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,
  2008





OR





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





Commission
file number 0-024828





SORL
AUTO PARTS, INC.


(Name of
Issuer in Its Charter)





DELAWARE
                (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 REGISTEREDCOMMON STOCK: 0.002 PARVALUE
              NASDAQ GLOBAL MARKET





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











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


Yes  ̈ No x





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





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





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





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


Large
accelerated filer  ̈
Accelerated filer  ̈
Non-accelerated  ̈
Smaller Reporting Companyx





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


Yes  ̈ No x





State
issuer’s revenues for its most recent fiscal year December 31, 2008:
$130,893,422





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, 2008, the value was approximately $37,231,185.





State the
number of shares outstanding of each of the issuer’s classes of common equity:
18,279,254 as of March 17, 2009.





DOCUMENTS
INCORPORATED BY REFERENCE





Portions
of the registrant’s definitive proxy statement for its annual meeting of
shareholders, scheduled for June 10th, 2009, are incorporated by reference into
Part III of this report.





2





TABLE
OF CONTENTS





PART
      IITEM
      1.
                    DESCRIPTION
      OF BUSINESS
                    
                    5ITEM
      1.A.
                    RISK
      FACTORS
                    
                    18ITEM
      1B.
                    UNRESOLVED
      STAFF COMMENTS
                    
                    31ITEM
      2.
                    PROPERTIES
                    
                    32ITEM
      3.
                    LEGAL
      PROCEEDINGS
                    
                    32ITEM
      4.
                    SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
                    
                    32PART
      IIITEM
      5.
                    MARKET
      FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS AND ISSUER
      PURCHASES OF EQUITY SECURITIES
                    
                    32ITEM
      6.
                    SELECTED
      FINANCIAL DATA
                    
                    33ITEM
      7.
                    MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
                    
                    34ITEM
      7A.
                    QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
                    
                    41ITEM
      8.
                    FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA
                    
                    42ITEM
      9.
                    CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE
                    
                    64ITEM
      9A(T).
                    CONTROLS
      AND PROCEDURES
                    
                    64





3





ITEM
      9B.
                  OTHER
      INFORMATION
                  
                  64PART
      IIIITEM
      10.
                  DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
                  
                  64ITEM
      11.
                  EXECUTIVE
      COMPENSATION
                  
                  65ITEM
      12.
                  SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS
                  
                  65ITEM
      13.
                  CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE
                  
                  65ITEM
      14.
                  PRINCIPAL
      ACCOUNTANT FEES AND SERVICES
                  
                  65ITEM
      15.
                  EXHIBITS,
      AND FINANCIAL STATEMENT SCHEDULES
                  
                  66SIGNATURES





4





PART
I





ITEM
1. DESCRIPTION OF BUSINESS





BUSINESS





Through
its 90% ownership of the Ruili Group Ruian Auto Parts Co., Ltd., a
sino-foreign joint venture (the “Joint Venture”), SORL Auto Parts, Inc. (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.





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





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





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





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





5





STRATEGIC
PLAN





The
financial turmoil which started in the U.S. has been spreading, materially
impacting worldwide economies and appears likely to cause a global recession.
The Chinese government, like many governments around the world that have taken
measures to stabilize the economy, has initiated a 4 trillion RMB stimulus
package to boost the economy. We believe that the positive impact will be
reflected in the economy beginning in the second half of 2009.





Meanwhile,
mounting pressure from the deterioration of and uncertainty in the macroeconomic
environment both domestically and internationally has posed a challenge to our
operational and financial performance. In response, we have adjusted our
strategic direction in 2009.





l
            Enhancing
      confidence in the automobile industry. As one of China’s pillar
      industries, the automotive industry occupies a critical role in the
      growth of China’s economy. The Chinese government has taken a series of
      measures to support the development of this industry. We are
      confident about the health of our auto parts business and are optimistic
      about the outlook.





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





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





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





l
            Develop
      new products. We plan to enhance the development of several new products
      including auto electronics and energy-saving products. We are working to
      upgrade traditional air brake drive products to electronic control
      products to achieve a higher profit
margin.





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





l
            Expand
      through strategic alliance and acquisitions. We are exploring
      opportunities to 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.





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.





6





The Joint
Venture makes an extensive range of air brake valves and related products
covering 40 categories and over 1000 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.





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





Product
                
                DescriptionRL3530 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. The RL3530 series Spring Brake Chamber was
      awarded a patent in China. In 2008, the Joint Venture produced 1.27
      million 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
      Servos, 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 898 thousand units in 2008, clutch servos are currently supplied to OEM
      customers such as FAW Qingdao.RL3511
      Series Air Dryer
                
                Air
      dryers dry and purify 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 213 thousand units in
      2008. The products are supplied to OEM customers such as FAW Qingdao and
      Dongfeng Group.RL3511
      Series Air Dryer has been patented in China.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 718
      thousand units in 2008. Also, we have been awarded a patent in China for
      the product.





7





Hand
      Brake Valves
              
              Hand
      brake valves serve as an auxiliary device for parking brakes. Current
      annual output is about 419 thousand units. They are supplied to many OEM
      customers including FAW
Qingdao.





The
Company obtained ISO9001/QS9000/VDA6.1 System Certifications in 2001. We passed
the ISO/TS 16949 System Certification test conducted by the TUV CERT
Certification Body of TUV Industrie Service GmbH in 2004, and its annual review
in 2008 The ISO/TS 16949 System, a higher standard replacing the
ISO9001/QS9000/VDA6.1 System, was enacted by the International Automotive Task
Force and is recognized by major automobile manufacturers all over the world.
The annual reviews for other certifications which we passed in 2008 included
ISO14001 on environmental management and OHSAS18001 on health and safety
management, reflecting the Company’s commitment to workplace safety, health and
environmental protection.





CHINA
AUTOMOBILE AND AUTO PARTS INDUSTRY





The
automobile industry is one of China’s key industries, contributing significantly
to the growth of China’s economy. In 2008, China’s automobile output and sales
volume both reached their record high levels of 9.35 million and 9.38 million
units, increasing by 5.2% and 6.7%, respectively, compared to 2007 figures. The
output and sales volume of commercial vehicles increased 4.2% and 5.3% to 2.61
million units and 2.62 million units, respectively.





According
to the latest forecast of the total demand in China’s market conducted by the
Industry Economy Research Department of State Council Development Research
Center, inventory of domestic automobiles will reach 56.69 million units in
2010 and 131.03 million units in 2020. This figure reflects the potential of the
domestic auto market in the long run and lays a foundation for the continued
development of the auto parts industry.





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, our customers are divided into three groups: OEMs in China,
aftermarket distributors in China, and international customers, accounting for
approximately 37.4%, 27.1% and 35.5%, respectively, of the Company’s annual
sales for 2008.





8





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
62 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 incorporated the Joint Venture’s
air brake valves.





The table
below presents comparative information for 2008 and 2007 on the Company’s
top 5 OEM customers.





Ranking
                            
                            Customer
                            
                            % of
                              2008
                              Sales
                            
                            
                            Customer
                            
                            % of
                              2007
                              Sales1
                            
                            FAW
      Jiefang Automotive Co., Ltd.
                            
                            
                            6.53
                            %
                            
                            FAW
      Jiefang Automotive Co., Ltd.
                            
                            
                            7.30
                            %2
                            
                            Dongfeng
      Axle Co., Ltd. ShiYan Automobile Works
                            
                            
                            5.97
                            %
                            
                            FAW
      Qingdao Automobile Works
                            
                            
                            4.56
                            %3
                            
                            FAW
      Qingdao Automobile Works
                            
                            
                            5.34
                            %
                            
                            Dongfeng
      Axle Co., Ltd.
                            
                            
                            4.18
                            %4
                            
                            Dongfeng
      Axle Co., Ltd.
                            
                            
                            2.64
                            %
                            
                            Beiqi
      Foton Motor Co., Ltd. Zhucheng Automobile Works
                            
                            
                            2.85
                            %5
                            
                            Beiqi
      Foton Motor Co., Ltd. Beijing Auman Heavy-Duty Vehicle
    Works
                            
                            
                            2.44
                            %
                            
                            Beiqi
      Foton Motor Co., Ltd. Beijing Auman Heavy-Duty Vehicle
    Works
                            
                            
                            2.57
                            %





A few of
our principal OEM customers are:





FAW Group
Corporation: 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. FAW Jiefang Automotive Co., Ltd. and FAW Qingdao Automotive Works are
subsidiaries of FAW Group Corporation.





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 77 billion RMB and has about 24,000
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 - The Joint
Venture has established sales networks of 28 authorized distributors covering
the following 7 regions nationwide:





·
            Northeast Region (Harbin,
      Changchun, Shenyang)





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





9





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





International Market -
Management views the export market as an important growth area. We have
signed agreements with 3 distributors in UAE, Australia, and USA, and begun to
supply our products to local OEMs in India. Company also actively
participate in international trade shows including more than ten international
exhibition as Automechanika in Frankfort Equip Auto in Pairs, Automotive
Aftermarket Products Expo in Las Vegas, Automechanika Middle East in Dubai
and China Import and Export Fair in Guangzhou, to acquire new customers and new
orders. In 2008, export sales accounted for 35.5% of total revenue.
Products are exported to more than 101 countries and regions in the world. Total
export sales in 2008 increased by 6.9% compared to that in 2007.





Ranking
                                    
                                    Country
                                    
                                    CustomerName
                                    
                                    %of
                                      2008
                                      Sales
                                    
                                    
                                    Country
                                    
                                    CustomerName
                                    
                                    %of
                                      2007
                                      Sales1
                                    
                                    United
      Arab Emirates
                                    
                                    GOLDEN
      DRAGAN AUTO SPARE PARTS
                                    
                                    
                                    6.65
                                    %
                                    
                                    United
      Arab Emirates
                                    
                                    GOLDEN
      DRAGAN AUTO SPARE PARTS
                                    
                                    
                                    6.30
                                    %2
                                    
                                    USA
                                    
                                    ITM
                                    
                                    
                                    3.17
                                    %
                                    
                                    USA
                                    
                                    ITM
                                    
                                    
                                    4.59
                                    %3
                                    
                                    USA
                                    
                                    SAP
                                    
                                    
                                    1.95
                                    %
                                    
                                    South
      Africa
                                    
                                    MICO
                                    
                                    
                                    1.10
                                    %4
                                    
                                    USA
                                    
                                    LLW
                                    
                                    
                                    1.38
                                    %
                                    
                                    USA
                                    
                                    SAP
                                    
                                    
                                    1.02
                                    %5
                                    
                                    India
                                    
                                    TATA
                                    
                                    
                                    1.25
                                    %
                                    
                                    Poland
                                    
                                    FOTA
                                    
                                    
                                    0.98
                                    %6
                                    
                                    South
      Africa
                                    
                                    MICO
                                    
                                    
                                    1.22
                                    %
                                    
                                    South
      Africa
                                    
                                    TPE
                                    
                                    
                                    0.95
                                    %7
                                    
                                    Indonesia
                                    
                                    LIL
                                    
                                    
                                    0.8
                                    %
                                    
                                    Poland
                                    
                                    MAKROTECH
                                    
                                    
                                    0.94
                                    %





10





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 the current global automotive industry,
vehicle manufacturers generally only engage in assembling but not manufacturing
non-key automotive parts. Rather, they source these components through a global
network of suppliers. As a result, only those automotive parts manufacturers
with large-scale production, advanced technology and the ability of producing
system modules, can supply their products to vehicle manufacturers directly. The
automotive parts industry in China is fragmented and there are many small
manufacturers which mainly target the aftermarket. However, there are not many
companies who have established both nationwide aftermarket sales networks and
close relationships with leading OEM manufacturers. As the largest commercial
vehicle air brake system manufacturer in China, 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, Beiqi Foton Motor Co., Ltd., Baotou North-Benz Heavy Duty Truck
Co., Ltd., Anhui Jianghuai Automobile Co., Ltd. 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, and reliability
and timeliness of delivery, which could be gained by recruiting highly qualified
managers and other employees, developing improved product design capability
and facilities, and maintaining better customer service.





