December 31, 2006.
  -36-
  Although
        the Company anticipates future issuances of stock awards to have a material
        impact on net income, we do not expect these awards to have a material impact
        on
        future cash flow.
  **MINORITY
        INTEREST**
  Minority
        interest represents a 10% non-controlling interest in the JV company. Minority
        interest in income was $ 797,117 and $549,957 for the fiscal year ended December
        31, 2006 and 2005, respectively.
  **NET
        INCOME**
  The
        net
        income for the fiscal year ended December 31, 2006 increased by approximately
        $2,748,284, to $7,697,894 from net income of $4,949,610 for the fiscal year
        ended December 31, 2005 due to the factors discussed above. Earnings per
        share
        (“EPS”) for basic and diluted for 2006 and 2005, was $0.56 and $0.37 per share,
        respectively.
  **FINANCIAL
        CONDITION**
  **LIQUIDITY
        AND CAPITAL RESOURCES**
  OPERATING
        -Net cash used in operating activities was $454,474 in the year ended December
        31, 2006 compared with that of $8,714,706 in the same period in 2005, a decrease
        of $8,260,232 or 94.8%. Our improvement in cash flow was primarily a result
        of
        the following:
  Our
        primary cash flows from net income were realized through the sale of automotive
        parts. The timely collection of accounts receivable will improve our liquidity.
        Our lower cash flow from operating activities in 2005 was mainly attributable
        to
        increased level of accounts receivable. However, in 2006, only $0.51 million
        of
        cash outflow was due to the same factor, a decrease of $13.1 million or 96%
        as
        compared with that for 2005. This is mainly due to our efforts of collecting
        a
        significant portion of the accounts receivable aged over one year. Additionally,
        to meet the requirements of sales growth and capacity expansion, we were
        required to keep a relatively higher level of inventories than in 2005. The
        level of prepayments also increased, as a result of the requirements to expand
        production facilities and purchase raw materials. For the fiscal year ended
        December 31, 2006, after adjustments for non-cash items, net income provided
        cash inflows of $9.1 million, which largely covered the increased working
        capital requirements as abovementioned. Management believes our cash flow
        will
        be improved gradually through the Company’s strategic move of its sales focus
        from the domestic OEM market to international markets, thereby providing
        the
        Company with the ability to restructure its OEM customer base by gradually
        phasing out customers with lower returns and higher credit risks.
  At
        December 31, 2006, the Company had cash and cash equivalents of $11,137,501,
        as
        compared to cash and cash equivalents of $961,131 at December 31, 2005. The
        Company had working capital of $47,195,220 at December 31, 2006, as compared
        to
        working capital of $10,571,086 at December 31, 2005, reflecting current ratios
        of 7.58:1 and1.49:1, respectively. The increase of working capital was mainly
        attributed to the balance of proceeds received from the follow-on public
        offering near the end of 2006, a large portion of which is scheduled to be
        gradually spent in the year of 2007.
  INVESTING-
        Net cash used in investing activities was $10,354,802 and $2,624,274 for
        the
        fiscal years ended December 31, 2006 and 2005, respectively. During fiscal
        2006,
        additional machines and equipment for purpose of capacity expansion were
        acquired for a total of $4,445,131. Other than machines and equipment, another
        major capital expenditure was for acquisition of the land use rights from
        Ruili
        Group (See Item 5 and Note 18) for $5,909,671. A new plant, for further
        expansion of air brake valves production capacity, will be constructed on
        the
        land. The Company has a total budget of approximately $15 million for this
        new
        plant building, inclusive of costs for land acquisition, leveling and
        construction of plant buildings.
  -37-
  FINANCING
        - Net cash provided by financing activities was $20,135,117 for the year
        ended
        December 31, 2006 compared to a net cash inflow in financing activities of
        $11,195,799 for the same period in 2005. During fiscal 2006, net cash provided
        by financing activities was primarily attributable to the net proceeds of
        our
        follow-on public offering (See Item 5) of approximately $32.5 million, including
        approximately $4.3 million as a result of the exercise of the over-allotment
        option granted to the underwriters. Additionally, another capital increase
        of
        $3.63 million was contributed from Ruili Group to the JV. Additionally, during
        fiscal 2006, the Company received in aggregate approximately $19.8 million
        short-term bank loans under its credit facilities. As a temporary approach
        to
        apply cash balances thereby saving interest expense, during fiscal 2006,
        the
        Company paid off outstanding loans which totaled $ 35.8 million. A large
        portion
        of the repayments, approximately $16.6 million, was funded from the net proceeds
        the public offering, with approval by the Company’s board of directors. The
        Company expects to make re-drawdowns in 2007 under the bank lines of credit,
        in
        line with its investment schedule related to the public offering.
  Management
        of the Company has taken a number of steps to restructure its customer base
        and
        phase out accounts which had failed to make prompt payments. The Company
        also
        placed more emphasis on receivable collection. During 2006, the Company
        continued developing higher profit margin new products, and adopting steps
        for
        further cost saving such as improving material utilization rate. Meanwhile,
        the
        Company maintains good relationships with local banks. We believe that our
        current cash and cash equivalents 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, 2006, 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.
  **RESULTS
        OF OPERATIONS**
  Year
        ended December 31, 2005 as compared to year ended December 31,
        2004:
  **SALES**
  **Sales**
              
              **2005**
              
              **2004**Air
                  brake valves & related components
              
              $
              47.9M
              
              
              74.6
              %
              $
              35.9M
              
              
              76.7
              %Non-valve
                  products
              
              $
              16.3M
              
              
              25.4
              %
              $
              10.9M
              
              
              23.3
              %Total
              
              $
              64.2M
              
              
              100.0
              %
              $
              46.8M
              
              
              100.0
              %
 
 Sales
        consisted of air brake valves and related components manufactured by SORL
        and
        sold to domestic OEM and aftermarket customers and international customers;
        as
        well as distribution of non-valve auto parts sourced from related
        parties.
  Total
        net
        sales were $64,182,544 and $46,815,037 for the fiscal years ended on December
        31, 2005 and 2004, respectively. Net sales in 2005 increased by $17.4 million
        or
        37% to $64.2 million, compared with 2004, despite an approximately 36% decrease
        in the output of heavy duty trucks in China. The increase in sales was primarily
        due to the expansion in the international market and in China’s aftermarket as a
        result of improvement in the Company’s China sales network.
  -38-
  A
        breakdown of net sales revenue for our three market segments, domestic OEM
        market, domestic aftermarket and international market, in 2005 and 2004 is
        as
        follows:
  **Years
                  Ended December 31,****2005**
              