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 air
      dryers, and ABS, primarily supplying to truck and bus OEM’s such asChina Heavy Duty Truck Group
      Corp., Ltd., andsome major bus
      manufacturers in China.





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





Management
believes the Company has the 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.SORLhas won“China Top Brand”and the“ExportBrand ofthe Year 2006”which isrecommendedby ChinaChamber of Commerce for
      Import & Export
      of machinery& Electronicproducts.





·
            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: Because management believes that products ultimately define a
      manufacturing company’s success, we continue to increase our budget for
      research and development activities. Through its international sales
      offices in the US, Australia and the Middle East, the Joint Venture is
      able to promptly collect information about current trends in automotive
      technologies, which in turn is applied to our new product development and
      used to enhance our capacity of providing domestic OEMs with advanced
      products. In addition, IT application and strict implementation of
      ISO/TS16949 standards in the development process greatly shorten the
      development lead time and improve new product
  quality.





11





·
              Sales Networks: The Joint Venture
      has contracted with28authorized distributors covering
      7 regions of China.We help train their sales force
      and improve their service quality. These authorized
      distributorsin turn
      channel “SORL”products through over800sub-distributors throughout
      China.


·
            Production
      Management: The Joint Venture continues to improve production methods in
      its manufacturing process. This has resulted in reducing the manufacturing
      cycle, reducing waste, enhancing quality consistency and reducing
      production cost.





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





The Joint
Venture strengthened its sales and marketing efforts in 2008. The
sales headcount for domestic (PRC) sales and international sales
was 35 and 37, respectively. 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 2012.





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





OEM Market–In 2008, the joint venture
strengthened its long tern relationship with major domestic OEM customers, and
expanded into the municipal bus market and agricultural vehicle market.
Currently, the joint venture has 62 OEM customers. Normally, these
customers sign one-year sales contracts and contracts are revised as
needed.





According
to the China Association of Automobile Manufacturers, the unit production of the
Chinese heavy duty vehicle and medium vehicle sectors including complete trucks,
chassis and semi-trailers, grew over 2.5% in 2008 as compared to 2007. The
Joint Venture has successfully expanded its production capacity so that it
was able to increase its sales to the OEM market by $7.7 million or 18.6%
for the year ended December 31, 2008, as compared to the year ended December 31,
2007. Our sales growth is the result of our enlarged customer base
and increasing orders from our existing major customers.





12





DomesticAftermarket - The Joint
Venture places great emphasis on the Chinese automotive aftermarket business and
sells products in the aftermarket for replacement purposes. With the rapid
growth of commercial vehicles output in recent years and the increasing number
of vehicles on the road, there has been an increasing demand for replacement
parts in the aftermarket. The joint venture has an aftermarket sales network
including 28 authorized distributors covering 7 regions nationwide in PRC.
These distributors sell only the products under the “SORL” trademark to over 800
Chinese distributors. The Joint Venture provides product technical services to
these distributors, and also conducts periodic performance evaluations, and
reserves the right to terminate the distributorship of those with frequent
delinquencies or poor sales records. For 2008, the Company achieved total
revenue of $35.5 million in domestic aftermarket sales, an increase of
14.1% from 2007.





International Markets -The Joint Venture seeks
to increase export sales to enhance our brand image and expand our
international market share. Currently our primary international sales
are in the aftermarket, and the company sells products to 101 countries or
regions, and has OEM business with leading local OEM customers in
India.





In
addition, to pursue the international market, we have signed agreements with
three distributors in UAE, Australia and the USA. We are pursuing
development of a sales network in South America, Asia-pacific and Western
Europe, and intend to pursue a localization strategy to respond to different
market conditions, and to reinforce the service and support effort to our
international customers.





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 CAPACITY





As of
December 31, 2008, the Joint Venture employed 113 technical staff members,
including 43 holding Engineer or Senior Engineer qualifications. Our technical
staff includes three information technology specialists, 81 for new product
development and design technique, nine for measurement and testing, six for MIS,
and the other 14 persons are quality management engineers.





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





·
            Tongji University at
      Shanghai andHarbin Institute of Technology:
      Contract for co-development of electronic controlbraking system
      andautomotive
      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 the
research centers of FAW Group and Dongfeng Group.





13





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





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





Patented
Technologies





We have
reinforced our R&D efforts on patented products. Currently the Joint Venture
owns 15 utility patents and has filed applications for 11 other patents in China
and an 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, our formula for aluminum
alloy, developed over many years of testing, considerably improves the
compactness of alloy, hence the strength of casting. The Joint Venture also
possesses a confidential “protection film” processing technique to enhance
the sealability of products.





Currently,
the Joint Venture is seeking to expand its use of a lean production
system, which has already begun to be used. It has not only decreased
manufacturing cost, but more importantly, it also shortened the production cycle
and set a reliable basis for prompt response to the demands of the market. Also,
in order to ensure the high quality of our products, the Joint Venture has
successfully replaced its traditional testing methods with computerized
testing systems and largely decreased quality problems caused by man-made
mistakes.





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 and, in 2007, registered the trademark in US.





PRODUCTION





The
Joint Venture owns the largest commercial vehicle air brake valve products
manufacturing base in China. During the 2008 fiscal year, the Joint Venture
added 10 processing centers, 15 Computerized Numerical Control machines and
8 die casting machines. Meanwhile, the Joint Venture re-deployed and streamlined
its production / assembly lines, enabling it to rapidly expand its production
capacity to meet increasing market demands for its products. The production
process includes fixture, jig and die making, aluminum alloy die casting, metal
sheet stamping, numerical control cutting, welding, numerical control
processing, surface treatment, filming, rubber/plastic processing, final
assembly and packaging. The Joint Venture possesses state-of-the-art
manufacturing and testing facilities sourced from the US, Korea, Taiwan and
mainland China, including Computerized Numerical Control processing centers,
Computerized Numerical Control lathes, casting, stamping and cutting machines,
automatic spraying and electroplating lines, cleaning machines, automatic
assembly lines and three-dimensional coordinate measuring machines and
projectors, etc.





14





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





ENVIRONMENT





In 2006,
we were granted ISO14001 certification on environmental management and
OHSAS18001 certification on health and safety management, which
reflects the Company’s commitment to workplace safety, health and
environmental protection. The Joint Venture carries out staff training to
enhance awareness of environment protection. We seek in all phases of our
operations to employ practices for environment friendly production, reducing or
preventing pollution, and reduction of energy consumption and manufacturing
costs. For example, 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, 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 2008, the three
largest suppliers were Shanghai Jinshi Materials Co., Ltd, Shanghai Lutie
Metal Trading Co., Ltd. and Shanghai
Dechen Commodity Co., Ltd., which together accounted for 24.3% of
the aggregate of raw materials we purchased.  Among these companies,
only Shanghai Jinshi Materials Co., Ltd accounted for more than 10% of total raw
material purchases, reached 14.5%.





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 favorable 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
our orders from customers change.





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





15





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 2006, 2007 and 2008 was 11.1%, 11.4% and
9.0% respectively.





According
to the PRC government outlook for 2009, the government’s primary mission
is to maintain a healthy economicgrowth
rate. Simultaneously, the Chinese government made significant changes
in economic policy, including adoption of expansionary financial and
currency. Simultaneously, central government promulgated a significant
investment plan with a total amount of RMB 4 Trillion for the coming two
years. This is intended to support economic growth for fiscal
2009, along with implementation of ten detailed economic policies,
including expanding domestic demand and accelerating economic
growth.





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.





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;





16





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





·
            Economic policies will not be
      significantly alteredfrom 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 2,098 employees, all of whom are employed full time:
53 for quality control, 113 technical staff, 72 sales and marketing staff,
1,823 production workers and 37 administrative staff. There are employment
agreements with all of the employees whereby administrative staff workers agree
to three years of employment and hourly workers agree to three years. Employment
contracts with all employees comply with relevant laws and regulations of
China.





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





DESCRIPTION
OF THE JOINT VENTURE





General





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





Management
of the Joint Venture





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





17





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.





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.





18





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





With the
deepening financial crisis and slowing global economy, there is a risk of
increased international trade protectionism. Many countries set trade barriers
which could negatively affect our export sales, as well as create potential
risks for litigation in the countries to which the products are
exported.





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





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





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. The Ruili Group also sells to us certain non-valve products which
allow us to fill out our product lines which in 2008 represented approximately
23.8% 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.





19





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.





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





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





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





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





Our
operations depend highly on Messrs. Xiao Ping Zhang, our Chief Executive
Officer, and 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 respond effectively to rapid growth in demand for our
products and of our manufacturing operations which could adversely affect our
customer relations and our growth prospects.





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





20





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 and our cash flow.





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 8% of our revenues for the
fiscal year ended December 31, 2008, our three largest customers accounted for
approximately 19.2% and 18.2% of our revenues in 2008 and 2007 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 15 patents in
China, have filed applications for 11 others in China and an additional
three in the U.S.A. We claim proprietary rights in various unpatented
technologies, know-how, trade secrets and trademarks relating to products and
manufacturing processes. We protect our proprietary rights in our products and
operations through contractual obligations, including nondisclosure agreements.
If these contractual measures fail to protect our proprietary rights, any
advantage those proprietary rights provide us would be negated. Monitoring
infringement of intellectual property rights is difficult, and we cannot be
certain that the steps we have taken will prevent unauthorized use of our
intellectual property and know-how, particularly in China and other countries in
which the laws may not protect our proprietary rights as fully as the laws of
the United States. Accordingly, other parties, including competitors, may
improperly duplicate our products using our proprietary technologies.
Pursuing legal remedies against persons infringing our patents or otherwise
improperly using our proprietary information is a costly and time consuming
process that would divert management’s attention and other resources from the
conduct of our other business, and could cause delays and other problems
with the marketing and sales of our products, as well as delays in
deliveries.





21





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





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





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





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





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





·
            coordinate research anddevelopment
      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;





22





·
            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.





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.





23





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





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





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





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





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





In 2008,
approximately 62.6% 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.





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.





24





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’patentrights, which may not be possible
      or could require substantial funds or
  time.





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.





25





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.





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





26





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 6.4% 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 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.





27





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, nationalization or domestic or global economic
conditions could result in a total investment loss in our common
stock.





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





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.





28





A
financial crisis is ongoing, both worldwide and within the PRC. The Chinese
government has announced it will implement an expansive national
policy to help normalize China’s economy and promote confidence and economic
expansion. However, there can be no assurance as to the success, or timing of
implementing these policies.





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





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





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





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





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





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





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





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





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





29





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





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





Risks
Related to Our Common Stock





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





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





·
            actual or anticipated
      fluctuations in our quarterly operating
  results,





·
            announcements of new products by
      us or our competitors,





·
            changes in financial estimates by
      securities
      analysts,





·
            conditions in the automotive
      market,





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





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





·
            additions or departures of key
      personnel, or





·
            potential
      litigation.





30





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 would have an adverse affect on our business by restricting access to
working capital to fund growth and operations. Furthermore, the comparatively
small public float of our common stock could adversely affect the market price
of our common stock.





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





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





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, was 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 imposes substantial
burdens in terms of financial expense and commitment of personnel. There can be
no assurance that we will have the personnel, financial resources or expertise
to meet requirements of these regulations.





ITEM
1B. UNRESOLVED STAFF COMMENTS








31




ITEM
2. PROPERTIES





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





ITEM
3. LEGAL PROCEEDINGS





None.





ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS





There
were no matters submitted to the stockholders in the fourth quarter of
2008.





PART
II





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





Price
Range of Common Stock





On April
18, 2006, SORL Auto Parts, Inc. was approved for listing its common shares on
the NASDAQ Capital Market and commence trading its shares on NASDAQ under the
symbol “SORL”. The Company was further approved for listing on NASDAQ Global
Market on November 21, 2006. High and low sales prices per share of our Common
Shares for each quarter ended during 2008 and 2007 are as follows:





Quarter Ended
                
                High
                
                Low2008First
      Quarter
                
                
                7.40
                
                4.70Second
      Quarter
                
                
                7.10
                
                4.83Third
      Quarter
                
                
                6.45
                
                3.32Forth
      Quarter
                
                
                3.89
                
                1.39





32





2007First
      Quarter
                
                
                9.88
                
                7.37Second
      Quarter
                
                
                8.96
                
                6.75Third
      Quarter
                
                
                8.30
                
                6.01Forth
      Quarter
                
                
                9.46
                
                6.07





Stockholders





At March
11, 2009, we had approximately 515 registered stockholders of record of our
common stock. This number does not include shares beneficially owned by
investors through brokerage clearing houses, depositories or otherwise held in
“street name”.





Dividend





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





ITEM
6. SELECTED FINANCIAL DATA.





Not
applicable.





33





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 presented. Undue reliance should not be
placed on these forward-looking statements, which speak only as of the date
hereof. We undertake no obligation to update these forward-looking
statements.





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





OVERVIEW





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





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





34





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





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





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





As a
result of the foregoing, through Fairford’s 90% interest in the Joint Venture,
the Company manufactures and distributes automotive air brake 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 one thousand different specifications. Management believes that it is
the largest manufacturer of automotive brake valves in China.





CRITICAL
ACCOUNTING POLICIES AND ESTIMATES







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





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





WARRANTIES





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


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.





35





INCOME
TAXES





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





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





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





REVENUE
RECOGNITION





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


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
collectiblity of outstanding accounts receivable.





RESULTS
OF OPERATIONS





Year
ended December 31, 2008 as compared to year ended December 31,
2007:





36




Years Ended December 31,2008
                              
                              
                              %
                              
                              
                              2007
                              
                              
                              %Sales(U.S. 
      dollars in million)Air
      brake valves & related components
                              
                              $
                              99.7
                              
                              
                              
                              76.2
                              %
                              
                              $
                              89.2
                              
                              
                              
                              77.0
                              %Non-valve
      products
                              
                              $
                              31.2
                              
                              
                              
                              23.8
                              %
                              
                              $
                              26.6
                              
                              
                              
                              23.0
                              %Total
                              
                              $
                              130.9
                              
                              
                              
                              100
                              %
                              
                              $
                              115.8
                              
                              
                              
                              100
                              %





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 $130,893,422 and $115,760,070 for the fiscal years ended December 31,
2008 and 2007, respectively, representing an increase of $15.1 million or 13.0%
year over year. The increase in sales was the result of balanced growth in
all three market segments:  the domestic OEM market, the domestic
aftermarket and international market. A breakdown of net sales revenue for our
three market segments, domestic OEM market, domestic aftermarket and
international markets, in 2008 and 2007 is as follows:




Years Ended December 31,2008
                              
                              
                              %
                              
                              
                              2007
                              
                              
                              %(U.S.
      dollars in million)China
      OEM market
                              
                              $
                              49.0
                              
                              
                              
                              37.4
                              %
                              
                              $
                              41.3
                              
                              
                              
                              35.6
                              %China
      Aftermarket
                              
                              $
                              35.5
                              
                              
                              
                              27.1
                              %
                              
                              $
                              31.1
                              
                              
                              
                              26.9
                              %International
      market
                              
                              $
                              46.4
                              
                              
                              
                              35.5
                              %
                              
                              $
                              43.4
                              
                              
                              
                              37.5
                              %Total
                              
                              $
                              130.9
                              
                              
                              
                              100
                              %
                              
                              $
                              115.8
                              
                              
                              
                              100
                              %




National
transportation in China was heavily affected by significant snow storms in
central and east China in the first two months of 2008, our OEM customers’
demands were sharply decreased in the first quarter. During the second quarter,
the national transportation system in China was recovering from the impact
caused by the significant snow storms. With the approaching of implementation of
the China III emission standard beginning July 1, 2008, the consumption of
trucks equipped with China II engines was significantly spurred before the
policy was enforced, which in turn boosted the output and sales volume of
vehicles made in China. As a result, our Chinese OEM sales achieved a strong
growth in the second quarter of 2008.





Further,
the additional costs required to achieve China III compliance will lead to
higher vehicle prices, which will likely discourage demand for various vehicles.
During the 2008 Beijing Olympic Games, our major customers, such as FAW
Qiongdao, Beiqi Foton Zhucheng and Beiqi Foton Aumen halted production due to
the traffic control in the regions around Beijing. Consequently, our OEM sales
in the third quarter of 2008 were sharply decreased compared to the second
quarter of 2008. With the worsening financial crisis and weakening global
economy, our OEM sales sharply decreased in the second half year of
2008 compared to the same period of last year.





37





For the
Joint Venture, its sales for the OEM market increased by $7.7 million or 18.6%
for the fiscal year ended December 31, 2008, as compared to the fiscal year
ended December 31, 2007. With its continuing efforts on new product
R&D, and timely delivery of products and services, the Joint Venture was
able to fully utilize its well-established relationship with major OEM customers
and to grow its business faster than the overall market.





As of
December 31, 2008, the Joint Venture had 28 authorized distributors covering
nearly all regions in China, which in turn channel our products
through over 800 sub-distributors. Based on its nation-wide sales networks
as well as increased production capacity, the Joint Venture achieved total
revenue of $35.5 million in domestic aftermarket sales for the fiscal year ended
December 31, 2008, an increase of $4.4 million, or 14.1% as compared to the same
period of last year.





The Joint
Venture’s overseas sales to Asian countries and the North American market, the
largest oversea market segments for the Company, increased by 8.8% and 28.4%. As
the result, our export sales increased by $3.0 million or approximately 6.9% for
the fiscal year ended December 31, 2008, as compared to $43.4 million for the
same period of 2007. This increase reflects the introduction of new
products, the expansion of the contract sales force, and the implementation of a
focused market plan on these market segments.





COST
OF SALES





Cost of
sales for the fiscal year ended December 31, 2008 increased to
$97.2 million from $88.8 million for the fiscal year ended December 31,
2007, $8.4 million or a 9.5 % increase, consistent with the increase in
revenues.





GROSS
PROFIT





Gross
profit for the fiscal year ended December 31, 2008 increased by approximately
$6.7 million or 24.8% to $33.7 million from $27.0 million for the
fiscal year ended December 31, 2007. Gross margin increased by
approximately 2.4% from 23.3% in 2007 to 25.7% in 2008.





The
higher gross margin was the result of raising prices and cutting production
costs. The Joint Venture continued to improve production methods in its
manufacturing process, which has resulted in reducing the manufacturing cycle,
reducing waste, and thereby reducing production cost. Also, favorable changes in
product and market mix helped raise the average selling price of our products.
For the Chinese OEM market, we have sold more system products as opposed to
individual components. For the Chinese and the international aftermarkets, we
have been able to pass part of our cost increases to the end users, largely due
to an uptrend in the prices for truck parts from China. The successful expansion
of our sales into the higher margin municipal bus market has also contributed to
the gross margin improvement of the Joint Venture since the last quarter of
2007.





SELLING
EXPENSES





Selling
expenses were $8,423,124 for the fiscal year ended December 31, 2008, as
compared to $7,461,652 for the fiscal year ended December 31, 2007, an increase
of $961,472 or 12.9%. The increase was mainly due to the following
factors:


(1)
            The
      salaries, travel and overhead costs of sales and marketing personnel in
      2008 increased by $76,027, as the Joint Venture increased its sales
      force.


(2)
            Advertising
      cost, public relations costs, exhibition fees and export sundry charges in
      2008 rose by $58,717, as compared to 2007, due to general increases in the
      level of such activities.


(3)
            Transportation
      costs and packaging costs increased by $692,006 for the fiscal year ended
      December 31, 2008, to $4,603,641, as compared to $3,911,635 for the fiscal
      year ended December 31, 2007. The increase in transportation expense was
      mainly due to increased sales, the increased price of fuel, and the
      strict restrictions on overloading implemented by the Chinese government
      since the third quarter of 2007.





GENERAL
AND ADMINISTRATIVE EXPENSES





General
and administrative expenses were $9,295,299 for the fiscal year ended December
31, 2008, as compared to $6,542,522 for the fiscal year ended December 31, 2007,
an increase of $2,752,777 or 42.1%. The increase was mainly due to the following
factors:





38





(1)
            The
      expansion of economic activities, facilities and workforce resulted in
      increased depreciation, office expenses, staff salary and welfare costs,
      travel expenses, supplies and utilities totaling $693,689, as compared to
      2007 year.


(2)
            R&D
      expense, which is included in general and administrative expenses,
      increased by $1,424,385, as compared to figure for fiscal year ended
      December 31, 2007, as discussed
below.




RESEARCH
AND DEVELOPMENT EXPENSE




Research
and development expense was $3,219,895 for the fiscal year ended December 31,
2008, as compared to $1,795,510 for the fiscal year ended December 31, 2007, an
increase of $1,424,385; as a result of the Company’s investment in new R&D
instrument purchases and the expansion of its staff to develop new
innovative products.




DEPRECIATION
AND AMORTIZATION





Depreciation
and amortization expense increased to $2.71 million for the fiscal year ended
December 31, 2008, compared with depreciation and amortization expense of $1.77
million for the fiscal year ended December 31, 2007.





The
increase in depreciation and amortization expense was primarily due to purchases
of production equipment, plant and land use rights in the 2007 fiscal
year.





FINANCIAL
EXPENSE




Financial
expense for the fiscal year ended December 31, 2008 decreased by $148,291 to
852,640 from $1,000,931 for the fiscal year ended December 31, 2007. 
Financial expense mainly consists of interest expense and exchange loss. The
interest expense decreased by $67,184 to $81,629 for the fiscal year ended
December 31, 2008, compared with $148,813 for the fiscal year ended December 31,
2007, mainly due to the lower outstanding average debt balance during current
period. The borrowed funds were mainly used for new equipment purchases, as well
as working capital purposes. Because a large part of our accounts receivable
arose from export sales denominated in US dollars, the appreciation of the RMB
against the U.S. dollar resulted in larger exchange loss during the fiscal year
ended December 31, 2008.Company recognized exchange losses of $628,520 and
$926,076 for the fiscal year ended December 31, 2008 and 2007,
respectively.




OTHER
INCOME





For the
fiscal year ended December 31, 2008, other income included subsidy income of
$307,520 compared with $503,464 for the fiscal year ended December 31, 2007.
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 two years ended December 31, 2006 and 2007. With the new PRC
Enterprise Income Tax Law, effective on 1st January 2008, the China’s
enterprises are generally subject to a PRC income tax rate of 25% and the
Joint Venture is entitled to a tax concession of 50% of the applicable income
tax rate of 25% for the year ended December 31, 2008.





39





Additionally,
the Company increased its investment in the Joint Venture as a result of its
financing in December, 2006. In accordance with the Income Tax Law of the
People's Republic of China on Foreign-invested Enterprises and Foreign
Enterprises, the Joint Venture is eligible for additional preferential tax
treatment. For the years 2007 and 2008, the Joint Venture entitled to an income
tax exemption on all pre-tax income generated by the company above its pre-tax
income generated in the fiscal year 2006. Thereafter, the Joint Venture will
enjoy a 50% exemption from the applicable income tax rate of 25% on any pre-tax
income above its 2006 pre-tax income, to be recognized in the years 2009, 2010
and 2011. In accordance with China's relevant regulations of income taxes,
there is a benefit, which 40% of the additional investment in the Joint
Venture used to purchase eligible domestic equipments can be used as a tax
credit to reduce the current income taxes to the limit of any incremental income
taxes in addition to the prior year. During the fiscal year ended Dec 31,
2008 and Dec 31, 2007, the Joint Venture received an abovementioned income tax
benefit of $377,147 and $991,133 respectively, which has been
reflected as a reduction to current income tax expense. As a result of the
factors discussed above, income tax expense was $1,586,503 for the fiscal
year ended December 31, 2008 compared with $636,976 for the fiscal year
ended December 31, 2007, an increase of $949,527.