              **%**
              
              **2004**
              
              **%****(U.S.
                  dollars in million)**China
                  OEM market
              
              $
              20.6
              
              
              32
              %
              $
              22.0
              
              
              47
              %China
                  Aftermarket
              
              $
              20.2
              
              
              32
              %
              $
              12.2
              
              
              26
              %International
                  market
              
              $
              23.4
              
              
              36
              %
              $
              12.6
              
              
              27
              %Total
              
              $
              64.2
              
              
              100
              %
              $
              46.8
              
              
              100
              %
 
 For
        2005,
        China’s heavy duty trucks output decreased by 35.7% compared to that in 2004, in
        contrast to a 45% increase in 2004 from 2003, primarily due to the Chinese
        Government’s macroeconomic regulation policy for 2005. Notwithstanding the
        decrease in output, sales revenue for this market segment decreased relatively
        slightly by 6.4% from $22 million in 2004 to $20.6 million in 2005, principally
        because of the introduction of new products to satisfy the OEM customers’
requirements, and the granting of extended credit terms to a selected number
        of
        OEM customers, such as FAW and Dongfeng Group, on a temporary basis, so as
        to
        maintain market share and strengthen long term relationships.
  Currently
        SORL has 27 authorized distributors covering nearly all regions in China,
        who in
        turn sell the products to over 800 sub-distributors. Based on the well
        established and continuously improving sales networks, SORL achieved total
        revenue of $20.2 million in domestic aftermarket sales, an increase of $8
        million, or 65.7% from 2004. During the year, the Company adjusted its
        compensation plan for distributors to increase sales growth.
  Export
        sales grew by approximately 83%, from $12.6 million in 2004 to $23.4 million
        in
        2005. The increase in sales was attributable to the introduction of new products
        and greater focus on participation in international trade shows leading to
        increased awareness of the Company’s products. Additionally, the Company has
        been able to 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. They accounted for approximately 20% of total export sales
        in
        both 2005 and 2004.
  **COST
        OF SALES**
  Cost
        of
        sales for the fiscal year ended December 31, 2005 increased to $49.9 million
        from $35.9 million for the fiscal year ended December 31, 2004, or a 39%
        increase consistent with the increase in revenues. Gross margin decreased
        by
        approximately 1% from 23.3% in 2004 to 22.3%.
  We
        purchase various components and raw materials for use in our manufacturing
        processes. The principal raw materials we purchase are aluminum and steel.
        The
        price of aluminum and steel has increased significantly in 2004, with aluminum
        prices continuing to increase in 2005. Steel prices peaked in March 2005
        and
        then started to decrease until they reached levels even lower than prices
        incurred during 2004. Experts predict that aluminum and steel prices will
        increase in 2006.
  The
        Company’s average purchase price (net of VAT) for steel materials (including
        stainless steel sheets) in 2005 was approximately $600 per ton, compared
        with
        $465 per ton on average in 2004, and $480 per ton at the end of 2005. The
        average purchase price (net of VAT) for aluminum ingot in 2005 was approximately
        $1,865 per ton, in contrast to the levels of $1,680 per ton on average in
        2004,
        and $1,950 per ton at the end of 2005.
  Total
        purchases of steel and aluminum materials in 2005 were 20,371 tons and 3,614
        tons, respectively.
  -39-
  **GROSS
        PROFIT**
  Gross
        profit for the fiscal year ended December 31, 2005 increased by $3.4 million
        or
        31% to $14.3 million from $10.9 million for the fiscal year ended December
        31,
        2004, while gross margin decreased by approximately 1% from 23.3% in 2004
        to
        22.3%.
  The
        approximately 2% appreciation of RMB against USD in late July 2005 had a
        certain
        negative impact on the gross margin, since in 2005, about 36% of total revenue
        was denominated in US Dollars, while nearly all costs were denominated in
        RMB.
        However, this impact was minimal as this resulted in an effect of approximately
        0.3% on Gross Margin.
  The
        materials price increases have had an adverse impact on gross margin, since
        some
        of the increases cannot be passed on to our customers. This negatively impacted
        our gross margin by 1.2% in 2005, or approximately $0.8 million.
  This
        negative impact on Gross Margin was largely offset by economies of scale
        and
        consistent efforts in production technique optimization. For example, in
        2005,
        we replaced the machining approach with a molding process, thereby reducing
        processing steps and materials consumption and increasing hourly output.
        Meanwhile, in the process of removing impurities from liquid aluminum,
        historically we used the high-temperature method. The adoption of a new
        technique of using a low-temperature method helped save power
        consumption.
  **SELLING,
        GENERAL AND ADMINISTRATIVE EXPENSES**
  Selling,
        general and administrative expenses for the fiscal year ended December 31,
        2005
        was $8.1 million or 12.6% of net sales compared to $5.2 million or 11.2%
        of net
        sales for the fiscal year ended December 31, 2004.
  The
        Company incurred $3.9 million in selling and distribution expenses for 2005,
        a
        43% increase from 2004. In addition to the increase in sales, the higher
        selling
        expenses were mainly attributable to the Company’s increased focus in
        international sales and marketing, including active participation in various
        trade shows and fairs, in an attempt to gather industry information, keep
        up
        with world market trends and acquaint and acquire more new
        customers.
  General
        and administrative expenses for the fiscal year ended December 31, 2005 amounted
        to $4.2 million, increasing by 68% from 2004. The major increase came from
        the
        increase in the provision of bad debt expense of $0.85 million in 2005, since
        we
        had experienced prolonged account receivable cycles from some of our customers.
        The remaining general and administrative expenses as a percentage of sales
        decreased as compared to 2004 as most of these expenses are fixed in nature,
        and
        coupled with the increase in revenues, we experienced economies of
        scale.
  **DEPRECIATION
        AND AMORTIZATION**
  Depreciation
        and amortization expense increased to $0.86 million for the fiscal year ended
        December 31, 2005, compared with depreciation and amortization expense of
        $0.55
        million for the fiscal year ended December 31, 2004.
  The
        increase in depreciation expense was primarily due to new investment in fixed
        assets, mainly production equipment and tools in 2005 for the amount of $2.6
        million, to upgrade the processing techniques and increase output.
  -40-
  **FINANCIAL
        EXPENSE**
  Financial
        expense for the fiscal year ended December 31, 2005 increased by $401,378
        to
        $688,811 from $287, 433 for the fiscal year ended December 31, 2004. Financial
        expenses consist of mainly interest expense. The increase in interest expense
        was due to the higher outstanding debt balance during the year, reaching
        $16
        million as of December 31, 2005, an increase of $11.2 million from $4.8 million
        at the end of 2004. The new drawdown of bank loans in 2005 was primarily
        for
        purpose of working capital use, as well as new equipment purchase, to support
        the sales growth.
  Interest
        rates ranged between 4.964% and 6.003% per annum.
  **INCOME
        TAX**
  There
        was
        no income tax expense for the fiscal year ended December 31, 2005 and 2004.
        As a
        result of the Joint Venture obtaining its sino-foreign joint venture status
        in
        2004, per applicable PRC tax regulations, the Company is exempted from PRC
        income tax in both fiscal 2004 and 2005.
  **MINORITY
        INTEREST**
  Minority
        interest represents a 10% non-controlling interest in the company. Minority
        interest in income amounted to US$549,957 and US$534,105 for the fiscal year
        ended December 31, 2005 and 2004, respectively.
  **FOURTH
        QUARTER ADJUSTMENT**
  During
        the fourth quarter of 2005, a significant adjustment in the amount of $794k
        was
        made to provide for potentially uncollectible accounts. That change was
        necessitated by the extension of temporary special credit terms to certain
        customers. Those special credit terms extended payment arrangements for certain
        customers for up to one year.
  **NET
        INCOME**
  The
        net
        income for the fiscal year ended December 31, 2005 increased by approximately
        $142,666, to a net income of $4,949,610 from a net income of $4,806,944 for
        the
        fiscal year ended December 31, 2004 due to the factors discussed above. Earnings
        per share (“EPS”) for basic and diluted for 2005 and 2004, was $0.37 per
        share.
  **FINANCIAL
        CONDITION**
  **LIQUIDITY
        AND CAPITAL RESOURCES**
  OPERATING
        -The Company’s operations utilized cash resources of $8,714,706 for the fiscal
        year ended December 31, 2005, as compared to generating cash resources of
        $2,336,592 for the fiscal year ended December 31, 2004, primarily as a result
        of
        the following:
  1.  For
        the
        year ended December 31, 2005, cash flow provided by sales was $7,574,462
        as
        compared to $5,963,694 for the year ended December 31, 2004, an increase
        of
        $1,610,768. The increase was primarily as a result of the increase in
        sales.
  2.  For
        the
        year ended December 31, 2005, account receivables increased by $13,590,206,
        primarily due to the temporary extension of credit terms to selected OEM
        customers as well as certain domestic aftermarket distributors as discussed
        above. Management believes this situation will be largely mitigated in 2006
        through the Company’s strategically move of its sales focus from its domestic
        OEM market to international markets, therefore providing the Company with
        the
        ability to restructure its OEM customer base by gradually phasing out customers
        with lower return and higher credit risks.
  -41-
  3.  For
        the
        year ended December 31, 2005, inventory increased by $637,283. The Company
        maintains a low level of inventory with an Inventory Conversion Period of
        approximately 19 days for 2005, the same as that for 2004, which largely
        reduced
        working capital requirements. Because of the strong demands for its products,
        the Company maintains less than one week of finished goods inventory. A low
        level of raw materials for approximately four to five days of production
        requirements are maintained in stock. Raw materials are readily available,
        given
        our access to different suppliers and efficient and timely delivery available.
        The majority of the WIP balances are incurred during later steps in
        manufacturing. The Company effectively adopts a “pull” system in its
        production.
  4.  For
        the
        year ended December 31, 2005, account payables decreased by $970,989, or
        20.5%,
        compared to the year ended December 31, 2004, mainly due to suppliers’
reluctance to extend long credit terms given the increased material prices.
        Prepayments at December 31, 2005 primarily represented advance payments for
        raw
        materials and equipment purchases. Prepayments as of December 31, 2005 increased
        by 28% to $1.8 million from $1.4 million as of December 31, 2004.
  At
        December 31, 2005, the Company had cash and cash equivalents of $961,131,
        as
        compared to cash and cash equivalents of $729,875 at December 31, 2004. The
        Company had working capital of $10,571,086 at December 31, 2005, as compared
        to
        working capital of $6,092,799 at December 31, 2004, reflecting current ratios
        of
        1.49:1 and 1.55:1, respectively.
  INVESTING
        - During the fiscal year ended December 31, 2005, the Company expanded net
        cash
        of $2,624,274 in the investing activities, including $2,623,151 for acquisition
        of property and equipment to support the growth of business. For the fiscal
        year
        ended December 31, 2004, the Company utilized $638,635 in investing
        activities.
  FINANCING
        - During the fiscal year ended December 31, 2005, the Company made new net
        drawdowns amounting to $11,195,799 from banks. During the fiscal year ended
        December 31, 2004, the Company paid off $968,082 on its outstanding debt.
        Net
        proceeds from bank loans were utilized primarily to cover the increasing
        working
        capital requirements in line with the rapid business growth, as well as cash
        requirements for new equipment acquisition given the growing demand for products
        and the limited production capacity buffer of the existing
        equipment.
  Management
        of the Company has taken a number of steps to restructure its customer base
        and
        phase out accounts which frequently fail to make prompt payments and bring
        lower
        returns in long run, placing more efforts on receivables collection, and
        continuing development of high profit margin new product, as well as adopting
        steps for further cost saving such as improving material utilization rate.
        Meanwhile, the Company maintains good relationships with local banks. In
        addition, the Company actively seeks opportunities for fund raising from
        the
        capital markets to finance further expansion of production, the building
        of
        international sales networks in new markets, strengthening of R&D force, and
        to supplement the working capital.
  At
        December 31, 2005, the Company does 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 market risk with respect to such factors as commodity
        prices, equity prices, and other market changes that affect market risk
        sensitive investments.
  -42-
  Although
        our reporting currency is the U.S. dollar, the functional currency of our
        JV
        enterprise 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. 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.
        As
        compared by December 31, 2005, the approximately 3.2% appreciation or
        fluctuation of the RMB against the USD did not have a material adverse effect
        on
        the Company’s operations, even though the Company has over one third of its
        total revenue denominated in USD. It is believed that further RMB appreciation
        against USD, if any, would be on a prudent, gradual basis with relatively
        small
        adjustments, so as to avoid drastic impacts on the Chinese economy as a
        whole.
  As
        the
        Company’s historical debt obligations are primarily short-term in nature, with
        fixed interest rates, the Company does not have any risk from an increase
        in
        market interest rates. However, to the extent that the Company arranges new
        borrowings in the future, an increase in market interest rate would cause
        a
        commensurate increase in the interest expense related to such
        borrowings.
  -43-
  **ITEM
        8 FINANCAL STATEMENTS AND SUPPLEMENTARY DATA**
 REPORT
          OF
          INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 
 To
          the
          Board of Directors
 and
          Stockholders
 SORL
          Auto
          Parts, Inc.
 Ruian
          City, Zhejiang Province
 People’s
          Republic of
          China
 
 We
          have
          audited the accompanying consolidated balance sheets of SORL Auto Parts,
          Inc. as
          of December
          31, 2006 and 2005, and the related consolidated statements of operations,
          changes in stockholders’
          equity, and cash flows for each of three years ended December 31, 2006,
          2005 and
          2004. These
          consolidated financial statements are the responsibility of the Company’s
          management. Our responsibility
          is to express an opinion on these consolidated financial statements based
          on our
          audits.
 
 We
          conducted our audits in accordance with the standards of the Public Company
          Accounting Oversight
          Board (United States). Those standards require that we plan and perform
          the
          audits to obtain reasonable
          assurance about whether the consolidated financial statements are free
          of
          material misstatement. An
          audit
          includes examining, on a test basis, evidence supporting the amounts and
          disclosures in the consolidated financial statements. An audit also includes
          assessing the accounting principles
          used and significant estimates made by management, as well as evaluating
          the
          overall consolidated
          financial statement presentation. We believe that our audits provide a
          reasonable basis for our
          opinion.
 
 In
          our
          opinion, the consolidated financial statements referred to above present
          fairly,
          in all material respects, the financial position of the Company as of December
          31, 2006 and 2005, and the results
          of its operations and its cash flows for each of the three years ended
          December
          31, 2006, 2005 and
          2004,
          in conformity with accounting principles generally accepted in the United
          States
          of America.
 
 
 /s/
          Rotenberg & Co., LLP
 
 Rotenberg
          & Co., LLP
 Rochester,
          New York
 March
          16,
          2007
  -44-
 **SORL
                    Auto Parts, Inc. and Subsidiaries****Consolidated
                    Balance Sheets****December
                    31, 2006 and 2005**
 
 **December
                    31,**
                  **2006**
                
                
                
                **December
                    31,**
                  **2005****(Audited)**
                
                
                
                **(Audited)****Assets****Current
                    Assets**Cash
                    and Cash Equivalents
                
                
                US$
                
                
                11,137,501
                
                
                US$
                
                
                961,131Accounts
                    Receivable, Net of Provision
                
                
                
                
                
                26,750,778
                
                
                
                
                
                25,339,774Notes
                    Receivable
                
                
                
                
                
                3,494,327
                
                
                
                
                
                1,488,104Inventory
                
                
                
                
                
                4,528,856
                
                
                
                
                
                2,512,583Prepayments
                
                
                
                
                
                5,532,802
                
                
                
                
                
                1,801,829Other
                    current assets
                
                
                
                
                
                2,925,558
                
                
                
                
                
                48,115**Total
                    Current Assets**
                
                
                
                
                
                54,369,822
                
                
                
                
                
                32,151,536**Fixed
                    Assets**Property,
                    Plant and Equipment
                
                
                
                
                
                20,418,557
                
                
                
                
                
                10,140,947Less:
                    Accumulated Depreciation
                
                
                
                
                
                (4,106,901
                )
                
                
                
                
                (3,024,281
                )Property,
                    Plant and Equipment, Net
                
                
                
                
                
                16,311,656
                
                
                
                
                
                7,116,666**Other
                    Assets**Deferred
                    compensation cost-stock options
                
                
                
                
                
                129,207
                
                
                
                
                
                —Intangible
                    Assets
                
                
                
                
                
                45,779
                
                
                
                
                
                44,297Less:
                    Accumulated Amortization
                
                
                
                
                
                (17,655
                )
                
                
                
                
                (11,873
                )Intangible
                    Assets, Net
                
                
                
                
                
                28,124
                
                
                
                
                
                32,424Other
                    Non-current Assets
                
                
                
                
                
                41,299Total
                    Other Assets
                
                
                
                
                
                198,630
                
                
                
                
                
                32,424**Total
                    Assets**
                
                
                **US**$****
                
                
                **70,880,108**
                
                
                **US**$****
                
                
                **39,300,626****Liabilities
                    and Shareholders' Equity****Current
                    Liabilities**Accounts
                    Payable and Notes Payable
                
                
                US$
                
                
                4,620,692
                
                
                US$
                
                
                3,746,666Deposit
                    Received from Customers
                
                
                
                
                
                508,268
                
                
                
                
                
                1,324,085Short
                    term bank loans
                
                
                
                
                
                —
                
                
                
                
                
                16,026,717Income
                    tax payable
                
                
                
                
                
                358,367Accrued
                    Expenses
                
                
                
                
                
                1,232,845
                
                
                
                
                
                482,982Other
                    Current Liabilities
                
                
                
                
                
                454,430
                
                
                
                
                
                —**Total
                    Current Liabilities**
                
                
                
                
                
                7,174,602
                
                
                
                
                
                21,580,450**Minority
                    Interest**
                
                
                
                
                
                6,336,557
                
                
                
                
                
                1,735,818**Shareholders'
                    Equity**Common
                    Stock - $0.002 Par Value; 50,000,000 authorized,18,275,126
                    and 13,346,555 issued and outstanding as ofDecember
                    31, 2006 and December 31, 2005 respectively
                
                
                
                
                
                36,550
                
                
                
                
                
                26,693Additional
                    Paid In Capital
                
                
                
                
                
                37,444,051
                
                
                
                
                
                4,444,118Reserves
                
                
                
                
                
                797,116Accumulated
                    other comprehensive income
                
                
                
                
                
                1,102,469
                
                
                
                
                
                336,993Retained
                    Earnings
                
                
                
                
                
                17,988,763
                
                
                
                
                
                11,176,55457,368,949
                
                
                
                
                
                15,984,358**Total
                    Liabilities and Shareholders' Equity**
                
                
                **US**$****
                
                
                **70,880,108**
                
                
                **US**$****
                
                
                **39,300,626**
 
 **The
            accompanying notes are an integral part of these financial
            statements**
  -45-
 
 **SORL
                    Auto Parts, Inc. and Subsidiaries****Consolidated
                    Statements of Income****For
                    Years Ended on December 31, 2006 , 2005 and
                    2004**
  **2006**
                
                
                
                **2005**
                
                
                