STOCK—BASED
COMPENSATION





On March
1, 2006, the Board of Directors approved a total of 60,000 options to be issued
to the four independent members of the Board of Directors. The contractual term
of the options is three years. Total deferred stock-based compensation expenses
related to stock options amounted to $178,904. This amount is amortized over the
three year vesting period in a manner consistent with Financial Accounting
Standards Board Interpretation No. 123R. The amortization of deferred
stock-based compensation for these equity arrangements was $59,636 per year
for each of the fiscal years ended December 31, 2008 and 2007.





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





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





MINORITY
INTEREST





Minority
interest represents a 10% non-controlling interest in the JV company. Minority
interest in income was $1,381,230 and $1,206,515 for the fiscal year ended
December 31, 2008 and 2007, respectively.





NET
INCOME





The net
income for the fiscal year ended December 31, 2008 increased by
$ 1,626,829, to $12,370,860 from net income of $10,744,031 for the
fiscal year ended December 31, 2007 due to the factors discussed above. Earnings
per share (“EPS”), both basic and diluted, for 2008 and 2007, were
$0.68 and $0.59 per share, respectively.




FINANCIAL
CONDITION




LIQUIDITY
AND CAPITAL RESOURCES




OPERATING
- Net cash provided in operating activities was $9,673,487 for the fiscal
year ended December 31, 2008, as compared to $8,858,603 of net cash
provided by operating activities for the fiscal year ended December 31,
2007, an increase of $ 835,633.





40




Our
primary cash flows from net income were realized through the sale of automotive
parts. Net income after deducting non-cash items provided cash inflows at
approximately $16.6 million for the fiscal year ended December 31, 2008 as
compared to $13.9 million for the fiscal year ended December 31, 2007, an
increase of $2.7 million. Cash flows from accounts receivable and notes
receivables increased by approximately $6.8 million for the fiscal year ended
December 31, 2008 as compared with the fiscal year ended December 31, 2007, as a
result of more notes receivables maturing near the fiscal year ended December
31, 2008. Due to our increased risk management related to customer credit, we
required certain customers to pay in advance before delivering goods. Thus the
cash flow generated from deposits received from customers increased by $2.5
million for the fiscal year ended December 31, 2008 as compared with the
fiscal year ended December 31, 2007. The Company established more
distribution warehouses close to major OEM customers and maintained more stock
in those warehouses to ensure timely deliveries at the request of major OEM
customers. As a result, the Company maintained a high inventory level as
of the end of fiscal year ended December 31, 2008. The increased cash
flow from operations, described above, was largely offset by the 2008 increase
in inventories.





At
December 31, 2008, the Company had cash and cash equivalents of $ 7,795,987, as
compared to cash and cash equivalents of $4,340,211 at December 31,
2007. The Company had working capital of $61,586,125
at December 31, 2008, as compared to working capital of $44,715,988 at December
31, 2007, reflecting current ratios of 5.36 and 4.32:1,
respectively.





INVESTING
- During the fiscal year ended December 31, 2007, the Company expended net cash
of $19,427,340 in investing activities, mainly including the funds for
acquisition of plant, land use rights and new equipment to support the growth of
business. For the fiscal year ended December 31, 2008, the Company utilized
$ 3,136,574 in investing activities.





FINANCING
–Net cash used by financing activities was $ 3,482,360 for the fiscal year
ended December 31, 2008 compared to a net cash inflow in financing activities of
$3,257,911 for the fiscal year ended December 31, 2007, due to the fact that
during fiscal year ended December 31, 2008, the Company repaid all its
outstanding debt.





The
Company’s management has taken a number of steps to restructure its customer
base and phase out accounts that failed to make prompt payment. The Company also
placed more emphasis on accounts receivable collection. In addition, the Company
maintains good relationships with local banks. We believe that our current cash
and cash equivalents 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, 2008 and December 31, 2007, we did not have any material
commitments for capital expenditures or have any transactions, obligations or
relationships that could be considered off-balance sheet
arrangements.





ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





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





Although
our reporting currency is the U.S. dollar, the functional currency of Joint
Venture is RMB. As a result, we are exposed to foreign exchange risk as our
revenues and results of operations may be affected by fluctuations in the
exchange rate between U.S. dollars and RMB. If the RMB depreciates against the
U.S. dollar, the value of our Renminbi revenues, earnings and assets as
expressed in our U.S. dollar financial statements will decline. 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.
Because of the approximately 6.4% appreciation of the RMB against the
USD during fiscal 2008, we recorded an exchange gain of $6,017,843 for
the fiscal year ended on December 31, 2008. But any 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, and because we have repaid our debt, 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.





41





ITEM
8 FINANCAL STATEMENTS AND SUPPLEMENTARY DATA





SORL
Auto Parts, Inc. and Subsidiaries


Consolidated
Balance Sheets


December
31, 2008 and 2007





December 31, 2008
                              
                              
                              
                              December 31, 2007(Audited)
                              
                              
                              
                              (Audited)AssetsCurrent
      AssetsCash
      and Cash Equivalents
                              
                              
                              
                              US$
                              7,795,987
                              
                              US$
                              
                              
                              4,340,211Accounts
      Receivable, Net of Provision
                              
                              
                              
                              
                              35,797,824
                              
                              
                              
                              
                              30,586,239Notes
      Receivable
                              
                              
                              
                              
                              7,536,534
                              
                              
                              
                              
                              9,410,385Inventory
                              
                              
                              
                              
                              19,105,845
                              
                              
                              
                              
                              8,220,373Prepayments, including $187,813 and $0
      from related parties at December 31, 2008 and December 31, 2007,
      respectively.
                              
                              
                              
                              
                              1,013,440
                              
                              
                              
                              
                              1,336,212Other current
      assets, including $1,906,070 and
      $1,761,007 from related parties at December 31, 2008 and December 31,
      2007, respectively.
                              
                              
                              
                              
                              4,445,778
                              
                              
                              
                              
                              4,275,294Total
      Current Assets
                              
                              
                              
                              
                              75,695,408
                              
                              
                              
                              
                              58,168,714Fixed
      AssetsProperty,
      Plant and Equipment
                              
                              
                              
                              
                              32,927,306
                              
                              
                              
                              
                              27,889,182Less:
      Accumulated Depreciation
                              
                              
                              
                              
                              (8,951,886
                              )
                              
                              
                              
                              (6,094,229
                              )Property,
      Plant and Equipment, Net
                              
                              
                              
                              
                              23,975,420
                              
                              
                              
                              
                              21,794,953Land
      Use Rights, Net
                              
                              
                              
                              
                              14,514,983
                              
                              
                              
                              
                              13,889,705Other
      AssetsDeferred
      compensation cost-stock options
                              
                              
                              
                              
                              9,935
                              
                              
                              
                              
                              69,571Intangible
      Assets
                              
                              
                              
                              
                              161,347
                              
                              
                              
                              
                              76,150Less:
      Accumulated Amortization
                              
                              
                              
                              
                              (39,018
                              )
                              
                              
                              
                              (25,116
                              )Intangible
      Assets, Net
                              
                              
                              
                              
                              122,329
                              
                              
                              
                              
                              51,034Deferred
      tax assets
                              
                              
                              
                              
                              189,228
                              
                              
                              
                              
                              -Total
      Other Assets
                              
                              
                              
                              
                              321,492
                              
                              
                              
                              
                              120,605Total
      Assets
                              
                              
                              
                              US$
                              114,507,303
                              
                              US$
                              
                              
                              93,973,977Liabilities and Stockholders'
      EquityCurrent
      LiabilitiesAccounts Payable and
      Notes Payable,
      including $0 and $97,503 due to related parties at December 31, 2008 and
      December 31, 2007, respectively.
                              
                              
                              
                              US$
                              4,623,850
                              
                              US$
                              
                              
                              5,305,172Deposit
      Received from Customers
                              
                              
                              
                              
                              6,295,857
                              
                              
                              
                              
                              2,079,946Short
      term bank loans
                              
                              
                              
                              
                              ―
                              
                              
                              
                              
                              3,370,328Income
      tax payable
                              
                              
                              
                              
                              340,138
                              
                              
                              
                              
                              373,769Accrued
      Expenses
                              
                              
                              
                              
                              2,389,314
                              
                              
                              
                              
                              1,859,938Other
      Current Liabilities
                              
                              
                              
                              
                              460,124
                              
                              
                              
                              
                              463,563Total
      Current Liabilities
                              
                              
                              
                              
                              14,109,283
                              
                              
                              
                              
                              13,452,716Non-Current
      LiabilitiesDeferred
      tax liabilities
                              
                              
                              
                              
                              106,826
                              
                              
                              
                              
                              -Total
      Liabilities
                              
                              
                              
                              
                              14,216,109
                              
                              
                              
                              
                              13,452,716Minority
      Interest
                              
                              
                              
                              
                              10,007,166
                              
                              
                              
                              
                              8,024,152Stockholders'
      EquityCommon
      Stock - $0.002 Par Value; 50,000,000 authorized,18,279,254
      and 18,279,254 issued and outstanding as ofDecember
      31, 2008 and December 31, 2007 respectively
                              
                              
                              36,558
                              
                              
                              
                              
                              36,558Additional
      Paid In Capital
                              
                              
                              
                              
                              37,498,452
                              
                              
                              
                              
                              37,498,452Reserves
                              
                              
                              
                              
                              3,126,086
                              
                              
                              
                              
                              1,882,979Accumulated
      other comprehensive income
                              
                              
                              
                              
                              10,848,248
                              
                              
                              
                              
                              5,432,189Retained
      Earnings
                              
                              
                              
                              
                              38,774,684
                              
                              
                              
                              
                              27,646,93190,284,028
                              
                              
                              
                              
                              72,497,109Total
      Liabilities and Stockholders' Equity
                              
                              
                              
                              US$
                              114,507,303
                              
                              US$
                              
                              
                              93,973,977





The
accompanying notes are an integral part of these financial
statements





42





SORL
Auto Parts, Inc. and Subsidiaries


Consolidated
Statements of Income


For
Years Ended on December 31, 2008 and 2007





2008
                            
                            
                            2007Sales
                            
                            
                            
                            US$
                            130,893,422
                            
                            
                            
                            115,760,070Include:
      sales to related parties
                            
                            
                            
                            
                            2,816,816
                            
                            
                            
                            1,398,638Cost
      of Sales
                            
                            
                            
                            
                            97,225,582
                            
                            
                            
                            88,757,611Gross
      Profit
                            
                            
                            
                            
                            33,667,840
                            
                            
                            
                            27,002,459Expenses:Selling
      and Distribution Expenses
                            
                            
                            
                            
                            8,423,124
                            
                            
                            
                            7,461,652General
      and Administrative Expenses
                            
                            
                            
                            
                            9,295,299
                            
                            
                            
                            6,542,522Financial
      Expenses
                            
                            
                            
                            
                            852,640
                            
                            
                            
                            1,000,931Total
      Expenses
                            
                            
                            
                            
                            18,571,063
                            
                            
                            
                            15,005,105Operating
      Income
                            
                            
                            
                            
                            15,096,777
                            
                            
                            
                            11,997,354Other
      Income
                            
                            
                            
                            
                            683,104
                            
                            
                            
                            731,982Non-Operating
      Expenses
                            
                            
                            
                            
                            (441,288
                            )
                            
                            
                            (141,814
                            )Income  Before
      Provision for Income Taxes
                            
                            
                            15,338,593
                            
                            
                            
                            12,587,522Provision
      for Income Taxes
                            
                            
                            
                            
                            1,586,503
                            
                            
                            
                            636,976Net
      Income Before Minority Interest & Other Comprehensive
      Income
                            
                            
                            
                            US$
                            13,752,090
                            
                            
                            
                            11,950,546Minority
      Interest
                            
                            
                            
                            
                            1,381,230
                            
                            
                            
                            1,206,515Net
      Income Attributable to Stockholders
                            
                            
                            12,370,860
                            
                            
                            
                            10,744,031Foreign
      Currency Translation Adjustment
                            
                            
                            6,017,843
                            
                            
                            
                            4,810,800Minority
      Interest's Share
                            
                            
                            
                            
                            601,784
                            
                            
                            
                            481,080Comprehensive
      Income
                            
                            
                            
                            
                            17,786,919
                            
                            
                            
                            15,073,751Weighted
      average common share - Basic
                            
                            
                            18,279,254
                            
                            
                            
                            18,277,094Weighted
      average common share - Diluted
                            
                            
                            18,279,254
                            
                            
                            
                            18,323,315EPS
      - Basic
                            
                            
                            
                            
                            0.68
                            
                            
                            
                            0.59EPS
      - Diluted
                            
                            
                            
                            
                            0.68
                            
                            
                            
                            0.59





43


SORL
Auto Parts, Inc. and Subsidiaries


Consolidated
Statements of Cash Flows


For
Years Ended on December 31,2008 and 2007





2008
                                            
                                            
                                            2007Cash
      Flows from Operating ActivitiesNet
      Income
                                            
                                            US$
                                            12,370,860
                                            
                                            
                                            
                                            10,744,031Adjustments
      to reconcile net income (loss) to net cash from operating
      activities:Minority
      Interest
                                            
                                            
                                            1,381,230
                                            
                                            
                                            
                                            1,206,515Bad
      Debt Expense
                                            
                                            
                                            32,674
                                            
                                            
                                            
                                            33,848Depreciation
      and Amortization
                                            
                                            
                                            2,706,053
                                            
                                            
                                            
                                            1,769,647Stock-Based
      Compensation Expense
                                            
                                            
                                            59,636
                                            
                                            
                                            
                                            114,045Loss
      on disposal of Fixed Assets
                                            
                                            
                                            24,892
                                            
                                            
                                            
                                            41,418Deferred tax
                                            
                                            
                                            (79,663
                                            )
                                            
                                            
                                            ―Changes
      in Assets and Liabilities:Account
      Receivables
                                            
                                            
                                            (3,000,167
                                            )
                                            
                                            
                                            (1,940,993
                                            )Notes
      Receivables
                                            
                                            
                                            2,437,182
                                            
                                            
                                            
                                            (5,485,625
                                            )Other
      Currents Assets
                                            
                                            
                                            111,707
                                            
                                            
                                            
                                            (1,111,529
                                            )Inventory
                                            
                                            
                                            (9,977,123
                                            )
                                            
                                            
                                            (3,266,270
                                            )Prepayments
                                            
                                            
                                            400,877
                                            
                                            
                                            
                                            4,425,704Accounts
      Payable and Notes Payable
                                            
                                            
                                            (1,011,371
                                            )
                                            
                                            
                                            353,406Income
      Tax Payable
                                            
                                            
                                            (33,631
                                            )
                                            
                                            
                                            (9,019
                                            )Deposits
      Received from Customers
                                            
                                            
                                            3,937,491
                                            
                                            
                                            
                                            1,485,349Other
      Current Liabilities and Accrued Expenses
                                            
                                            
                                            312,840
                                            
                                            
                                            
                                            498,076Net
      Cash Flows from Operating Activities
                                            
                                            
                                            9,673,487
                                            
                                            
                                            
                                            8,858,603Cash
      Flows from Investing ActivitiesAcquisition
      of Property and Equipment
                                            
                                            
                                            (3,063,458
                                            )
                                            
                                            
                                            (10,103,783
                                            )Sales
      Proceeds of Disposal of Fixed Assets
                                            
                                            
                                            4,187
                                            
                                            
                                            
                                            ―Acquisition
      of Land Use Rights
                                            
                                            
                                            ―
                                            
                                            
                                            
                                            (9,297,253
                                            )Investment
      in Intangible Assets
                                            
                                            
                                            (77,303
                                            )
                                            
                                            
                                            (26,304
                                            )Net
      Cash Flows from Investing Activities
                                            
                                            
                                            (3,136,574
                                            )
                                            
                                            
                                            (19,427,340
                                            )Cash
      Flows from Financing ActivitiesProceeds
      from (Repayment of) Bank Loans
                                            
                                            
                                            (3,482,360
                                            )
                                            
                                            
                                            3,257,911Proceeds
      from Share Issuance
                                            
                                            
                                            ―
                                            
                                            
                                            
                                            ―Capital
      contributed by Minority S/H
                                            
                                            
                                            ―
                                            
                                            
                                            
                                            ―Net
      Cash flows from Financing Activities
                                            
                                            
                                            (3,482,360
                                            )
                                            
                                            
                                            3,257,911Effects
      on changes in foreign exchange rate
                                            
                                            
                                            401,223
                                            
                                            
                                            
                                            513,536Net
      Change in Cash and Cash Equivalents
                                            
                                            
                                            3,455,776
                                            
                                            
                                            
                                            (6,797,290
                                            )Cash
      and Cash Equivalents- Beginning of the year
                                            
                                            
                                            4,340,211
                                            
                                            
                                            
                                            11,137,501Cash
      and cash Equivalents - End of the year
                                            
                                            US$
                                            7,795,987
                                            
                                            
                                            
                                            4,340,211Supplemental
      Cash Flow Disclosures:Interest
      Paid
                                            
                                            
                                            182,385
                                            
                                            
                                            
                                            148,813Tax
      Paid
                                            
                                            
                                            2,106,992
                                            
                                            
                                            
                                            1,784,965Supplemental
      Disclosures of Non-Cash Investing and Financing
Activities:Common
      stock of 49,500 shares issued to key employees60,000 options
      issued in 2006 to employees
                                            
                                            
                                            
                                            
                                            
                                            
                                            59,6364,128
      options issued in 2007 for service rendered
                                            
                                            
                                            
                                            
                                            
                                            
                                            23,201Common
      stock of 4,128 shares issued in 2007 for service rendered
                                            
                                            
                                            
                                            
                                            
                                            
                                            31,208Non-Cash
      Transaction Disclosure:Exchange
      of Construction in Progress for Acquisition ofProperty
      and Equipment:
                                            
                                            
                                            
                                            
                                            
                                            
                                            2,059,276Exchange
      of Construction in Progress for Acquisition ofLand
      Use Rights
                                            
                                            
                                            
                                            
                                            
                                            
                                            4,203,728





44





SORL
Auto Parts, Inc. and Subsidiaries


Consolidated
Statements of Changes in Stockholders' Equity


For
Years Ended on December 31, 2008 and 2007





Additional
                                    
                                    
                                    
                                    
                                    
                                    Retained
                                    
                                    
                                    Accumu.
      OtherNumber
                                    
                                    
                                    Common
                                    
                                    
                                    Paid-in
                                    
                                    
                                    
                                    
                                    
                                    Earnings
                                    
                                    
                                    Comprehensive
                                    
                                    
                                    Stockholders'
                                    
                                    
                                    Minorityof
      Share
                                    
                                    
                                    Stock
                                    
                                    
                                    Capital
                                    
                                    
                                    Reserves
                                    
                                    
                                    (Deficit)
                                    
                                    
                                    Income
                                    
                                    
                                    Equity
                                    
                                    
                                    InterestBeginning
      Balance – Jan 1, 2007
                                    
                                    
                                    18,275,126
                                    
                                    
                                    
                                    36,550
                                    
                                    
                                    
                                    37,444,051
                                    
                                    
                                    
                                    797,116
                                    
                                    
                                    
                                    17,988,763
                                    
                                    
                                    
                                    1,102,469
                                    
                                    
                                    
                                    57,368,949
                                    
                                    
                                    
                                    6,336,557Net
      Income
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    10,744,031
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    10,744,031
                                    
                                    
                                    
                                    1,206,515Other
      Comprehensive Income(Loss)
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    4,329,720
                                    
                                    
                                    
                                    4,329,720
                                    
                                    
                                    
                                    481,080Common
      stock of 4,128 shares issued
                                    
                                    
                                    4,128
                                    
                                    
                                    
                                    8
                                    
                                    
                                    
                                    31,200
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    31,208
                                    
                                    
                                    
                                    ―Transfer
      to reserve
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    1,085,863
                                    
                                    
                                    
                                    (1,085,863
                                    )
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―4,128
      options issued in 2007
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    23,201
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    23,201
                                    
                                    
                                    
                                    ―Ending
      Balance - December 31, 2007
                                    
                                    
                                    18,279,254
                                    
                                    
                                    
                                    36,558
                                    
                                    
                                    
                                    37,498,452
                                    
                                    
                                    
                                    1,882,979
                                    
                                    
                                    
                                    27,646,931
                                    
                                    
                                    
                                    5,432,189
                                    
                                    
                                    
                                    72,497,109
                                    
                                    
                                    
                                    8,024,152Net
      Income
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    12,370,860
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    12,370,860
                                    
                                    
                                    
                                    1,381,230Other
      Comprehensive Income(Loss)
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    5,416,059
                                    
                                    
                                    
                                    5,416,059
                                    
                                    
                                    
                                    601,784Transfer
      to reserve
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    1,243,107
                                    
                                    
                                    
                                    (1,243,107
                                    )
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―Ending
      Balance - December 31, 2008
                                    
                                    
                                    18,279,254
                                    
                                    
                                    
                                    36,558
                                    
                                    
                                    
                                    37,498,452
                                    
                                    
                                    
                                    3,126,086
                                    
                                    
                                    
                                    38,774,684
                                    
                                    
                                    
                                    10,848,248
                                    
                                    
                                    
                                    90,284,028
                                    
                                    
                                    
                                    10,007,166




The
accompanying notes are an integral part of these financial
statements





45





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
1000 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.





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
conducts business with its related parties in the ordinary course of business.
All transactions have been recorded at far market value of the goods and
services exchanged.





46





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 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
collectiblity of outstanding accounts receivable. The Company has
four customers that respectively account for more than 5.5% of its total
revenues for the period. The Company also has a concentration of credit risk due
to geographic sales as a majority of its products are marketed and sold in the
PRC.


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


(iii)
Interest rate risk - The interest rate and terms of repayments of short-term and
long-term bank borrowings are approximately 6.47% 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.





PROPERTY,
PLANT AND EQUIPMENT





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





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





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





47





LAND
USE RIGHTS





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





IMPAIRMENT
OF LONG-LIVED ASSETS





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





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.





48





REVENUE
RECOGNITION





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





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.





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








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. Refer to Note 19: stock
compensation plan for additional information on our stock option plan and
related stock-based compensation expense.





EMPLOYEES’
BENEFITS





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





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.





49





ADVERTISING
COSTS





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





WARRANTY
CLAIMS





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





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.





RECENTLY
ISSUED FINANCIAL STANDARDS




In
February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities-Including an Amendment of SFAS 115",
which allows for the option to measure financial instruments and certain other
items at fair value. Unrealized gains and losses on items for which the fair
value option has been elected are reported in earnings. The adoption of SFAS No.
159 has not had a material impact on the Company's consolidated results of
operations or financial position.




In
December 2007, the FASB issued FASB 141(R), "Business Combinations" of which the
objective is to improve the relevance, representational faithfulness, and
comparability of the information that a reporting entity provides in its
financial reports about a business combination and its effects. The new standard
requires the acquiring entity in a business combination to recognize all (and
only) the assets acquired and liabilities assumed in the transaction;
establishes the acquisition-date fair value as the measurement objective for all
assets acquired and liabilities assumed; and requires the acquirer to disclose
to investors and other users all of the information they need to evaluate and
understand the nature and financial effect of the business
combination.