                **2004**Sales
                
                
                US$
                
                
                84,898,316
                
                
                US$
                
                
                64,182,544
                
                
                US$
                
                
                46,815,037Cost
                    of Sales
                
                
                
                
                
                65,631,004
                
                
                
                
                
                49,865,235
                
                
                
                
                
                35,904,232Gross
                    Profit
                
                
                
                
                
                19,267,312
                
                
                
                
                
                14,317,309
                
                
                
                
                
                10,910,805Expenses:Selling
                    and Distribution Expenses
                
                
                
                
                
                5,101,313
                
                
                
                
                
                3,919,996
                
                
                
                
                
                2,737,652General
                    and Administrative Expenses
                
                
                
                
                
                3,259,066
                
                
                
                
                
                4,169,460
                
                
                
                
                
                2,489,604Financial
                    Expenses
                
                
                
                
                
                1,055,237
                
                
                
                
                
                688,811
                
                
                
                
                
                287,433Total
                    Expenses
                
                
                
                
                
                9,415,616
                
                
                
                
                
                8,778,267
                
                
                
                
                
                5,514,689Operating
                    Income
                
                
                
                
                
                9,851,696
                
                
                
                
                
                5,539,042
                
                
                
                
                
                5,396,116Other
                    Income
                
                
                
                
                
                146,530
                
                
                
                
                
                52,592Non-Operating
                    Expenses
                
                
                
                
                
                (250,357
                )
                
                
                
                
                (92,067
                )
                
                
                
                
                (55,067
                )Income
                    (Loss) Before Provision for Income Taxes
                
                
                
                
                
                9,747,869
                
                
                
                
                
                5,499,567
                
                
                
                
                
                5,341,049Provision
                    for Income Taxes
                
                
                
                
                
                1,252,858
                
                
                
                
                
                —
                
                
                
                
                
                —Net
                    Income Before Minority Interest&
                    Other Comprehensive Income
                
                
                US$
                
                
                8,495,011
                
                
                US$
                
                
                5,499,567
                
                
                US$
                
                
                5,341,049Minority
                    Interest
                
                
                
                
                
                797,117
                
                
                
                
                
                549,957
                
                
                
                
                
                534,105Net
                    Income Attributable to Shareholders
                
                
                
                
                
                7,697,894
                
                
                
                
                
                4,949,610
                
                
                
                
                
                4,806,944Foreign
                    Currency Translation Adjustment
                
                
                
                
                
                850,529
                
                
                
                
                
                374,437
                
                
                
                
                
                —Minority
                    Interest's Share
                
                
                
                
                
                85,053
                
                
                
                
                
                37,444
                
                
                
                
                
                —Comprehensive
                    Income (Loss)
                
                
                
                
                
                8,463,370
                
                
                
                
                
                5,286,603
                
                
                
                
                
                4,806,944Weighted
                    average common share - Basic
                
                
                
                
                
                13,753,991
                
                
                
                
                
                13,302,763
                
                
                
                
                
                13,165,241Weighted
                    average common share - Diluted
                
                
                
                
                
                13,778,535
                
                
                
                
                
                13,302,763
                
                
                
                
                
                13,165,241EPS
                    - Basic
                
                
                
                
                
                0.56
                
                
                
                
                
                0.37
                
                
                
                
                
                0.37EPS
                    - Diluted
                
                
                
                
                
                0.56
                
                
                
                
                
                0.37
                
                
                
                
                
                0.37
  **The
            accompanying notes are an integral part of these financial
            statements**
 -46-
  **SORL
                    Auto Parts, Inc. and Subsidiaries****Consolidated
                    Statements of Cash Flows****For
                    Years Ended on December 31, 2006 and
                    2005**
  **2006**
                
                
                
                **2005**
                
                
                
                **2004****Cash
                    Flows from Operating Activities**Net
                    Income
                
                
                US$
                
                
                7,697,894
                
                
                US$
                
                
                4,949,610
                
                
                US$
                
                
                4,806,944**Adjustments
                    to reconcile net income (loss) to net cash****from
                    operating activities:**Minority
                    Interest
                
                
                
                
                
                797,117
                
                
                
                
                
                549,957
                
                
                
                
                
                534,105Bad
                    Debt Expense
                
                
                
                
                
                (911,000
                )
                
                
                
                
                846,337
                
                
                
                
                
                68,384Depreciation
                    and Amortization
                
                
                
                
                
                1,058,261
                
                
                
                
                
                866,558
                
                
                
                
                
                554,261Stock-Based
                    Compensation Expense
                
                
                
                
                
                348,749
                
                
                
                
                
                362,000
                
                
                
                
                
                —Loss
                    on disposal of Fixed Assets
                
                
                
                
                
                69,600
                
                
                
                
                
                —
                
                
                
                
                
                —**Changes
                    in Assets and Liabilities:**Account
                    Receivables
                
                
                
                
                
                (505,052
                )
                
                
                
                
                (13,590,206
                )
                
                
                
                
                (9,507,289
                )Notes
                    Receivables
                
                
                
                
                
                (2,006,223
                )
                
                
                
                
                (1,358,429
                )
                
                
                
                
                (129,675
                )Other
                    Currents Assets
                
                
                
                
                
                (2,877,443
                )
                
                
                
                
                345,184
                
                
                
                
                
                (393,300
                )Inventory
                
                
                
                
                
                (2,016,273
                )
                
                
                
                
                (637,283
                )
                
                
                
                
                (38,300
                )Prepayments
                
                
                
                
                
                (3,730,973
                )
                
                
                
                
                (397,119
                )
                
                
                
                
                1,197,290Accounts
                    Payable and Notes Payable
                
                
                
                
                
                874,026
                
                
                
                
                
                (970,989
                )
                
                
                
                
                4,717,655Provision
                    of income tax
                
                
                
                
                
                358,367
                
                
                
                
                
                —
                
                
                
                
                
                —Deposits
                    Received from Customers
                
                
                
                
                
                (815,817
                )
                
                
                
                
                462,461
                
                
                
                
                
                861,624Other
                    Current Liabilities and Accrued Expenses
                
                1,204,293
                
                
                
                
                
                (142,787
                )
                
                
                
                
                625,769Net
                    Working Capital from Discontinued Operations
                
                
                
                
                
                
                
                
                
                
                
                
                
                (960,876
                )**(454,474**
                **)**
                
                
                
                
                **(8,714,706**
                **)**
                
                
                
                
                **2,336,592****Cash
                    Flows from Investing Activities**Acquisition
                    of Property and Equipment
                
                
                
                
                
                (10,354,802
                )
                
                
                
                
                (2,623,151
                )
                
                
                
                
                (593,488
                )Investment
                    in Intangible Assets
                
                
                
                
                
                —
                
                
                
                
                
                (1,123
                )
                
                
                
                
                (28,720
                )Investing
                    activities - Discontinued operations
                
                
                
                
                
                —
                
                
                
                
                
                —
                
                
                
                
                
                (16,427
                )**(10,354,802**
                **)**
                
                
                
                
                **(2,624,274**
                **)**
                
                
                
                
                **(638,635**
                **)****Cash
                    Flows from Financing Activities**Proceeds
                    from (Repayment of) Bank Loans
                
                
                
                
                
                (16,026,717
                )
                
                
                
                
                11,195,799
                
                
                
                
                
                (968,082
                )Proceeds
                    from Share Issuance
                
                
                
                
                
                32,531,834
                
                
                
                
                
                —
                
                
                
                
                
                —Capital
                    contributed by Minority S/H
                
                
                
                
                
                3,630,000
                
                
                
                
                
                —
                
                
                
                
                
                —**20,135,117**
                
                
                
                
                
                **11,195,799**
                
                
                
                
                
                **(968,082**
                **)****Effects
                    on changes in foreign exchange rate**
                
                850,529
                
                
                
                
                
                374,437
                
                
                
                
                
                —Net
                    Change in Cash and Cash Equivalents
                
                
                
                
                
                10,176,370
                
                
                
                
                
                231,256
                
                
                
                
                
                729,875Cash
                    and Cash Equivalents- Beginning of the year
                
                961,131
                
                
                
                
                
                729,875
                
                
                
                
                
                —**Cash
                    and cash Equivalents - End of the year**
                
                
                **US**$****
                
                
                **11,137,501**
                
                
                **US**$****
                
                
                961,131
                
                
                **US**$****
                
                
                729,875**Supplemental
                    Cash Flow Disclosures:**Interest
                    Paid
                
                
                
                
                
                783,794
                
                
                
                
                
                513,776
                
                
                
                
                
                287,433Tax
                    Paid
                
                
                
                
                
                900,388
                
                
                
                
                
                —
                
                
                
                
                
                —**Supplemental
                    Disclosures of Non-Cash Investing and Financing
                    Activities:**Common
                    stock of 10,000 shares issued to Keating for advisory service
                
                
                
                
                
                —
                
                
                
                
                
                65,000
                
                
                
                
                
                —Common
                    stock of 49,500 shares issued to key employees
                
                
                
                
                
                —
                
                
                
                
                
                297,000
                
                
                
                
                
                —60,000
                    options issued in 2006
                
                
                
                
                
                49,697
                
                
                
                
                
                —
                
                
                
                
                
                —100,000
                    warrants issued in 2006
                
                
                
                
                
                299,052
                
                
                
                
                
                —
                
                
                
                
                
                —Common
                    stock Issued in Exchange for Preferred Stock
                
                
                
                
                
                —
                
                
                
                
                
                —
                
                
                
                
                
                25,908Distribution
                    of Discontinued Operations
                
                
                
                
                
                —
                
                
                
                
                
                —
                
                
                
                
                
                (22,775,189
                )
 
 **The
            accompanying notes are an integral part of these financial
            statements**
  -47-
 **SORL
                    Auto Parts, Inc. and Subsidiaries****Consolidated
                    Statements of Changes in Shareholders' Equity****For
                    Years Ended on December 31, 2006, 2005 and 2004**
  **Additional**
                
                
                
                **Retained**
                
                **Accumu.
                    Other****Number**
                
                **Common**
                
                **Paid-in**
                
                
                
                **Earnings**
                
                **Comprehensive**
                
                **Shareholders'**
                
                **Minority****of
                      Share**
                
                **Stock**
                
                **Capital**
                
                **Reserves**
                
                **(Deficit)**
                
                **Income**
                
                **Equity**
                
                **Interest****Beginning
                    Balance - Jan 1, 2004**
                
                
                **12,953,720**
                
                
                **25,908**
                
                
                **26,858,092**
                
                
                **—**
                
                
                **1,420,000**
                
                
                **—**
                
                
                **28,304,000**
                
                
                —Corporate
                    Reorganization:Distribution
                    of discontinued operations to shareholders
                
                
                —
                
                
                —
                
                
                (22,775,189
                )
                
                —
                
                
                —
                
                
                —
                
                
                (22,775,189
                )
                
                —Acquisition
                    of Enchanted Village
                
                
                328,533
                
                
                657
                
                
                (657
                )
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —Capital
                    contributed by Minority S/H
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                614,312Net
                    Income (Loss)
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                4,806,944
                
                
                —
                
                
                4,806,944
                
                
                534,105***Ending
                    Balance - Dec 31, 2004***
                
                
                13,282,253
                
                
                26,565
                
                
                4,082,246
                
                
                —
                
                
                6,226,944
                
                
                —
                
                
                10,335,755
                
                
                1,148,417Adjustment
                    for fractional shares
                
                
                4,802
                
                
                9
                
                
                (9
                )
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —Common
                    Stock issued to consultants
                
                
                10,000
                
                
                20
                
                
                64,980
                
                
                —
                
                
                —
                
                
                —
                
                
                65,000
                
                
                —Common
                    Stock issued to employees
                
                
                49,500
                
                
                99
                
                
                296,901
                
                
                —
                
                
                —
                
                
                —
                
                
                297,000
                
                
                —Net
                    Income (Loss)
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                4,949,610
                
                
                —
                
                
                4,949,610
                
                
                549,957Other
                    Comprehensive Income (Loss)
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                336,993
                
                
                336,993
                
                
                37,444***Ending
                    Balance - Dec 31, 2005***
                
                
                13,346,555
                
                
                26,693
                
                
                4,444,118
                
                
                —
                
                
                11,176,554
                
                
                336,993
                
                
                15,984,358
                
                
                1,735,818Net
                    Income
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                7,697,894
                
                
                —
                
                
                7,697,894
                
                
                797,117Other
                    Comprehensive Income(Loss)
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                765,476
                
                
                765,476
                
                
                85,053Common
                    stock issued in public offering
                
                
                4,928,571
                
                
                9,857
                
                
                32,521,977
                
                
                —
                
                
                —
                
                
                —
                
                
                32,531,834
                
                
                —Capital
                    contributed by Minority S/H
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                3,630,000Transfer
                    to reserve
                
                
                —
                
                
                —
                
                
                —
                
                
                797,116
                
                
                (885,685
                )
                
                —
                
                
                (88,569
                )
                