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




Both FASB
141(R) and FASB 160 are effective for fiscal years beginning after December 15,
2008. The Company does not believe that the adoption of these standards will
have any impact on its financial statements.





In
December 2007, the SEC issued Staff Accounting Bulletin No. 110 (“SAB 110”). SAB
110 permits companies to continue to use the simplified method, under certain
circumstances, in estimating the expected term of “plain vanilla” options beyond
December 31, 2007. SAB 110 updates guidance provided in SAB 107 that previously
stated that the Staff would not expect a company to use the simplified method
for share option grants after December 31, 2007. Adoption of SAB 110 is not
expected to have a material impact on the Company’s consolidated financial
statements.





50





In March
2008, the FASB issued SFAS No.161, Disclosures about Derivative Instruments and
Hedging Activities- an amendment of FASB statement No.133.SFAS No.161 requires
enhanced disclosures about an entity’s derivative and hedging activities and
thereby improves the transparency of financial reporting. SFAS No.161 is
effective for fiscal years, and interim periods within those fiscal years,
beginning after November 15, 2008, with early application encouraged. As such,
the Company is required to adopt these provisions at the beginning of the fiscal
year ending December 31, 2009. The Company is currently evaluating the impact of
SFAS No. 161 on its financial statements.




In May
2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted
Accounting Principles.” SFAS 162 identifies the sources of accounting principles
and the framework for selecting the principles used in the preparation of
financial statements of nongovernmental entities that are presented in
conformity with GAAP in the United States. SFAS 162 is effective 60 days
following the SEC’s approval of the Public Company Accounting Oversight Board
amendments to AU Section 411, The Meaning of Present Fairly in Conformity With
Generally Accepted Accounting Principles. The Company is currently evaluating
the impact of SFAS 162 on its consolidated financial statements but does not
expect it to have a material effect.




Also in
May 2008, the FASB issued SFAS No. 163, "Accounting for Financial Guarantee
Insurance Contracts—an interpretation of FASB Statement No. 60" (“SFAS 163”).
SFAS 163 interprets Statement 60 and amends existing accounting pronouncements
to clarify their application to the financial guarantee insurance contracts
included within the scope of that Statement. SFAS 163 is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and all
interim periods within those fiscal years. As such, the Company is required to
adopt these provisions at the beginning of the fiscal year ended December 31,
2009. The Company is currently evaluating the impact of SFAS 163 on its
consolidated financial statements but does not expect it to have a material
effect.




NOTE
3 - RELATED PARTY TRANSACTIONS





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





The
following related party transactions occurred for the fiscal year ended December
31, 2008 and 2007:





December31,2008
                  
                  
                  2007PURCHASES
      NON-VALVE PRODUCT , COMPONENTS FOR VALVE AUTO PARTS AND PACKAGING
      MATERIAL FROM FROM:Ruili
      Group Co., Ltd.
                  
                  $
                  35,344,273
                  
                  
                  $
                  26,589,425Total
      Purchases
                  
                  $
                  35,344,273
                  
                  
                  
                  26,589,425PURCHASES
      LAND USE RIGHTS FROM RUILI GROUP CO., LTD.
                  
                  $
                  ―
                  
                  
                  $
                  13,501,009PURCHASES
      PLANT FROM RUILI GROUP CO., LTD.
                  
                  $
                  ―
                  
                  
                  $
                  6,613,724SALES
      TO:Ruili
      Group Co., Ltd.
                  
                  
                  2,816,816
                  
                  
                  
                  1,398,638Total
      Sales
                  
                  $
                  2,816,816
                  
                  
                  $
                  1,398,638




51





December31,2008
                      
                      
                      2007ACCOUNTS
      PAYABLE AND OTHER PAYABLESRuili
      Group Co., Ltd.
                      
                      $
                      —
                      
                      
                      $
                      97,503Total
                      
                      $
                      —
                      
                      
                      $
                      97,503PREPAYMENTSRuili
      Group Co., Ltd.
                      
                      $
                      187,813
                      
                      
                      $
                      —Total
                      
                      $
                      187,813
                      
                      
                      $
                      —OTHER  ACCOUNTS
      RECEIVABLERuili
      Group Co., Ltd.
                      
                      $
                      1,906,070
                      
                      
                      $
                      1,761,007Total
                      
                      $
                      1,906,070
                      
                      
                      $
                      1,761,007





1.
            The
      total purchases from Ruili Group during the fiscal year ended December 31,
      2008 consisted of $29.6  million of finished products for
      non-valve auto parts, $4.2 million of components for non-valve auto
      parts and $1.6 million of packaging
  materials.


2.
            On September 28, 2007, the
      Company purchased land use rights, a manufacturing plant, and an office
      building from Ruili Group for an aggregate purchase price of approximately
      RMB152 million (approximately $20.1 million translated with an average
      exchange rate of
      7.5567). DTZ Debenham Tie Leung Ltd., an internationally recognized
      appraiser, appraised the total asset value at RMB154 million
      (approximately $20.4 million translated with an average exchange rate of
      7.5567). RMB69.4million(approximately $9.1 million translated with an
      average exchange rate of 7.5567) of the purchase price was paid on a
      transfer of the Company’s an existing project that
      includes a construction-in-progress and prepayment of land use rights. The
      remaining balance was paidby the cash generated from
      operation and a bank credit
line.





NOTE
4 - ACCOUNTS RECEIVABLE





The
changes in the allowance for doubtful accounts at December 31, 2008 and December
31, 2007 were summarized as follows:




December
                                  31,2008
                                
                                
                                December
                                  31,2007Beginning
      balance
                                
                                $
                                27,987
                                
                                
                                $
                                8,769Add:
      Increase to allowance
                                
                                
                                (2,990
                                )
                                
                                
                                19,218Less:
      Accounts written off
                                
                                
                                —
                                
                                
                                
                                —Ending
      balance
                                
                                $
                                24,997
                                
                                
                                $
                                27,987





52


December 31,
                                        2008
                                      
                                      
                                      December 31,
                                        2007Accounts
      receivable
                                      
                                      $
                                      35,822,821
                                      
                                      
                                      $
                                      30,614,226Less:
      allowance for doubtful accounts
                                      
                                      
                                      (24,997
                                      )
                                      
                                      
                                      (27,987
                                      )Account
      receivable balance, net
                                      
                                      $
                                      35,797,824
                                      
                                      
                                      $
                                      30,586,239





NOTE
5 - INVENTORIES





On
December 31, 2008 and December 31, 2007, inventories consisted of the
following:





December 31,
      2008
                  
                  
                  December 31, 2007Raw
      Material
                  
                  $
                  2,705,224
                  
                  
                  $
                  2,354,637Work
      in process
                  
                  
                  8,074,488
                  
                  
                  
                  4,157,643Finished
      Goods
                  
                  
                  8,326,133
                  
                  
                  
                  1,708,093Total
      Inventory
                  
                  $
                  19,105,845
                  
                  
                  $
                  8,220,373





NOTE
6 - PROPERTY, PLANT AND EQUIPMENT





Property,
plant and equipment consisted of the following, on December 31, 2008 and
December 31, 2007:




December31,2008
                  
                  
                  December31,2007Machinery
                  
                  $
                  22,085,672
                  
                  
                  $
                  18,118,125Molds
                  
                  
                  1,275,561
                  
                  
                  
                  1,193,488Office
      equipment
                  
                  
                  618,403
                  
                  
                  
                  358,163Vehicle
                  
                  
                  972,422
                  
                  
                  
                  757,311Building
                  
                  
                  7,975,248
                  
                  
                  
                  7,462,096Sub-Total
                  
                  
                  32,927,306
                  
                  
                  
                  27,889,182Less:
      Accumulated depreciation
                  
                  
                  (8,951,886
                  )
                  
                  
                  (6,094,229
                  )Fixed
      Assets, net
                  
                  $
                  23,975,420
                  
                  
                  $
                  21,794,953




Depreciation
expense charged to operations was $2,375,363 and $1,689,021 for the fiscal year
ended December 31, 2008 and 2007, respectively.


NOTE
7 – LAND USE RIGHTS
 
 December
      31,2008
                      
                      
                      December
      31,2007Cost:
                      
                      $
                      14,927,340
                      
                      
                      $
                      13,966,870Less:
      Accumulated amortization:
                      
                      
                      412,357
                      
                      
                      
                      77,165Land
      use rights, net
                      
                      $
                      14,514,983
                      
                      
                      $
                      13,889,705




53





According
to the law of China, the government owns all the land in China. Companies and
individuals are authorized to possess and use the land only through land use
rights granted by the Chinese government. The company purchased the land use
rights from Ruili Group for approximately $13.9 million on September 28, 2007.
The Company has not yet obtained the land use right certificate. However, the
Company is in the process of applying to obtain the land use right
certificate. The remaining balance of land use rights as of Dec 31,
2008 is amortized on a straight-line basis over 44 years, its remaining useful
lives. Amortization expenses were $335,192 and $77,165 for the fiscal years
ended December 31, 2008 and 2007, respectively.





NOTE
8 - INTANGIBLE ASSETS





Gross
intangible assets were $161,347, less accumulated amortization of
$39,018 for net intangible assets of $ 122,329 as of December 31, 2008.
Gross intangible assets were $76,150, less accumulated amortization of $25,116
for net intangible assets of $51,034 as of December 31, 2007. Amortization
expenses were $11,770 and $6,035 for the fiscal years ended December 31,
2008 and 2007 respectively. Future estimated amortization expense is as
follows:





2009
                    
                    2010
                    
                    
                    2011
                    
                    
                    2012
                    
                    
                    2013
                    
                    
                    Thereafter$
                    16,135
                    
                    $
                    16,135
                    
                    
                    $
                    16,135
                    
                    
                    $
                    16,135
                    
                    
                    $
                    16,135
                    
                    
                    $
                    42,115





NOTE
9 - PREPAYMENT





Prepayment
consisted of the following as of December 31, 2008 and December 31,
2007:


December
      31,
                  
                  
                  December
      31,2008
                  
                  
                  2007Raw
      material suppliers
                  
                  $
                  878,374
                  
                  
                  $
                  929,178Equipment
      purchase
                  
                  
                  135,066
                  
                  
                  
                  407,035Total
      prepayment
                  
                  $
                  1,013,440
                  
                  
                  $
                  1,336,212




NOTE
10- DEFERRED TAX ASSETS AND DEFERRED TAX LIABILITIES





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


Dec
      31, 2008Deferred
      tax assets - currentProvision
                  
                  
                  3,990Warranty
                  
                  
                  277,892Deferred
      tax assets
                  
                  
                  281,883Valuation
      allowance
                  
                  
                  ―Net
      deferred tax assets - current
                  
                  
                  281,883Deferred
      tax liabilities - currentRevenue
                  
                  
                  92,655Deferred
      tax liabilities - current
                  
                  
                  92,655Net
      deferred tax assets - current
                  
                  
                  189,228Deferred
      tax liabilities - non-currentLand
      use right
                  
                  
                  106,826Deferred
      tax liabilities - non-current
                  
                  
                  106,826





54





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





NOTE
11 - ACCRUED EXPENSES





Accrued
expenses consisted of the following as of December 31, 2008 and December 31,
2007:





December31,2008
                                
                                
                                December31,2007Accrued
      payroll
                                
                                $
                                617,522
                                
                                
                                $
                                601,733Other
      accrued expenses
                                
                                
                                1,771,792
                                
                                
                                
                                1,258,205Total
      accrued expenses
                                
                                $
                                2,389,314
                                
                                
                                $
                                1,859,938





NOTE
12 - BANK LOANS





Bank
loans represented the following as of December 31, 2008 and December 31,
2007:





December 31, 2008
                      
                      
                      December 31, 2007Secured
                      
                      $
                      —
                      
                      
                      $
                      3,370,328Less:
      Current portion
                      
                      $
                      —
                      
                      
                      $
                      (3,370,328
                      )Non-current
      portion
                      
                      $
                      —
                      
                      
                      $
                      —


As of
December 31, 2008, the Company had repaid all outstanding short-term loans
with banks. The Company did not provide any sort of guarantee to any other
parties.