                88,56960,000
                    options issued in 2006
                
                
                —
                
                
                —
                
                
                178,904
                
                
                —
                
                
                —
                
                
                —
                
                
                178,904
                
                
                —100,000
                    warrants issued in 2006
                
                
                —
                
                
                —
                
                
                299,052
                
                
                —
                
                
                —
                
                
                —
                
                
                299,052
                
                
                —***Ending
                    Balance - December 31, 2006***
                
                
                **18,275,126**
                
                
                **36,550**
                
                
                **37,444,051**
                
                
                **797,116**
                
                
                **17,988,763**
                
                
                **1,102,469**
                
                
                **57,368,949**
                
                
                **6,336,557**
 **The
            accompanying notes are an integral part of these financial
            statements**
 -48-
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
  **NOTE
        1 - DESCRIPTION OF BUSINESS**
  SORL
        Auto
        Parts, Inc. is principally engaged in the manufacture and distribution of
        automotive air brake valves and related components for commercial vehicles
        weighing more than three tons, such as trucks, and buses, through its 90%
        ownership of Ruili Group Ruian Auto Parts Company Limited (“Ruian”, or “the
        Company”) 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 valves with over 800
        different specifications.
  **NOTE
        2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**
  **ACCOUNTING
        METHOD**
  The
        Company uses the accrual method of accounting for financial statement and
        tax
        return purposes.
  **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.
  **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.
  -49-
  **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.
  **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’s
        policy is that all related party transactions must be in arm’s length.
  **FINANCIAL
        RISK FACTORS AND FINANCIAL RISK MANAGEMENT**
  The
        Company is exposed to the following risk factors:
  (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 has two
        customers that respectively account for more than 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 5.58% 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.
  **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.
  **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.
  -50-
  **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 assets estimated useful life for periods ranging
        from five to ten years. 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.
  **IMPAIRMENT
        OF LONG-LIVED ASSETS**
  Long-lived
        assets, such as property, plant and equipment and other non-current assets,
        including intangible assets, are reviewed 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.
  **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.
  **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
        uncollectibility. 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.
  **NOTES
        RECEIVABLE**
  Notes
        receivable 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.
  -51-
  **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. 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.
  **INCOME
        TAXES**
  The
        Company accounts for income taxes under the provision of Statement of Financial
        Accounting Standards (“SFAS” 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.
  **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 SFAS 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.
  Foreign
        currency gains and losses, if any, are included in the Consolidated Statements
        of Income as a component of other comprehensive income.
  **STOCK-BASED
        COMPENSATION**
  In
        December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
        123R, “Share-Based Payment” (“SFAS 123R”). SFAS 123R revises FASB Statement No.
        123 “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25
“Accounting for Stock Issued to Employees”. SFAS 123R requires 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 SFAS 123R as of January 1, 2005.
  **RESEARCH
        AND DEVELOPMENT EXPENSES**
  Research
        and development costs are classified as general and administrative expenses
        and
        are expensed as incurred.
  **SHIPPING
        AND HANDLING COSTS**
  Shipping
        and handling cost are classified as selling expenses and are expensed as
        incurred.
  **ADVERTISING
        COSTS**
  Advertising
        costs are classified as selling expenses and are expensed as incurred.
  -52-
  **WARRANTY
        CLAIMS**
  The
        Company offers product warranties for certain products. Warranty claims are
        classified as selling expenses and are expensed as incurred. The Company
        accrues
        the costs of unsettled product warranty claims based on the historical claims
        made in previous years.
  **PURCHASE
        DISCOUNTS**
  Purchase
        discounts, if applicable, are netted in the cost of goods sold.
  **LEASE
        COMMITMENTS**
  The
        Company has adopted SFAS 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. The current lease agreement with Ruili Group Co. Ltd. does not
        meet
        any of the above criteria, so it is classified and recorded as an operating
        lease.
  **RECENTLY
        ISSUED ACCOUNTING STANDARDS**
  In
        November 2004, the FASB issued SFAS No. 151 “Inventory Costs - an amendment of
        ARB No. 43, Chapter 4” (“SFAS 151”). This statement amends the guidance in ARB
        No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal
        amounts of idle facility expense, freight, handling costs, and wasted material
        (spoilage). SFAS 151 requires that those items be recognized as current-period
        charges. In addition, this Statement requires that allocation of fixed
        production overheads to costs of conversion be based upon the normal capacity
        of
        the production facilities. The provisions of SFAS 151 are effective for fiscal
        years beginning after June 15, 2005. As such, the Company is required to
        adopt
        these provisions at the beginning of the fiscal year ended December 31, 2006.
        This statement has had no effect on the Company.
  In
        December 2004, the FASB issued SFAS No. 152 “Accounting for Real Estate
        Time-Sharing Transactions - an amendment of FASB Statements No. 66 and 67”
(“SFAS 152”). This statement amends FASB Statement No. 66 “Accounting for Sales
        of Real Estate” to reference the financial accounting and reporting guidance for
        real estate time-sharing transactions that is provided in AICPA Statement
        of
        Position 04-2 “Accounting for Real Estate Time-Sharing Transactions” (“SOP
        04-2”). SFAS 152 also amends FASB Statement No. 67 “Accounting for Costs and
        Initial Rental operations of Real Estate Projects” to state that the guidance
        for incidental operations and costs incurred to sell real estate projects
        does
        not apply to real estate time-sharing transactions, with the accounting for
        those operations and costs being subject to the guidance in SOP 04-2. The
        provisions of SFAS 152 are effective in fiscal years beginning after June
        15,
        2005. As such, the Company is required to adopt these provisions at the
        beginning of the fiscal year ended December 31, 2006. This statement has
        had no
        effect on the Company.
  In
        December 2004, the FASB issued SFAS No. 153, “Exchanges of No monetary Assets -
        an amendment of APB Opinion No. 29” (“SFAS 153”). SFAS 153 replaces the
        exception from fair value measurement in APB Opinion No.29 for no monetary
        exchanges of similar productive assets with a general exception from fair
        value
        measurement for exchanges of no monetary assets that do not have commercial
        substance. A no monetary exchange has commercial substance if the future
        cash
        flows of the entity are expected to change significantly as a result of the
        exchange. SFAS 153 is effective for all interim periods beginning after June
        15,
        2005. As such, the Company is required to adopt these provisions at the
        beginning of the fiscal quarter ended September 30, 2005. This statement
        has had
        no effect on the Company.
  -53-
  In
        March
        2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset
        Retirement Obligations - an interpretation of FASB Statement No. 143” (“FIN
        47”). FIN 47 clarifies that the term conditional asset retirement obligation
        refers to a legal obligation to perform and asset retirement activity in
        which
        the timing and (or) method of settlement are conditional on a future event
        that
        may or may not be within the control of the entity. Accordingly, an entity
        is
        required to recognize a liability for the fair value of a conditional asset
        retirement obligation if the fair value of the liability can be reasonably
        estimated. FIN 47 is effective for fiscal years that end after December 15,
        2005. As such, the Company is required to adopt these provisions for the
        fiscal
        year ended December 31, 2005. This statement has had no effect on the Company.
  In
        May
        2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections -
        a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS 154”). SFAS
        154 changes the requirements for the accounting for and reporting of a change
        in
        accounting principle. These requirements apply to all voluntary changes and
        changes required by an accounting pronouncement in the unusual instance that
        the
        pronouncement does not include specific transition provisions. SFAS 154 is
        effective for fiscal years beginning after December 15, 2005. As such, the
        Company is required to adopt these provisions at the beginning of the fiscal
        year ended December 31, 2006. This statement has had no effect on the Company.
  In
        February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
        Financial Instruments - an amendment of FASB Statement No. 133 and 140” (“SFAS
        155”). SFAS 155 resolves issues addressed in Statement 133 Implementation Issue
        No. D1, “Application of Statement 133 to Beneficial Interests in Securitized
        Financial Assets.” SFAS 155 is effective for all financial instruments acquired
        or issued after the beginning of the first fiscal year that begins after
        September 15, 2006. As such, the Company is required to adopt these provisions
        at the beginning of the fiscal year ended December 31, 2007. This statement
        has
        had no effect on the Company.
  In
        March
        2006, the Financial Accounting Standards Board (“FASB”) issued Statement of
        Financial Accounting Standard (“SFAS”) No. 156, “Accounting for Servicing of
        Financial Assets - an amendment of FASB Statement No. 140” (“SFAS 156”). SFAS
        156 amends FASB Statement No. 140 with respect to the accounting for separately
        recognized servicing assets and servicing liabilities. SFAS 156 requires
        all
        separately recognized servicing assets and servicing liabilities to be initially
        measured at fair value, if practical. SFAS 156 is effective as of the beginning
        of the first fiscal year that begins after September 15, 2006. As such, the
        Company is required to adopt these provisions at the beginning of the fiscal
        year ended December 31, 2007. This statement has had no effect on the Company.
  In
        July
        2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes—an
        Interpretation of FASB Statement No. 109, which clarifies the accounting
        for
        uncertainty in tax positions. This Interpretation requires that the Company
        recognizes in its consolidated financial statements the impact of a tax position
        if that position is more likely than not of being sustained on audit, based
        on
        the technical merits of the position. The provisions of FIN 48 are effective
        for
        the Company on January 1, 2007, with the cumulative effect of the change
        in
        accounting principle, if any, recorded as an adjustment to opening retained
        earnings. This statement has had no effect on the Company.
  In
        September 2006, the FASB issued SFAS 157, Fair Value Measurements, which
        defines
        fair value , establishes a framework for measuring fair value in generally
        accepted accounting principles, and expands disclosures about fair value
        measurements. SFAS 157 applies under other accounting pronouncements that
        require or permit fair value measurements, where fair value is the relevant
        measurement attribute. The standard does not require any new fair value
        measurements. SFAS 157 is effective for financial statements issued for fiscal
        years beginning after November 15, 2007, and interim periods within those
        fiscal
        years. This statement has had no effect on the Company.
  In
        September 2006, the SEC issued SAB No. 108, which provides guidance on the
        process of quantifying financial statement misstatements. In SAB No. 108,
        the
        SEC staff establishes an approach that requires quantification of financial
        statement errors, under both the iron-curtain and the roll-over methods,
        based
        on the effects of the error on each of the Company’s financial statements and
        the related financial statement disclosures. SAB No.108 is generally effective
        for annual financial statements in the first fiscal year ending after November
        15, 2006. The transition provisions of SAB No. 108 permits existing public
        companies to record the cumulative effect in the first year ending after
        November 15, 2006 by recording correcting adjustments to the carrying values
        of
        assets and liabilities as of the beginning of that year with the offsetting
        adjustment recorded to the opening balance of retained earnings. Management
        does
        not expect that the adoption of SAB No.108 would have a material effect on
        the
        Company’s consolidated financial statements.
  -54-




In
      September 2006, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Accounting Standard (“SFAS”) No. 158, "Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans - an
      amendment of FASB Statements No. 87, 88, 106, and 132(R)" (“SFAS 158”). SFAS 158
      requires an employer to recognize the overfunded or underfunded status of a
      defined benefit postretirement plan (other than a multiemployer plan) as an
      asset or liability in its statement of financial position and to recognize
      changes in that funded status in the year in which the changes occur through
      comprehensive income. SFAS 158 is effective for an employer with publicly traded
      equity securities as of the end of the first fiscal year ending after December
      15, 2006. SFAS 158 also requires an employer to measure the funded status of
      a
      plan as of the date of its year-end statement of financial position, effective
      for fiscal years ending after December 15, 2008. As such, the Company is
      required to recognize the funded status of its defined benefit postretirement
      plan and to provide the required disclosures at the beginning of the fiscal
      year
      ended June 30, 2009. The Company is currently evaluating the impact of SFAS
      158
      on its financial statements.




**NOTE
      3 - RELATED PARTY TRANSACTIONS**




The
      Company continued to purchase non-valve automotive components, raw materials
      and
      packaging materials from the Ruili Group Co., Ltd., which is the minority
      shareholder of the JV and has the common controlling party, i.e. the Zhang
      family. It also sources some non-valve parts from Ruian Ruili Haizhiguan Auto
      Part Co., Ltd., a subsidiary of Ruili Group.




The
      following related party transactions occurred for the fiscal year ended December
      31, 2006 and 2005:




**December
                31,****2006**
            
            **2005**PURCHASES
                NON-VALVE PRODUCT FROM:Ruili
                Group Co., Ltd.
            
            $
            21,882,495
            
            $
            16,780,670Ruian
                Ruili Haizhiguan Auto Part Co., Ltd.
            
            
            —
            
            $
            283,024Total
                Purchases
            
            
            21,882,495
            
            
            17,063,694PURCHASES
                LAND USE RIGHTS FROM RUILI GROUP CO., LTD.
            
            $
            5,909,671
            
            
            —SALES
                TO:Ruili
                Group Co., Ltd.
            
            
            5,778,660
            
            
            4,471,022Total
                Sales
            
            $
            5,778,660
            
            $
            4,471,022




The
      total
      purchases from Ruili Group in 2006 all are finished products of non-valve auto
      parts.




**December
                31,****2006**
            
            **2005**Accounts
                Payable and Other PayablesRuili
                Group Co., Ltd.
            
            $
            —
            
            $
            —Shuping
                Chi
            
            
            —
            
            
            273,559Total
            
            
            —
            
            
            273,559PrepaymentRuili
                Group Co., Ltd.
            
            $
            2,309,073
            
            $
            1,060,193Total
            
            
            2,309,073
            
            
            1,060,193Other
                Accounts receivableRuili
                Group Co., Ltd.
            
            
            903,304
            
            
            —$
            903,304
            
            $
            —






-55-





**NOTE
      4 - ACCOUNTS RECEIVABLE**




The
      changes in the allowance for doubtful accounts at December 31, 2006 and 2005
      are
      summarized as follows:




**December
                31,****2006**
            
            **2005**Beginning
                balance
            
            $
            914,721
            
            $
            68,384Add:
                Increase to allowance
            
            
            -905,952
            
            
            846,337Less:
                Accounts written off
            
            
            —
            
            
            —Ending
                balance
            
            $
            8,769
            
            $
            914,721





The
      company’s receivables are summarized as follows:




**December
                31****2006**
            
            **2005**Balance
                before allowance
            
            $
            26,759,547
            
            $
            26,254,495Less:
                Allowance for doubtful accounts
            
            
            (8,769
            )
            
            (914,721
            )Account
                receivable balance, net
            
            $
            26,750,778
            
            $
            25,339,774





**NOTE
      5 - INVENTORIES**




On
      December 31, 2006 and 2005, inventories consist of the following:




**December
                31,****2006**
            
            **2005**Raw
                Material
            
            $
            1,081,569
            
            $
            747,858Work
                in process
            
            
            2,429,979
            
            
            1,057,740Finished
                Goods
            
            
            1,017,308
            
            
            706,985Total
                Inventory
            
            $
            4,528,856
            
            $
            2,512,583






-56-




**NOTE
      6 - PROPERTY, PLANT AND EQUIPMENT**




Property,
      plant and equipment consisted of the following, on December 31, 2006 and 2005:




**December
                31,****2006**
            
            **2005**Machinery
            
            $
            12,123,775
            
            $
            8,706,039Molds
            
            
            1,116,441
            
            
            1,080,291Office
                equipment
            
            
            226,647
            
            
            185,088Vehicle
            
            
            310,681
            
            
            169,529Building
            
            
            580,126
            
            
            —Construction
                In Progress
            
            
            6,060,887
            
            
            —Sub-Total
            
            
            20,418,557
            
            
            10,140,947Less:
                Accumulated depreciation
            
            
            (4,106,901
            )
            
            (3,024,281
            )Fixed
                Assets, net
            
            $
            16,311,656
            
            $
            7,116,666





Depreciation
      expense charged to operations was $1,052,965 and $859,139 for the years ended
      December 31, 2006 and 2005, respectively.




**NOTE
      7 - INTANGIBLE ASSETS**




Gross
      intangible assets were $45,779, less accumulated amortization of $17,655 for
      net
      intangible assets of $28,124 as of December 31, 2006. Gross intangible assets
      were $44,297, less accumulated amortization of $11,873 for net intangible assets
      of $32,424 as of December 31, 2005. Amortization expenses were $5,296 and$7,419
      for the fiscal years ended December 31, 2006 and 2005 respectively.




Future
      estimated amortization expense is as follows:




**2007**
            
            **2008**
            
            **2009**
            
            **2010**
            
            **2011**
            
            **Thereafter**$3,772
            
            $
            3,772
            
            $
            3,772
            
            $
            3,772
            
            $
            3,772
            
            $
            9,264





**NOTE
      8 - PREPAYMENT**




Prepayment
      consisted of the following as of December 31, 2006 and 2005:




**December
                31,****2006**
            
            **2005**Raw
                material suppliers
            
            $
            5,080,452
            
            $
            1,584,193Equipment
                purchase
            
            
            452,350
            
            
            217,637Total
                prepayment
            
            $
            5,532,802
            
            $
            1,801,829





**NOTE
      9 - ACCRUED EXPENSES**




Accrued
      expenses consisted of the following as of December 31, 2006 and 2005:




**December
                31,****2006**
            
            **2005**Accrued
                payroll
            
            $
            448,420
            
            $
            297,928Accrued
                rent
            
            
            —
            
            
            —Accrued
                legal
            
            
            —
            
            
            —Other
                accrued expenses
            
            
            784,425
            
            
            185,054Total
                accrued expenses
            
            $
            1,232,845
            
            $
            482,982




-57-




**NOTE
      10 - BANK BORROWINGS**




Bank
      borrowings represent the following as of December 31:




**December
                31,****2006**
            
            **2005**Secured
            
            
            —
            
            
            16,026,717Less:
                Current portion
            
            
            —
            
            
            16,026,717Non-current
                portion
            
            
            —
            
            
            —





During
      2006, the short term loans were from two banks, Bank of China and CITIC Bank,
      to
      finance the general working capital as well as urgent new equipment acquisition.
      Before the fiscal year end of 2006, the Company paid off all outstanding balance
      of the short term bank loans. The Company did not provide any sort of guarantee
      to any other parties. Interest rates for the loans ranged between 5.220% and
      5.580% per annum.




**NOTE
      11 - RESERVE**




The
      reserve funds are comprised of the following:




**2006**
            
            **2005**Statutory
                surplus reserve fund
            
            $
            797,116
            
            $
            —Total
            
            $
            797,116
            
            $
            —





Pursuant
      to the relevant laws and regulations of Sino-foreign joint venture enterprises,
      the profits of the Company's subsidiary, which are based on their PRC statutory
      financial statements, are available for distribution in the form of cash
      dividends after they have satisfied all the PRC tax liabilities, provided for
      losses in previous years, and made appropriations to reserve funds, as
      determined at the discretion of the board of directors in accordance with PRC
      accounting standards and regulations.




As
      stipulated by the relevant laws and regulations for enterprises operating in
      the
      PRC, the Company's Sino-foreign joint venture is required to make annual
      appropriations to two reserve funds, consisting of the statutory surplus and
      public welfare funds. In accordance with the relevant PRC regulations and the
      articles of association of the respective companies, the Joint Venture is
      required to allocate a certain percentage of its profits after taxation, as
      determined in accordance with PRC accounting standards applicable to the
      company, to the statutory surplus reserve until such reserve reaches 50% of
      the
      registered capital of the company.




Net
      income as reported in the US GAAP financial statements differs from that as
      reported in the PRC statutory financial statements. In accordance with the
      relevant laws and regulations in the PRC, the profits available for distribution
      are based on the statutory financial statements. If the Joint Venture has
      foreign currency available after meeting its operational needs, the Joint
      Venture may make its profit distributions in foreign currency to the extent
      foreign currency is available. Otherwise, it is necessary to obtain approval
      and
      convert such distributions at an authorized bank.




-58-




**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 Manufacturers, the Joint Venture was 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 tax concession of 50% of the statutory income tax
      rate
      of 26.4%, for the following three years ended December 31, 2006, 2007, and
      2008.




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 December 31,
      2006
      is as follows:




Statutory
                tax rate
            
            
            26.4
            %Tax
                holidays and concessions
            
            
            -13.2
            %Effective
                tax rate
            
            
            13.2
            %





No
      provision for deferred tax liabilities has been made, since the Joint Venture
      had no material temporary differences between the tax bases of assets and
      liabilities and their carrying amount.




**NOTE
      13 - LEASES**




Commencing
      in 2004, the Company has a lease agreement with Ruili Group Co., Ltd., a related
      party, for the lease of a manufacturing plant. The lease is for a ten year
      term
      ending in February 2014.




In
      December 2006, the Company entered into one new lease agreement with Ruili
      Group
      Co., Ltd. for the lease of two apartment buildings. These two apartment
      buildings are respectively for its management personnel and ordinary staff.
      The
      lease term is from January 2007 to December 2011 for one of the apartment
      buildings and from January 2007 to December 2012 for the other.




Rental
      expenses for the fiscal years ended December 31, 2006 and 2005, was $457,845
      and
      $439,009 respectively.




**2007**
            
            **2008**
            
            **2009**
            
            **2010**
            
            **2011**
            
            **Thereafter**Rental
                of plant
            
            
            457,845
            
            
            457,845
            
            
            457,845
            
            
            457,845
            
            
            457,845
            
            
            991,998Rental
                of apartment buildings
            
            
            242,043
            
            
            242,043
            
            
            242,043
            
            
            242,043
            
            
            242,043
            
            
            58,727Total
            
            
            699,888
            
            
            699,888
            
            
            699,888
            
            
            699,888
            
            
            699,888
            
            
            1,050,725





**NOTE
      14 - ADVERTISING COSTS**




Advertising
      costs are expensed as incurred and are classified as selling expenses.
      Advertising costs were $30,927 and $19,622 for the fiscal years ended December
      31, 2006 and 2005, respectively.




-59-




**NOTE
      15 - RESEARCH AND DEVELOPMENT EXPENSES**




Research
      and development costs are expensed as incurred and were $773,559and $361,503
      for
      the fiscal years ended December 31, 2006 and 2005, respectively.




**NOTE
      16 - WARRANTY CLAIMS**




Warranty
      claims were $1,867,514 and $778,763for the fiscal years ended on December 31,
      2006 and 2005 respectively. The movement of accrued warranty expenses for fiscal
      year 2006 is as follows:





Beginning
                balance at January 01, 2006
            
            $
            179,932Accrued
                during the fiscal year ended December 31,2006:
            
            
            1,867,514Less:
                Actual Paid during the fiscal year ended December 31,2006:
            
            
            1,433,529Ending
                balance at December 31, 2006:
            
            $
            613,917





**NOTE
      17 - Stock-Based Compensation**




(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. In accordance with the vesting provisions of the
      grants, the options will become vested and exercisable under the following
      schedules.




**Number
                of Shares**
            
            **%
                of Shares Issued**
            
            **Initial
                Vesting Date**60,000
            
            100%
            
            March
                1, 2009




The
      Company accounts for stock-based compensation in accordance with SFAS No. 123
      Revised, “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
            
            
            96.54
            %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 Financial Accounting Standards Board Interpretation
      No.
      123 (R). The amortization of deferred stock-based compensation for these equity
      arrangements was $49,697 for the fiscal year ended December 31, 2006. As of
      December 31, 2006, there was $ 129,207 of total unrecognized compensation cost
      related to non-vested share-based compensation arrangements granted under the
      plan. The cost is expected to be recognized over a period of 2.2 years.




-60-




A
      summary
      of option activity under the Plan as of December 31, 2006 and changes during
      the
      fiscal year then ended is as follows:




**Options**
            
            **Weighted
                Average Exercise Price**
            
            **Weighted
                Average Remaining Contractual Term**
            
            **Aggregate
                Intrinsic Value**1-Jan-06
            
            
            —
            
            
            —
            
            
            —
            
            
            —Granted
            
            
            60,000
            
            $
            4.79
            
            
            3
                Years
            
            
            —Exercised
            
            
            —
            
            
            —
            
            
            —
            
            
            —Forfeited
            
            
            —
            
            
            —
            
            
            —
            
            
            —Outstanding
                at December 31, 2006
            
            
            60,000
            
            $
            4.79
            
            
            2.2
                Years
            
            
            254,400Exercisable
                at December 31,2006
            
            
            —
            
            
            —
            
            
            —
            
            
            —





(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 will retain Maxim Group
      LLC
      and Chardan Capital Markets, LLC as its exclusive financial advisors and
      investment bankers for a period of twelve months.




**Number
                of Shares**
            
            **%
                of Shares Issued**
            
            **Initial
                Vesting Date**100,000
            
            100%
            
            January
                5, 2006





The
      Company accounts for stock-based compensation in accordance with SFAS No. 123
      Revised, “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
            
            
            95.01
            %Risk-Free
                Interest Rate
            
            
            4.36
            %Contractual
                Term
            
            
            4yearsStock
                Price at Date of Grant
            
            $
            4.70Exercise
                Price
            
            $
            6.25





Total
      deferred stock-based compensation expenses related to the 100,000 warrants
      granted amounted to $299,052. This amount is amortized over one year in a manner
      consistent with Financial Accounting Standards Board Interpretation No. 123
      (R).
      The amortization of deferred stock-based compensation for these equity
      arrangements was $299,052 for the fiscal year ended December 31, 2006.