NOTE
13 - INCOME TAXES





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





55





Additionally,
the Company increased its investment in the Joint Venture as a result of its
financing in December, 2006. In accordance with the Income Tax Law of the
People's Republic of China on Foreign-invested Enterprises and Foreign
Enterprises, the Joint Venture is eligible for additional preferential tax
treatment. For the years 2007 and 2008, the Joint Venture entitled to an income
tax exemption on all pre-tax income generated by the company above its pre-tax
income generated in the fiscal year 2006. Thereafter, the Joint Venture
will enjoy a 50% exemption from the applicable income tax rate of 25% on any
pre-tax income above its 2006 pre-tax income, to be recognized in the years
2009, 2010 and 2011. In addition, in accordance with China's relevant
regulations of income taxes, there is a benefit, which 40% of the additional
investment in the Joint Venture used to purchase eligible domestic equipments
can be used as a tax credit to reduce the current income taxes to the limit of
any incremental income taxes in addition to the prior year.The company
received an income tax benefit of $377,147 and $991,133 in 2008 and 2007,
respectively.





The
reconciliation of the effective income tax rate of the Joint Venture to the
statutory income tax rate in the PRC for the fiscal year ended on December 31,
2008 and 2007 is as follows:





2008
                                
                                
                                2007Statutory
      tax rate
                                
                                
                                25.0
                                %
                                
                                
                                26.4
                                %Tax
      holidays and concessions
                                
                                
                                -12.5
                                %
                                
                                
                                -13.2
                                %Effective
      tax rate
                                
                                
                                12.5
                                %
                                
                                
                                13.2
                                %





Income
taxes are calculated on a separate entity basis. Deferred income taxes reflect
the net tax effects of temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes and the amounts used for
income tax purposes Significant components of the Company’s net deferred tax
assets and liabilities are approximately as follows at December 31,2008. No
valuation allowance is deemed necessary. There currently is no tax benefit
or burden recorded for the United States or Hong Kong.The
provisions for income taxes for the years ended December 31, 2008 and 2007,
respectively, are summarized as follows:


2008
                    
                    
                    2007PRC
      only:Current
                    
                    $
                    1,666,166
                    
                    
                    $
                    636,976Deferred
                    
                    
                    (79,663
                    )
                    
                    
                    ―Total
                    
                    $
                    1,586,503
                    
                    
                    $
                    636,976





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





NOTE
14 - LEASES





In
December 2006, the Joint Venture entered into a lease agreement with Ruili Group
Co., Ltd. for the lease of two apartment buildings. These two apartment
buildings are for the Joint Venture’s management personnel and staff,
respectively. 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.





56





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





2009
                    
                    
                    2010
                    
                    
                    2011
                    
                    
                    2012
                    
                    
                    2013
                    
                    
                    ThereafterBuildings
                    
                    $
                    281,167
                    
                    
                    $
                    281,167
                    
                    
                    $
                    281,167
                    
                    
                    $
                    68,219
                    
                    
                    $
                    —
                    
                    
                    $
                    —Total
                    
                    $
                    281,167
                    
                    
                    $
                    281,167
                    
                    
                    $
                    281,167
                    
                    
                    $
                    68,219
                    
                    
                    $
                    —
                    
                    
                    $
                    —





NOTE
15 - ADVERTISING COSTS





Advertising
costs are expensed as incurred and are classified as selling expenses.
Advertising costs were $6,126 and $110,512 for the fiscal years ended
December 31, 2008 and 2007, respectively.





NOTE
16 - RESEARCH AND DEVELOPMENT EXPENSE





Research
and development costs are expensed as incurred and were $3,219,895 and
$1,795,510 for the fiscal years ended December 31, 2008 and 2007,
respectively.





NOTE
17 - WARRANTY CLAIMS





Warranty
claims were $1,901,974 and $2,152,978 for the fiscal year ended on
December 31, 2008 and 2007 respectively. The movement of accrued warranty
expenses for fiscal year 2008 is as follows. Accrued warranty expenses are
included in Accrued Expenses.





Beginning
      balance at Jan 01, 2008
                  
                  $
                  863,428Accrued
      during the fiscal
      year ended December 31, 2008:
                  
                  $
                  1,901,974Less:
      Actual Paid during the fiscal year ended December
      31, 2008:
                  
                  $
                  1,653,833Ending
      balance at December 31, 2008
                  
                  $
                  1,111,569





NOTE
18 - STOCK COMPENSATION PLAN





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





Pursuant
to the Plan, the Company issued 60,000 options with an exercise price of $4.79
per share on March 1, 2006. In accordance with the vesting provisions of the
grants, the options will become vested and exercisable under the following
schedule.





Number of Shares
                    
                    % of Shares Issued
                    
                    Initial Vesting Date60,000
                    
                    
                    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
                  
                  
                  75.75
                  %Risk-Free
      Interest Rate
                  
                  
                  4.59
                  %Contractual
      Term
                  
                  3
      yearsStock
      Price at Date of Grant
                  
                  $
                  4.79Exercise
      Price
                  
                  $
                  4.79





57





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 both $59,636 for the fiscal year ended December
31, 2008 and 2007. As of December 31, 2008, there was $ 9,935 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 0.2 years.





A summary
of option activity under the Plan as of December 31, 2008 and changes
during the fiscal year ended December 31, 2008 is as follows:


Options
                            
                            
                            Weighted
                              Average
                              Exercise
                              Price
                            
                            
                            Weighted
                              Average
                              Remaining
                              Contractual
                              Term
                            
                            
                            Aggregate
                              Intrinsic
                              ValueJanuary
      1, 2006
                            
                            
                            —
                            
                            
                            $
                            —
                            
                            
                            
                            —
                            
                            
                            $
                            —Granted
                            
                            
                            60,000
                            
                            
                            
                            4.79
                            
                            
                            3Years
                            
                            
                            
                            —Exercised
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —Forfeited
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —Outstanding
      at December 31, 2008
                            
                            
                            60,000
                            
                            
                            $
                            4.79
                            
                            
                            0.2Years
                            
                            
                            $
                            —Exercisable
      at December 31, 2008
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —








(ii).
Subject to all the terms and provisions of the 2005 Stock Compensation
Plan,on June 20,
2007,the Company granted to its
previous senior manager of investor relations, David Ming He options to purchase
4,128 shares of its common stocks with an exercise price of $7.25 per share.The option became vested and exercisable immediately on the date
thereof.





Number of Shares
                  
                  % of Shares Issued
                  
                  Initial Vesting Date4,128
                  
                  
                  100
                  %
                  June
      20, 2007





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





58





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





A summary
of option activity under the Plan as of December 31, 2008 and changes
during the fiscal year ended December 31, 2008 is as follows:


Options
                          
                          
                          Weighted
                            Average
                            Exercise
                            Price
                          
                          
                          Weighted
                            Average
                            Remaining
                            Contractual
      Term
                          
                          
                          Aggregate
                            Intrinsic
                            ValueJanuary
      1, 2007
                          
                          
                          —
                          
                          
                          $
                          —
                          
                          
                          
                          —
                          
                          
                          $
                          —Granted
                          
                          
                          4,128
                          
                          
                          $
                          7.25
                          
                          
                          3Years
                          
                          
                          
                          —Exercised
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Forfeited
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Outstanding
      at December 31, 2008
                          
                          
                          4,128
                          
                          
                          $
                          7.25
                          
                          
                          1.6Years
                          
                          
                          $
                          —Exercisable
      at December 31, 2008
                          
                          
                          4,128
                          
                          
                          $
                          7.25
                          
                          
                          1.6Years
                          
                          
                          $
                          —





(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 Date100,000
                  
                  
                  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
                  
                  
                  77.62
                  %Risk-Free
      Interest Rate
                  
                  
                  4.36
                  %Contractual
      Term
                  
                  4
      yearsStock
      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 option activity with respect to the warrants as of December 31, 2008 and
changes during the fiscal year ended December 31, 2008 is as
follows:





59





Warrants
                          
                          
                          Weighted
                            Average
                            Exercise
                            Price
                          
                          
                          Weighted
                            Average
                            Remaining
                            Contractual
                            Term
                          
                          
                          Aggregate
                            Intrinsic
                            ValueJanuary
      1, 2006
                          
                          
                          —
                          
                          
                          $
                          —
                          
                          
                          
                          —
                          
                          
                          $
                          —Granted
                          
                          
                          100,000
                          
                          
                          $
                          6.25
                          
                          
                          4Years
                          
                          
                          
                          —Exercised
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Forfeited
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Outstanding
      at December 31, 2008
                          
                          
                          100,000
                          
                          
                          $
                          6.25
                          
                          
                          1.1Years
                          
                          
                          $
                          —Exercisable
      at December 31, 2008
                          
                          
                          100,000
                          
                          
                          $
                          6.25
                          
                          
                          1.1Years
                          
                          
                          $
                          —





NOTE
19- COMMITMENTS AND CONTINGENCIES





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





(2)  The
information of lease commitments is provided in Note 14.





NOTE
20 - OFF-BALANCE SHEET ARRANGEMENTS





At
December 31, 2008, 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
21 - SUBSEQUENT EVENTS





On March
24, 2009, we collected $1,463,143 of other accounts receivable due from RuiLi
Group, one related party.





NOTE
22 – RESTRICTED NET ASSETS





Relevant
PRC laws and regulations permit payments of dividends by our PRC subsidiaries
only out of their retained earnings, if any, as determined in accordance with
PRC accounting standards and regulations. In addition, PRC laws and regulations
require that annual appropriations of 10% of after-tax income should be set
aside prior to payment of dividends as a general reserve fund. As a result of
these PRC laws and regulations, our PRC subsidiaries and our affiliated PRC
entities are restricted in their ability to transfer a portion of their
net assets to us whether in the form of dividends, loans or advances. As of
December 31, 2008 and 2007, the amounts of our restricted net assets
were approximately $ 3.1 million and $1.9 million,
respectively.





Additional
Information—Financial Statement Schedule I




This
financial statements schedule has been prepared in conformity with accounting
principles generally accepted in the United States of America.





SORL
AUTO PARTS, INC.





This
financial statements schedule has been prepared in conformity with accounting
principles generally accepted in the United States of America. The parent
company financial statements have been prepared using the same accounting
principles and policies described in the notes to the consolidated financial
statements, with the only exception being that the company accounts for its
subsidiaries using the equity method. Please refer to the notes to the
consolidated financial statements presented above for additional information and
disclosures with respect to these financial statements.