A
      summary
      of warrant activity as of December 31, 2006 and changes during the fiscal year
      then ended is as follows:




**Warrants**
            
            **Weighted
                Average Exercise Price**
            
            **Weighted
                Average Remaining Contractual Term**
            
            **Aggregate
                Intrinsic Value**1-Jan-06
            
            
            —
            
            
            —
            
            
            —
            
            
            —Granted
            
            
            100,000
            
            $
            6.25
            
            
            4
                Years
            
            
            —Exercised
            
            
            —
            
            
            —
            
            
            —
            
            
            —Forfeited
            
            
            —
            
            
            —
            
            
            —
            
            
            —Outstanding
                at December 31, 2006
            
            
            100,000
            
            $
            6.25
            
            
            3
                Years
            
            $
            278,000Exercisable
                at December 31, 2006
            
            
            100,000
            
            $
            6.25
            
            
            3
                Years
            
            $
            278,000






-61-





**NOTE
      18-Commitments and Contingencies**




(1)  In
      November 2006, the Joint Venture purchased approximately 861,543 square feet
      of
      land for $5.9 million from Ruili Group, a related party. The Joint Venture
      has
      commenced building one new plant on the site. To build the new plant, the
      anticipated aggregate investment is $ 15.4 million, inclusive of $5.9 million
      paid for purchasing the land use right.




According
      to relevant PRC laws and regulations, a land use right certificate, along with
      government approvals for land planning, project planning, and construction
      need
      to be obtained before construction of building is commenced. An ownership
      certificate will be granted by government upon application under the condition
      that the aforementioned certificate and government approvals are
      obtained.




The
      Joint
      Venture has applied to obtain the land use right certificate of approval, but
      has not yet obtained the land use right certificate. However, Ruili Group owned
      the land use right certificate and has acquired government approval for building
      one new plant on the site. Accordingly, there is no risk that the buildings
      to
      be constructed will have to be vacated.




(2)  The
      following table shows the Company's significant contractual obligations as
      of
      December 31, 2006.




**Payment
                Due by Period****(in
                thousands)**
            
            **Total
                Contractual Obligations**
            
            **Less
                than 1 year**
            
            **Between
                2-3 years**
            
            **Between
                4-5 years**
            
            **Over
                5 years**Capital
                commitments(*)
            
            $
            1,028
            
            
            994
            
            
            34
            
            
            —
            
            
            —





(*)
            Capital
                commitments include the investment for construction of a new plant
                to
                expand the production capacity of air brake valves and related products.
                The Company has budgeted an aggregate amount of approximately $15.4
                million for construction of the new plant. However, some of the projected
                amounts without existing contractual commitments nor scheduled maturities
                are not listed in this table.




(3)
            The
                information of lease commitments is provided in Note
                13.




**NOTE
      19 - Off-balance Sheet Arrangements**




At
      December 31, 2006, 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
      20 - Subsequent Events**




None.




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




Not
      applicable.




-62-




**ITEM
      9A. CONTROLS AND PROCEDURES**




As
      of
      December 31, 2006, the end of the period covered by this report, our Chief
      Executive Officer and our Chief Financial Officer reviewed and evaluated the
      effectiveness of the our disclosure controls and procedures (as defined in
      Exchange Act Rule 13a-15(e) and 15d-15(e)), which are designed to ensure that
      material information we are required to disclose in our reports filed or
      submitted under the Securities Exchange Act of 1934, as amended (the “Exchange
      Act”) is recorded, processed, summarized, and reported within required time
      periods. Disclosure controls and procedures include, without limitation,
      controls and procedures designed to ensure that information required to be
      disclosed is accumulated and communicated to the Company’s management including
      its Chief Executive Officer and Chief Financial Officer as appropriate to allow
      timely decision regarding required disclosures. We have concluded, based on
      that
      evaluation, that as of the end of the period covered by this report, our
      disclosure controls and procedures were effective to ensure that information
      required to be disclosed by us in reports that we file or submit under the
      Exchange Act is accumulated and communicated to our Chief Executive Officer
      and
      Chief Financial Officer as appropriate to allow timely decisions regarding
      required disclosure.




**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.




**ITEM
      9B. OTHER INFORMATION.**




None.




**ITEM
      10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT**




The
      following table sets forth our executive officers, directors and key employees,
      their ages and the positions they held as of December 31, 2006.




**Name**
            
            **Age**
            
            **Position**Xiao
                Ping Zhang
            
            44
            
            Chief
                Executive Officer and ChairmanXiao
                Feng Zhang
            
            39
            
            Chief
                Operating Officers and DirectorZong
                Yun Zhou
            
            52
            
            Chief
                Financial OfficerLi
                Min Zhang
            
            51
            
            Director(1)Zhi
                Zhong Wang
            
            62
            
            Director(1),(2)Yi
                Guang Huo
            
            64
            
            Director(1),(2)Jiang
                Hua Feng
            
            41
            
            Director(2)Jung
                Kang Chang
            
            41
            
            DirectorJason
                Zhang
            
            43
            
            Deputy
                General ManagerDavid
                Ming He
            
            36
            
            Senior
                Manager, Capital Markets and Investor
                Relations





(1)  Member
      of
      Audit Committee




(2)  Member
      of
      Compensation Committee





All
      directors have a term of office expiring at the next annual general meeting,
      unless re-elected or earlier vacated in accordance with the Bylaws. All officers
      have a term of office lasting until their removal or replacement by the Board
      of
      Directors.




-63-




**Executive
      Officers and Directors**




**XIAO
      PING ZHANG - CHAIRMAN OF THE BOARD OF DIRECTORS AND CEO**




Xiao
      Ping
      Zhang has served as CEO and chairman of the board since our inception. He
      founded the Ruili Group, a company specializing in a variety of automotive
      parts
      and components, in 1987, and has served as chairman of Ruili Group since then.
      In 2003, he was elected the President of Wenzhou Auto Parts Association, and
      Vice-President of China Federation of Industry and Commerce Auto & Motorbike
      Parts Chamber of Commerce. Mr. Zhang is also a member of the Standing Committee
      of the People’s Congress in Rui’an City, Zhejiang, China. He is also currently
      engaged as a mentor in entrepreneurship for graduate students of Zhejiang
      University. Mr. Zhang graduated from Zhejiang Radio and TV University in 1986
      with a major in Industrial Management.




**XIAO
      FENG ZHANG - CHIEF OPERATING OFFICER AND DIRECTOR**




Xiao
      Feng
      Zhang has served as COO and a member of the board of directors since our
      inception. He is responsible for sales and marketing. Mr. Zhang co-founded
      the
      Ruili Group with his brother, Mr. Xiao Ping Zhang, in 1987, and served as the
      General Manager of Ruili Group until March 2004. Mr. Zhang received his diploma
      in economics from Shanghai Fudan University in 1994.




**ZONG
      YUN ZHOU - CHIEF FINANCIAL OFFICER**




Zong
      Yun
      Zhou has served as our CFO since our inception. Between April 2002 and May
      2004,
      Ms. Zhou served as the Financial Controller of Shanghai Huhao Auto Parts
      Manufacturing Company Limited, a joint venture between Ruili Group and Shanghai
      Automotive Industry Corporation. From January 1996 until April 2002, Ms. Zhou
      worked for the Auditing Department of Anhui Province, China, in charge of
      auditing state-owned companies in Anhui Province. Ms. Zhou is a Chinese
      Certified Public Accountant, and a member of the Institute of Internal Auditors
      (IIA). Ms. Zhou completed her undergraduate studies at Anhui
      University.




**JUNG
      KANG CHANG - DIRECTOR**




Jung
      Kang
      Chang has served as a member of our board of directors since our inception.
      He
      is also in charge of our international sales. From January 1998 to May 2004,
      Mr.
      Chang served as the General Manager of JieXiangHao Enterprise Company Limited
      based in Taipei, Taiwan; before taking office as the general manager, he was
      the
      sales engineer and sales manager with JieXiangHao in Taipei. Mr. Chang graduated
      from Taiwan Taoyuan Longhua Industry College in 1986.




**LI
      MIN ZHANG - DIRECTOR**




Dr.
      Li
      Min Zhang has served as a member of our board of directors since August 2004.
      He
      chairs the audit committee of our board. Dr. Zhang currently is a professor
      at
      Sun Yat-Sen University Management School in Guangdong, China, coaching PhD
      candidates with an accounting major. During 1994 and 1995, Dr. Zhang conducted
      academic research at the University of Illinois at Urbana-Champaign, and
      practiced at Mok & Chang CPAs in USA. In 1986, he conducted academic
      research at the Office of Auditor General of Canada. Dr. Zhang currently also
      serves as vice chairman of China Audit Society, and secretary of China
      Association of Chief Financial Officers. He is a member of American Accounting
      Association. Also, Dr. Zhang is involved with the China CPA Society Auditing
      Principles Task Force and China Audit Society Training Committee. Dr. Zhang
      earned his Ph.D. in Economics in January 1991.




**ZHI
      ZHONG WANG - DIRECTOR**




Zhi
      Zhong
      Wang has served as a member of our board of directors, as well as a member
      of
      both audit and compensation committees since August 2004. From 1980 until
      present, Mr. Wang has served as instructor and professor at Beijing Jiaotong
      University (formerly Northern Jiaotong University), Department of Electrical
      Engineering. Before 1980, he was an electrical engineer with Science and
      Technology Institute of the Qiqihaer Railway Administration, Heilongjiang,
      China. Mr. Wang has led over twenty research projects such as novel pneumatic
      generator and streamer discharging, and corona power supply for
      desulphurization. His numerous publications include Research on the Novel AC
      Voltage Stabilized Power Supply in Power Electronics . Mr. Wang received his
      bachelor degree in electrical engineering from Northern Jiaotong University
      in
      1968.




-64-




**YI
      GUANG HUO - DIRECTOR**




Yi
      Guang
      Huo has served as a member of our board of directors, as well as a member of
      the
      audit committee and chairman of the compensation committee under the board
      since
      August 2004. Mr. Huo has been engaged in scientific and technological work
      and
      has been responsible for various national key research projects, such as
      designing and conducting experiments for automotive products, drafting ministry
      standards and econo-technological policies, etc. He has been awarded
      ministry-level First Prize for Technology Innovation. Mr. Huo has also served
      as
      President of China Federation of Industry and Commerce Auto & Motorbike
      Parts Chamber of Commerce, a board member and visiting professor of Wuhan
      University of Technology, and secretary of Society of Auto Engineering - China.
      Between 1995 and 1996, Mr. Huo conducted academic research as a visiting
      researcher at Tokyo University Economics Department. During 1987 and 1988,
      he
      studied Scientific Research and Management with Japan Automobile Research
      Institute as well as Japanese automobile companies including Nissan, Hino,
      Isuzu
      and Mitsubishi. Mr. Huo earned his B.S. degree from Jilin University Automobile
      Department in 1965.




**JIANG
      HUA FENG - DIRECTOR**




Jiang
      Hua
      Feng has served as a member of our board of directors as well as a member of
      the
      compensation committee under the board since August 2004. Since 1988, Mr. Feng
      has also served as chief lawyer at Yuhai Law Firm, Rui’an, Zhejiang. Mr. Feng is
      a member of China Lawyers Association. He was elected People’s Congress
      representative for Wenzhou area, Zhejiang. Mr. Feng received his bachelor degree
      in law from East China University of Politics and Law.




**JASON
      ZHANG - DEPUTY GENERAL MANAGER**




Jason
      Zhang joined us in May 2006 as Deputy General Manager, supervising our capital
      market operations and M&A strategies. Before joining us, Mr. Zhang served as
      the Managing Director of JPK Capital Inc., an investment company based in
      Shenzhen, China. From 1999 to 2001, he worked for Qiao Xing Group Corporation
      as
      the Manager of Capital Market Business Department. From 1996 to 1999, he served
      as the General Manager of Shenzhen Zhihui Finance Co., Ltd. 1994 till 1996,
      he
      served as the General Manager of the Underwriting Division of Shenzhen
      Non-Ferrous Metals Finance Co., Ltd. From 1992 to 1994, he served as the General
      Manager of the Investment Department of Shenzhen Lantern Fund Management
      Company. Mr. Zhang received his master degree in economics from Xiamen
      University.




**DAVID
      MING HE, CFA, CPA, SENIOR MANAGER INVESTOR RELATIONS**




David
      Ming He joined us in November 2004 as a Senior Manager in charge of investor
      relations and capital market strategies. Mr. He, who speaks fluent English,
      holds the designations of Chartered Financial Analyst and Illinois Certified
      Public Accountant. Between July 1994 and June 2001, he served as credit analyst
      and senior manager in corporate banking at Credit Agricole Indosuez (now Calyon)
      Shanghai Branch. Mr. He received his Bachelor’s degree in Economics from
      Shanghai Institute of Foreign Trade, China, and Master of Science degree in
      Accountancy and Master of Business Administration degree in Finance from
      University of Illinois at Urbana-Champaign, U.S.A.




-65-




**Committees
      of the Board of Directors**




**Audit
      Committee.** The
      members of our audit committee are Professor Zhang and Messrs. Wang and Huo.
      Professor Zhang chairs the audit committee. Our audit committee assists our
      board of directors in its oversight of:




·
            the
                integrity of our financial
                statements;




·
            our
                independent auditors’ qualifications and independence;
                and




·
            the
                performance of our independent
                auditors.




The
      audit
      committee has the sole and direct responsibility for appointing, evaluating
      and
      retaining our independent auditors and for overseeing their work. All audit
      services and all non-audit services, other than de minimis non-audit services,
      to be provided to us by our independent auditors must be approved in advance
      by
      our audit committee. We believe that the composition of our audit committee
      meets the requirements for independence under the current Nasdaq Capital Market
      and SEC rules and regulations. We believe that the functioning of our audit
      committee complies with the applicable requirements of the Nasdaq National
      Market and SEC rules and regulations. We intend to comply with future
      requirements as applicable.




Compensation
      Committee. The members of our compensation committee are Messrs. Wang, Feng
      and
      Huo. Mr. Huo chairs the compensation committee. The purpose of our compensation
      committee is to discharge the responsibilities of our board of directors
      relating to compensation of our executive officers. Specific responsibilities
      of
      our compensation committee include:




·
            reviewing
                and recommending approval of compensation of our executive
                officers;




·
            administering
                our stock incentive and employee stock purchase plans;
                and




·
            reviewing
                and making recommendations to our board with respect to incentive
                compensation and equity plans.




**Compensation
      Committee Interlocks and Insider Participation**




As
      noted
      above, the compensation committee of our board of directors consists of Messrs.
      Wang, Feng and Huo. None of our executive officers serve as a member of the
      board of directors or compensation committee of any entity that has one or
      more
      executive officers who serve on our board of directors or compensation
      committee.




**Item
      11. EXECUTIVE COMPENSATION**




**Compensation
      Discussion and Analysis**




***Overview
      of Executive Compensation Program***




The
      Compensation Committee of our board of directors has responsibility for
      establishing, implementing and monitoring our executive compensation program
      philosophy and practices. The Compensation Committee seeks to ensure that the
      total compensation paid to our named executive officers is fair, reasonable
      and
      competitive. Generally, the types of compensation and benefits provided to
      named
      executive officers are similar to those provided to our other officers.




-66-




Throughout
      this Annual Report, the individuals who served as our Chief Executive Officer
      and Chief Financial Officer during fiscal 2006, and who are included in the
      Summary Compensation Table are referred to as the “named executive
      officers.”




***Compensation
      Philosophy and Objectives***




The
      Compensation Committee believes that an effective executive compensation program
      should provide base annual compensation that is reasonable in relation to
      individual executive’s job responsibilities and reward the achievement of both
      annual and long-term strategic goals of our company.




Because
      of the size of our company, the small number of executive officers in our
      company, and our company’s financial priorities, the Committee has decided not
      to implement or offer any retirement plans, pension benefits, deferred
      compensation plans, or other similar plans for our executive officers.
      Accordingly, the components of the executive compensation currently consist
      of
      cash salary. The Compensation Committee will consider using stock option grants
      to provide executives with longer-term incentives.




As
      a
      manufacturing company operating in Zhejiang Province, China, the Compensation
      Committee also takes the local average executives’ salary level into account in
      its compensation decisions. The Compensation Committee may reassess the proper
      level of equity and cash compensation in light of the company’s improved
      profitability and working capital situation.




***Role
      of Executive Officers in Compensation Decisions***




The
      Compensation Committee makes all compensation decisions for the named executive
      officers and approves recommendations regarding equity awards to all of our
      officers. Decisions regarding the non-equity compensation of other officers
      are
      made by the Chief Executive Officer.




The
      Compensation Committee and the Chief Executive Officer annually review the
      performance of each named executive officer (other than the Chief Executive
      Officer, whose performance is reviewed only by the Committee). The conclusions
      reached and recommendations based on these reviews, including with respect
      to
      salary adjustments and annual award amounts, are presented to the Committee.
      The
      Committee can exercise its discretion in modifying any recommended adjustments
      or awards to executives.




***Setting
      Executive Compensation***




Based
      on
      the foregoing objectives, the Committee has structured the Company’s annual cash
      and incentive-based cash and non-cash executive compensation to motivate
      executives to achieve the business goals set by the Company, to reward the
      executives for achieving such goals, and to retain the executives. In doing
      so,
      the Committee does not employ outside compensation consultants. The Compensation
      Committee utilized this data to set compensation for our executive officers
      at
      levels targeted at or around the average of the compensation amounts provided
      to
      executives at comparable local companies considering, for each individual,
      their
      individual experience level related to their position with us. There is no
      pre-established policy or target for the allocation between either cash and
      non-cash incentive compensation.




***2006
      Executive Compensation Components***




For
      2006,
      the principal component of compensation for the named executive officers was
      base salary.




The
      Company provides named executive officers and other employees with a base salary
      to compensate them for services rendered during the fiscal year. Base salary
      ranges for the named executive officers are determined for each executive based
      on his or her position and responsibility.




During
      its review of base salaries for executives, the Committee primarily considers:




-67-




·
            the
                negotiated terms of each executive employment
                agreement;




·
            internal
                review of the executive’s compensation, both individually and relative to
                other executive officers; and




·
            individual
                performance of the executive.




Salary
      levels are typically considered annually as part of the company’s performance
      review process, as well as upon a change in job responsibility. Merit-based
      increases to salaries are based on the Compensation Committee’s assessment of
      the individual’s performance. Base salaries for the named executive officers in
      2006 have not been changed from the base salaries in effect during the prior
      year.




**Compensation
      Committee Report**




The
      Compensation Committee has reviewed and discussed with management the
“Compensation Discussion and Analysis” required by Item 402(b) of Regulation S-K
      and, based on such review and discussions, has recommended to our board of
      directors that the foregoing “Compensation Discussion and Analysis” be included
      in this Annual Report.




**Yi
                Guang Huo**
            **Zhi
                Zhong Wang**
            **Jiang
                Hua Feng**




**Summary
      Compensation Table**




The
      following table presents summary information concerning all compensation paid
      or
      accrued by us for services rendered in all capacities during 2006 by Mr. Xiao
      Ping Zhang and Ms. Zong Yun Zhou, who are the only individuals who served as
      our
      principal executive and financial officers during the year ended December 31,
      2006. No other executive officer received compensation in excess of $100,000
      for
      the fiscal year then ended.




**Summary
      Compensation Table**




**Name
                and Position**
            
            **Year**
            
            **Salary ($)**
            
            **Bonus**
              **($)
                (1)**
            
            **Option****Awards**
              **($)
                (2)**
            
            **Total**
              **($)**Mr.
                Xiao Ping Zhang, CEO (1)
            
            
            2006
            
            
            50,000
            
            
            —
            
            
            —
            
            
            50,000Ms.
                Zong Yun Zhou, CFO (2)
            
            
            2006
            
            
            20,000
            
            
            —
            
            
            —
            
            
            20,000







(1)
            Mr.
                Zhang is also employed by the Ruili Group which makes separate payments
                to
                him for his services to that company. Mr. Zhang did not receive any
                compensation other than the cash salary of $50,000 listed herein
                from the
                Company in 2006;





(2)
            Ms.
                Zhou did not receive any of compensation other than the cash salary
                of
                $20,000 listed herein from the Company in 2006






-68-




**Employment
      Agreements**




Effective
      May 1, 2006, the Company entered into employment agreements with Mr. Xiao Ping
      Zhang, our Chief Executive Officer, Mr. Xiao Feng Zhang, our Chief Operating
      Officer, and Ms. Zong Yun Zhou, our Chief Financial Officer. The term of their
      employment with the Company is for a period of five years with an additional
      one
      year period unless the Company decides not to renew. Their compensation is
      subject to an annual review by the Compensation Committee of the Board of
      Directors. The agreements also set forth their respective duties and
      confidentiality responsibilities.




**Severance
      and Change of Control Arrangements**




There
      are no severance or change of control arrangements.




**Equity
      Benefit Plans**




Our
      2005 Stock Compensation Plan was adopted by our board of directors in July
      2005.




Share
      Reserve . We have reserved 1,700,000 shares for issuance under the 2005 Stock
      Compensation Plan of which options to purchase 60,000 shares have been granted
      and 49,500 shares have been awarded to date.




Administration
      . The Compensation Committee of our board of directors administers the 2005
      Compensation Plan and has complete discretion to make all decisions relating
      to
      our 2005 Compensation Plan. Our compensation committee may also re-price
      outstanding options and modify outstanding awards in other ways.




Eligibility
      . Employees, non-employee members of our board of directors, advisors and
      consultants are eligible to participate in our 2005 Stock Compensation Plan.




Types
      of
      Awards. Our 2005 Stock Compensation Plan provides for awards of stock options
      to
      purchase shares of our common stock and awards of restricted shares of our
      common stock, stock appreciation rights and performance shares.




Change
      in
      Control . If we are merged or consolidated with another company, and such merger
      or consolidation results in a change in control, an award under the 2005 Stock
      Compensation Plan will be subject to the terms of the merger agreement, which
      may provide that the option continues, is assumed or substituted, fully vests
      or
      is settled for the full value of such option in cash, followed by the
      cancellation of such option.




Amendments
      or Termination . Our board of directors may amend, suspend or terminate the
      2005
      Stock Compensation Plan at any time. If our board amends the plan, it does
      not
      need to seek stockholder approval of the amendment unless required to comply
      with any applicable tax or regulatory environment. No award may be made under
      the 2005 Stock Compensation Plan after the tenth anniversary of the effective
      date of the Plan.




Options.
      The Board may determine the number of shares covered by each option, the
      exercise price therefore, the conditions and limitations on the exercise and
      any
      restrictions on the shares issuable. Optionees may pay the exercise price by
      using cash, shares of common stock that the optionee already owns or, at the
      election of the Board, a promissory note, an immediate sale of the option shares
      through a broker designated by us, or other property.




Performance
      Shares . The Board may make performance share awards entitling recipients to
      acquire shares of Common Stock upon the attainment of specified performance
      goals.




Stock
      Appreciation Rights . A participant who exercises a stock appreciation right
      receives the increase in fair market value of our common stock over the fair
      market value on the date of grant.




Restricted
      Shares . Restricted shares may be awarded under the 2005 Stock Compensation
      Plan. Restricted shares vest at the times and payment terms therefor shall
      be
      determined by our compensation committee.




-69-




Adjustments
      . If there is a subdivision of our outstanding shares of common stock, a
      dividend declared in stock or a combination or consolidation of our outstanding
      shares of common stock into a lesser number of shares, corresponding adjustments
      will be automatically made in each of the following: (a) the number of shares
      of
      common stock available for future awards under the 2005 Stock Compensation
      Plan;
      (b) any limitation on the maximum number of shares of common stock that may
      be
      subject to awards in a fiscal year; (c) the number of shares of common stock
      covered by each outstanding option or stock appreciation right, as well as
      the
      exercise price under each such award; (d) the number of shares of common stock
      covered by the options to be granted under the automatic option grant program;
      or (e) the number of stock units included in any prior award that has not yet
      been settled.




**Stock
      Option Grants**




None
      of
      the Company’s executive officers have received any grant of stock options or
      stock awards.




**Limitation
      of Liability and Indemnification of Officers and Directors**




As
      permitted by Delaware law, we have adopted provisions in our amended and
      restated certificate of incorporation and bylaws, both of which will become
      effective upon the closing of this offering, that limit or eliminate the
      personal liability of our directors and officers to the fullest extent permitted
      by Delaware law, as it now exists or may in the future be amended, and against
      all expenses and liabilities reasonably incurred in connection with their
      service for or on behalf of SORL.  In addition, the new amended and
      restated certificate of incorporation provides that our directors will not
      be
      personally liable for monetary damages to us for breaches of their fiduciary
      duty as directors, unless they violated their duty of loyalty to us or our
      stockholders, acted in bad faith, knowingly or intentionally violated the law,
      authorized illegal dividends or redemptions or derived an improper personal
      benefit from their action as directors.  We maintain liability insurance
      which insures our directors and officers against certain losses and which
      insures us against our obligations to indemnify our directors and officers.




In
      addition, we have entered into separate indemnification agreements with each
      of
      our directors and officers.  These agreements, among other things, require
      us to indemnify each director and officer to the fullest extent permitted by
      Delaware law, including indemnification of expenses such as attorneys’ fees,
      judgments, fines and settlement amounts incurred by the director or officer
      in
      any action or proceeding, including any action or proceeding by or in right
      of
      us, arising out of the person’s services as a director or officer.  At
      present, we are not aware of any pending or threatened litigation or proceeding
      involving any of our directors, officer, employees or agents in which
      indemnification would be required or permitted.  We believe provisions in
      our new amended and restated certificate of incorporation and indemnification
      agreements are necessary to attract and retain qualified persons as directors
      and officers.