60




Financial
Information Of Parent Company


Balance
Sheets





31-Dec-08
                                  
                                  
                                  31-Dec-07ASSETSCurrent
      Assets:Cash
      and cash equivalents
                                  
                                  $
                                  32,718
                                  
                                  
                                  $
                                  33,288Other
      current assets
                                  
                                  
                                  16,161
                                  
                                  
                                  
                                  16,161Total
      current assets
                                  
                                  
                                  48,879
                                  
                                  
                                  
                                  49,449Deferred
      compensation cost-stock options
                                  
                                  
                                  9,935
                                  
                                  
                                  
                                  69,571Investments
      in subsidiaries
                                  
                                  
                                  81,952,101
                                  
                                  
                                  
                                  69,521,035TOTAL
      ASSETS
                                  
                                  $
                                  82,010,915
                                  
                                  
                                  $
                                  69,640,055LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      Liabilities:Other
      current liability
                                  
                                  
                                  2,486,566
                                  
                                  
                                  
                                  2,486,566Total
      current liabilities
                                  
                                  
                                  2,486,566
                                  
                                  
                                  
                                  2,486,566Total
      liabilities
                                  
                                  
                                  2,486,566
                                  
                                  
                                  
                                  2,486,566Stockholders'
      equity:Common
      Stock - $0.002 Par Value; 50,000,000 authorized, 18,279,254 and 18,279,254
      issued and outstanding as of  December 31, 2008 and December 31,
      2007 respectively
                                  
                                  
                                  36,558
                                  
                                  
                                  
                                  36,558Additional
      paid-in capital
                                  
                                  
                                  37,498,452
                                  
                                  
                                  
                                  37,498,452Retained
      earnings
                                  
                                  
                                  41,989,339
                                  
                                  
                                  
                                  29,618,479Total
      stockholders' equity
                                  
                                  
                                  79,524,349
                                  
                                  
                                  
                                  67,153,489TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                                  
                                  $
                                  82,010,915
                                  
                                  
                                  $
                                  69,640,055





61





Financial
Information Of Parent Company


Statements
Of Income


For
Years Ended on Dec 31, 2008 and 2007





2008
                                  
                                  
                                  2007Equity
      in earnings of subsidiaries
                                  
                                  $
                                  12,431,066
                                  
                                  
                                  $
                                  10,858,638General
      and administrative expenses
                                  
                                  
                                  59,636
                                  
                                  
                                  
                                  114,045Financial
      expenses
                                  
                                  
                                  570
                                  
                                  
                                  
                                  562Net
      income attributable to stockholders
                                  
                                  $
                                  12,370,860
                                  
                                  
                                  $
                                  10,744,031Weighted
      average common share - Basic
                                  
                                  
                                  18,279,254
                                  
                                  
                                  
                                  18,277,094Weighted
      average common share - Diluted
                                  
                                  
                                  18,279,254
                                  
                                  
                                  
                                  18,323,315EPS
      - Basic
                                  
                                  
                                  0.68
                                  
                                  
                                  
                                  0.59EPS
      - Diluted
                                  
                                  
                                  0.68
                                  
                                  
                                  
                                  0.59





Financial
Information Of Parent Company


For
Years Ended On December 31, 2008 And 2007


Additional
                                  
                                  
                                  RetainedNumber
                                  
                                  
                                  Common
                                  
                                  
                                  Paid-in
                                  
                                  
                                  Earnings
                                  
                                  
                                  Stockholders'of
      Share
                                  
                                  
                                  Stock
                                  
                                  
                                  Capital
                                  
                                  
                                  (Deficit)
                                  
                                  
                                  EquityBeginning
      Balance – Jan 1, 2007
                                  
                                  
                                  18,275,126
                                  
                                  
                                  
                                  36,550
                                  
                                  
                                  
                                  37,444,051
                                  
                                  
                                  
                                  18,874,448
                                  
                                  
                                  
                                  56,355,049Net
      Income
                                  
                                  
                                  ―
                                  
                                  
                                  
                                  ―
                                  
                                  
                                  
                                  ―
                                  
                                  
                                  
                                  10,744,031
                                  
                                  
                                  
                                  10,744,031Common
      stock of 4,128 shares issued
                                  
                                  
                                  4128
                                  
                                  
                                  
                                  8
                                  
                                  
                                  
                                  31,200
                                  
                                  
                                  
                                  ―
                                  
                                  
                                  
                                  31,2084,128
      options issued in 2007
                                  
                                  
                                  ―
                                  
                                  
                                  
                                  ―
                                  
                                  
                                  
                                  23,201
                                  
                                  
                                  
                                  ―
                                  
                                  
                                  
                                  23,201Ending
      Balance - December 31, 2007
                                  
                                  
                                  18,279,254
                                  
                                  
                                  
                                  36,558
                                  
                                  
                                  
                                  37,498,452
                                  
                                  
                                  
                                  29,618,479
                                  
                                  
                                  
                                  67,153,489Net
      Income
                                  
                                  
                                  ―
                                  
                                  
                                  
                                  ―
                                  
                                  
                                  
                                  ―
                                  
                                  
                                  
                                  12,370,860
                                  
                                  
                                  
                                  12,370,860Ending
      Balance - December 31, 2008
                                  
                                  
                                  18,279,254
                                  
                                  
                                  
                                  36,558
                                  
                                  
                                  
                                  37,498,452
                                  
                                  
                                  
                                  41,989,339
                                  
                                  
                                  
                                  79,524,349
  62




Financial
Information Of Parent Company


Statements
Of Cash Flows


For
Years Ended on Dec 31, 2008 and 2007





2008
                                    
                                    
                                    2007Cash
      flow from operating activities:Net
      income
                                    
                                    $
                                    12,370,860
                                    
                                    
                                    $
                                    10,744,031Adjustments
      to reconcile net income to net cash provided by operating
      activitiesEquity
      in earnings of subsidiaries
                                    
                                    
                                    (12,431,066
                                    )
                                    
                                    
                                    (10,858,638
                                    )Stock-Based
      Compensation Expense
                                    
                                    
                                    59,636
                                    
                                    
                                    
                                    114,045Changes
      in other current assets
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    (14,396
                                    )Changes
      in other current  liabilities
                                    
                                    
                                    ―
                                    
                                    
                                    
                                    ―Net
      cash provided by operating activities
                                    
                                    $
                                    (570
                                    )
                                    
                                    $
                                    (14,958
                                    )Cash
      flows from investing activities:Investment
      in subsidiaries, net of cash acquired
                                    
                                    $
                                    ―
                                    
                                    
                                    $
                                    ―Net
      cash (used in) provided by investing activities
                                    
                                    $
                                    ―
                                    
                                    
                                    $
                                    ―Cash
      flows from financing activities:Proceeds
      from Share Issuance
                                    
                                    $
                                    ―
                                    
                                    
                                    $
                                    ―Net
      cash provided by (used in) financing activities
                                    
                                    $
                                    ―
                                    
                                    
                                    $
                                    ―Net
      change in increase in cash and cash equivalents
                                    
                                    $
                                    (570
                                    )
                                    
                                    $
                                    (14,958
                                    )Cash
      and cash equivalents, beginning of period
                                    
                                    
                                    33,288
                                    
                                    
                                    
                                    48,246Cash
      and cash equivalents, end of period
                                    
                                    $
                                    32,718
                                    
                                    
                                    $
                                    33,288




63





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





None.





ITEM
9A. CONTROLS AND PROCEDURES





Evaluation
of Disclosure Controls and Procedures





As of
December 31, 2008, an evaluation was performed under the supervision and with
the participation of the Company’s management, including the chief executive
officer (“CEO”) and the chief financial officer (“CFO”), of the effectiveness of
the design and operation of the Company’s disclosure controls and procedures.
Based on that evaluation, the Company’s management, including the CEO and CFO,
conclude that the Company’s disclosure controls and procedures were effective as
of December 31, 2008.





Changes
in Internal Control over Financial Reporting





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





Management’s
Report on Internal Control over Financial Reporting





Our
management is responsible for establishing adequate internal control over
financial reporting, as such item is defined in Exchange Act Rule 13a-15(f) and
15d-15(f). In evaluating the Company’s internal control over financial
reporting, management has adopted the framework in Internal Control-Integrated
Frameworkissued by the Committee of Sponsoring Organization of the
Treadway Commission. Under the supervision and with the participation of our
management, including the principal executive officer and principal financial
officer, we conducted an evaluation of the effectiveness of our internal control
over financial reporting, as of December 31, 2008. Based on our evaluation under
the framework in Internal
Control-Integrated Framework, our management has concluded that our
internal control over financial reporting was effective as of December 31,
2008.





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





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





ITEM
9B. OTHER INFORMATION





None.





ITEM
10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE





The
following table sets forth our executive officers and key employees, their ages
and the positions they held as of December 31, 2008.





64





Name
              
              Age
              
              PositionXiao
      Ping Zhang
              
              46
              
              Chief
      Executive Officer and ChairmanXiao
      Feng Zhang
              
              41
              
              Chief
      Operating Officer and DirectorZong
      Yun Zhou
              
              54
              
              Chief
      Financial Officer





Information
about our directors is presented under the caption “Election of Directors” in
our definitive Proxy Statement for the Annual Meeting of Stockholders to be held
on June 10th, 2009 and is incorporated herein by reference.





Information
about our Audit Committee is presented under the caption “Election of
Directors–Committees of the Board of Directors–Audit Committee” in our
definitive Proxy Statement for the Annual Meeting of Stockholders to be held on
June 10th, 2009 and is incorporated herein by reference.





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





Information
about our compliance with Section 16 of the Exchange Act of 1934, as amended, is
presented under the caption “Section 16(a) Beneficial Ownership Reporting
compliance” in our definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on June 10th, 2009 and is incorporated herein by
reference.





Item
11. EXECUTIVE COMPENSATION





Information about executive compensation
is presented under the captions “Compensation to Executive Officers,”
“Compensation of Directors,” “Report of the Compensation Committee” and
“Compensation Committee Interlocks and Insider Participation” in our definitive
Proxy Statement for the Annual Meeting of Stockholders to be held on June 10th,
2009 and is incorporated herein by reference.





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





Information
about security ownership is presented under the caption “Beneficial Ownership of
Common Stock” in our definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on June 10th, 2009 and is incorporated herein by
reference.





Information
about our equity compensation plans is presented under the caption “Equity
Compensation Plans” in our definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on June 10th, 2009 and is incorporated herein by
reference.





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





Information
about transactions with related persons is presented under the caption “Related
Person Transactions” in our definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on June 10th, 2009 and is incorporated herein by
reference.





Information
about director independence is presented under the caption “Election of
Directors–Director Independence” in our definitive Proxy Statement for the
Annual Meeting of Stockholders to be held on June 10th, 2009 and is incorporated
herein by reference.




65




ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
 
 Information
about aggregate fees billed to us by our principal accountant is presented under
the caption “Principal Accounting Firm Fees” in our definitive Proxy Statement
for the Annual Meeting of Stockholders to be held on June 10th, 2009 and is
incorporated herein by reference.


ITEM
15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES


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





(a)           1.           Financial
Statements.





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





2.           Financial
Statement Schedules.





See Item 8 of this report





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





1.           Financial
Statements.





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





2.           Financial
Statement Schedules.





See Item 8 of this report





EXHIBIT
INDEX





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





66





10.5
                
                Employment
      Agreement—Zong Yun Zhou (5)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
                
                Certification
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 (Chief Executive Officer and Chief
      Financial Officer).







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





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





(3)
            Incorporated herein by reference
      from Registrant’s Form 8-K Current Report, and
      amendment thereto, as filed with the Securities and Exchange Commission on
      May 24, 2004.





(4)
            Incorporated
      by reference to Exhibit 10.2 to the Registrant’s Annual Report on Form
      10-K for the fiscal year ended December 31, 2007, as filed with the
      Securities and Exchange Commission on March 27,
  2008.





(5)
            Incorporated herein by reference
      from the Registrant’s Form S-1 as filed with the
      Securities and Exchange Commission on August31,
  2006.





67





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 30th day
of March 2009.





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
      30, 2009Xiao
      Ping Zhang/s/ Xiao Feng Zhang
              
              Chief
      Operating Officer and Director
              
              March
      30, 2009Xiao
      Feng Zhang/s/ Zong Yun Zhou
              
              Chief
      Financial Officer
              
              March
      30, 2009Zong
      Yun Zhou/s/ Li Min Zhang
              
              Director
              
              March
      30, 2009Li
      Min Zhang/s/ Zhi Zhong Wang
              
              Director
              
              March
      30, 2009Zhi
      Zhong Wang





68





/s/ Yi Guang Huo
              
              Director
              
              March
      30, 2009Yi
      Guang Huo/s/ Jiang Hua Feng
              
              Director
              
              March
      30, 2009Jiang
      Hua Feng/s/ Jung Kang Chang
              
              Director
              
              March
      30, 2009Jung
      Kang Chang





69