-70-


**Compensation
        of Directors**
  The
        following table sets forth the compensation paid to our directors other than
        our
        Chief Executive Officer for 2006:


**Director
        Compensation Table**




**Name
                (1)**
            
            **Fees Earned or**
              **Paid in Cash**
              **($)
                (2)**
            
            **Option**
              **Awards**
              **($)
                (3)**
            
            **All
                other compensation**
              **($)**
            
            **Total**
              **($)**Xiao
                Feng Zhang (4)
            
            
            —
            
            
            —
            
            
            30,000
            
            
            30,000COO
                & DirectorJung
                Kang Chang (5)
            
            
            —
            
            
            —
            
            
            15,000
            
            
            15,000DirectorLi
                Min Zhang
            
            
            10,000
            
            
            12,424
            
            
            
            
            
            22,424DirectorZhi
                Zhong Wang
            
            
            10,000
            
            
            12,424
            
            
            
            
            
            22,424DirectorYi
                Guang Huo
            
            
            10,000
            
            
            12,424
            
            
            
            
            
            22,424DirectorJiang
                Hua Feng
            
            
            10,000
            
            
            12,424
            
            
            
            
            
            22,424Director







(1)
            Mr.
                Xiaoping Zhangdoes
                not receive additional compensation for his role as a Director. For
                information relating toMr.
                Xiaoping Zhang’scompensation
                asChairmanand Chief Executive Officer, see the Summary Compensation Table
                above.





(2)
            The
                amounts in this column represent cash payments made to Non-Employee
                Directors for attendance at meetings during the
                year.





(3)
            The
                amounts in this column represent the compensation cost of stock options
                awarded by the Compensation Committee granted in 2006, except that
                these
                amounts do not include any estimate of forfeitures. The grant date
                fair
                value of option awards granted were determined in accordance with
                Statement of Financial Accounting Standards No. 123R (SFAS123(R))
                and are
                recognized as compensation cost over the requisite service period.
                The
                amount recognized for these awards was calculated using the Black
                Scholes
                option-pricing model, and our 2005 Compensation Plan is described
                under
                this Item 11.




(4)
            Mr.
                Xiao Feng Zhang is not a non-employee director and did not receive
                cash
                compensation for attending board meetings or other stock options
                in 2006.
                However, he received cash compensation of $30,000 as salary for his
                managerial role with the Company. Mr. Zhang is also employed by the
                Ruili
                Group which makes separate payments to him for his services to that
                company.




(5)
            Mr.
                Jung Kang Chang is not a non-employee director and did not receive
                cash
                compensation for attending board meetings or other stock options
                in 2006.
                However, he received cash compensation of $15,000 as salary for his
                managerial role with the Company.




We
      use a
      combination of cash and stock-based compensation to attract and retain qualified
      candidates to serve on our board of directors. Directors who also are employees
      of our company currently receive no compensation for their service as directors
      or as members of board committees. In setting director compensation, we consider
      the significant amount of time that directors dedicate to the fulfillment of
      their director responsibilities, as well as the competency and skills required
      of members of our board. The directors’ current compensation schedule has been
      in place since March 2006. The directors’ annual compensation year begins with
      the annual election of directors at the annual meeting of shareholders. The
      annual retainer year period has been in place for directors since 2006.
      Periodically, our board of directors reviews our director compensation policies
      and, from time to time, makes changes to such policies based on various criteria
      the board deems relevant.




-71-




Non-employee
      directors are reimbursed for travel, lodging and other reasonable out-of-pocket
      expenses incurred in attending meetings of our board of directors and for
      meetings of any committees of our board of directors on which they serve. During
      2006, our non-employee directors had each received or earned cash compensation
      for attending board or committee meetings of $10,000. On March 1, 2006, the
      Board of Directors approved a total of 60,000 options (See note 17) to be issued
      to the four non-employee directors. Each non-employee director received
      options to purchase 15,000 shares of common stock with an exercise price of
      $4.79 per share. The contractual term of the options is three years.




**Compensation
      Committee Interlocks and Insider Participation**




As
      noted above, the compensation committee of our board of directors consists
      of
      Messrs. Wang, Feng and Huo.  None of our executive officers serve as a
      member of the board of directors or compensation committee of any entity that
      has one or more executive officers who serve on our board of directors or
      compensation committee.




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




The
      following table sets forth certain information known to us regarding beneficial
      ownership of our common stock as of December 31, 2006 and as adjusted to reflect
      the sale of the shares of common stock in this offering and the conversion
      of
      all outstanding shares of our convertible preferred stock by:




·
            each
                person known by us to be the beneficial owner of more than 5% of
                any class
                of our voting securities;




·
            our
                named executive officers;




·
            each
                of our directors; and




·
            all
                executive officers and directors as a
                group.




Beneficial
      ownership is determined according to the rules of the SEC and generally means
      that a person has beneficial ownership of a security if he or she possesses
      sole
      or shared voting or investment power of that security, and includes options
      and
      warrants that are currently exercisable within 60 days. Information with respect
      to beneficial ownership has been furnished to us by each, director, executive
      officer or 5% or more stockholder, as the case may be. Unless otherwise
      indicated, to our knowledge, each stockholder possesses sole voting and
      investment power over the shares listed, except for shares owned jointly with
      that person’s spouse.




This
      table lists applicable percentage ownership based on 18,275,126 shares of common
      stock outstanding as of December 31, 2006.




The
      address for each of the stockholders in the table is c/o of the
      Company.




-72-




**NAME
                OF BENEFICIAL OWNER**
            
            **AMOUNT
                AND NATURE BENEFICIAL OWNER**
            
            **POSITION**
            
            **PERCENT
                OF CLASS**Xiao
                Ping Zhang
            
            
            9,087,527
            
            
            Chief
                Executive Officer and Chairman
            
            
            49.7
            %Xiao
                Feng Zhang
            
            
            1,135,938
            
            
            Chief
                Operating Officer and Director
            
            
            6.2
            %Zong
                Yun Zhou
            
            
            —
            
            
            Chief
                Financial Officer
            
            
            *Jung
                Kang Chang
            
            
            —
            
            
            Director
            
            
            *Li
                Min Zhang
            
            
            —
            
            
            Director
            
            
            *Zhizhong
                Wang
            
            
            —
            
            
            Director
            
            
            *Yiguang
                Huo
            
            
            —
            
            
            Director
            
            
            *Jianghua
                Feng
            
            
            —
            
            
            Director
            
            
            *Officers
                and Directors as a Group (8 persons)
            
            
            10,223,465
            
            
            
            
            
            55.9
            %PRINCIPAL
                SHAREHOLDERSShu
                Ping Chi
            
            
            1,135,938
            
            
            
            
            
            6.2
            %




*  Less
      than
      1%





**ITEM
      13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS**




**Capital
      Stock Issuances in the Reverse Acquisition**




Pursuant
      to the reverse acquisition, Mr. Xiao Ping Zhang, our Chief Executive Officer,
      and Mr. Xiao Feng Zhang, our Chief Operating Officer, received 9,087,527 shares
      and 1,135,938 shares, respectively, of our Common Stock representing 68.4%
      and
      8.55% respectively, of our then outstanding shares.




**Ruili
      Group**




Mr.
      Xiao
      Ping Zhang and Mr. Xiao Feng Zhang are the principal shareholders of the Ruili
      Group which was the owner of the assets contributed to the Joint Venture in
      the
      reverse acquisition. We purchase non-valve automotive products and packaging
      material from the Ruili Group. In 2006, we purchased products from the Ruili
      Group representing approximately $21.9 million of our sales. We generate only
      a
      small profit on these sales, but our sales of these products represent an
      important marketing benefit as they enable us to fill out our product line
      and
      reduce our customers’ transaction costs. The Ruili Group also guaranteed certain
      bank loans to the Joint Venture without fee and licensed two patents and the
      trademark “SORL” to the Joint Venture on a royalty free basis. The two patents
      licensed were assigned to the JV in 2006 for $50,000. We also lease from the
      Ruili Group our production facility and warehouse consisting of approximately
      271,700 square feet. The lease commenced in March 2004 and is for a term of
      ten
      years at an annual rental of approximately $457,845. In December 2006, the
      Company entered into one new lease agreement with Ruili Group Co., Ltd., to
      lease two apartment buildings. The two apartment buildings are for its
      management personnel and ordinary staff, respectively. The lease term is from
      January 2007 to December 2011 for one apartment building, and is from January
      2007 to December 2012 for the other. The annual rental of the two apartment
      buildings is approximately $242,043. Additionally, in November 2006, the JV
      enterprise purchased approximately 120 acres of land for $5.9 million from
      RuiLi
      Group. The Company believes that the transactions above-mentioned are of arm’s
      length, and all prices charged and payments made between them are at least
      as
      favorable to the Joint Venture as would be obtained from a third
      party.




-73-




**ITEM
      14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.**




Rotenberg
      & Co. LLP, Certified Public Accountants, was the Registrant’s independent
      registered public accounting firm engaged to examine the financial statements
      of
      the Registrant for the fiscal year ended December 31, 2006 and 2005. Hein &
Associates LLP, was the Registrant’s independent registered public accounting
      firm engaged to examine the financial statements of the Registrant for the
      fiscal year ended January 31, 2003. The Registrant changed its fiscal year
      end
      from January 31 to December 31 on May 19, 2004. Rotenberg & Co. LLP
      performed the following services and has been paid the following
      fees.




**FISCAL
      YEAR ENDED DECEMBER 31, 2006 and 2005**




**AUDIT
      FEES**




Rotenberg
      & Co. LLP was paid aggregate fees of approximately $120,000 and $120,000 for
      the fiscal years ended December 31, 2006 and 2005, respectively, for
      professional services rendered for the audit of the Registrant’s annual
      financial statements and for the reviews of the financial statements included
      in
      the Registrant’s quarterly reports on Form 10-QSB for the periods ended March
      31, 2006 and 2005, June 30, 2006 and 2005, as well as September 30, 2006 and
      2005.




**AUDIT-RELATED
      FEES**




Rotenberg
      & Co. LLP was not paid additional fees for the fiscal years December 31,
      2006 and December 31, 2005 for assurance and related services reasonably related
      to the performance of the audit or review of the Registrant’s financial
      statements.




**TAX
      FEES**




Rotenberg
      & Co. LLP was not paid any fees for the fiscal years ended December 31, 2006
      and December 31, 2005 for professional services rendered for tax compliance,
      tax
      advice and tax planning. This service was not provided.




**ALL
      OTHER FEES**




Rotenberg
      & Co. LLP was paid no other fees for professional services during the fiscal
      years ended December 31, 2006 and December 31, 2005.




**AUDIT
      COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES**




Our
      Audit
      Committee’s policy is to pre-approve all audit and permissible non-audit
      services provided by our independent auditors. These services may include audit
      services, audit-related services, tax services and other services. Pre-approval
      is generally provided for up to one year and any pre-approval is detailed as
      to
      the particular service or category of services. The independent auditor and
      management are required to periodically report to the Audit Committee regarding
      the extent of services provided by the independent auditor in accordance with
      this pre-approval.




-74-




**ITEM
      15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**




EXHIBIT
                NO.
            
            DOCUMENT
                DESCRIPTION3.1
            
            Articles
                of Incorporation (1)3.2
            
            Bylaws
                (1)10.1
            
            Share
                Exchange Agreement and Plan of Reorganization (2)10.2
            
            Joint
                Venture Agreement (revised)10.3
            
            Employment
                Agreement—Xiao Ping Zhang (3)10.4
            
            Employment
                Agreement—Xiao Feng Zhang (3)10.5
            
            Employment
                Agreement—Zong Yun Zhou (3)31.1
            
            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.32.1
            
            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).32.2
            
            Certification
                pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
                906 of
                the Sarbanes-Oxley Act of 2002 (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 and
                amendment thereto as filed with the Securities and Exchange Commission,
                on
                May 24, 2004.




(3)
            Incorporated
                herein by reference from the Registrant’s Form S-1 as filed with the
                Securities and Exchange Commission on August 31,
                2006.




-75-


**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 23 rd day of
      March 2006.


**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
                23, 2006Xiao
                Ping Zhang/s/
                Xiao Feng Zhang
            
            Chief
                Operating Officer and Director
            
            March
                23, 2006Xiao
                Feng Zhang/s/
                Zong Yun Zhou
            
            Chief
                Financial Officer
            
            March
                23, 2006Zong
                Yun Zhou/s/
                Li Min Zhang
            
            Director
            
            March
                23, 2006Li
                Min Zhang/s/
                Zhi Zhong Wang
            
            Director
            
            March
                23, 2006Zhi
                Zhong Wang/s/
                Yi Guang Huo
            
            Director
            
            March
                23, 2006Yi
                Guang Huo/s/
                Jiang Hua Feng
            
            Director
            
            March
                23, 2006Jiang
                Hua Feng/s/
                Jung Kang Chang
            
            Director
            
            March
                23, 2006Jung
                Kang Chang




-76-