**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**




**FORM
      10-K**




**(Mark
                One)**x
            **ANNUAL
                REPORT **PURSUANT
                TO**SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
                OF
                1934.****For
                the fiscal year ended December 31, 2006**o
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934.****For
                the transition period from ____________ to
                ____________.**




**Commission
      File Number 000-33123**




**CHINA
      AUTOMOTIVE SYSTEMS, INC.**


*(Exact
      name of Registrant as specified in its charter)*




**Delaware**
            
            **33-0885775***(State
                or Other Jurisdiction*
              *of
                Incorporation or Organization)*
            
            *(I.R.S.
                Employer*
              *Identification
                No.)***No.
                1 Henglong Road, Yu Qiao Development Zone**
              **Shashi
                District, Jing Zhou City Hubei Province,
                China**
            
            **434000***(Address
                of Principal Executive Offices)*
            
            *(Zip
                Code)*





**(86)
                716-8329196**




*(Registrant’s
      Telephone Number, Including Area Code)*




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




None




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




Common
      Stock, $ 0.0001 par value




Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act. Yes o No x









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




Indicate
      by check mark whether the registrant: (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days. Yes x No o




Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K (§ 229.405 of this chaper) is not contained herein, and will not
      be contained, to the best of registrant’s knowledge, in definitive proxy or
      information statements incorporated by reference in Part III of this Form 10-K
      or any amendment to this Form 10-K. o




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one):




Large
      Accelerated Filer o  Accelerated Filer o  Non-Accelerated
      Filer x




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




The
      Company’s revenues for its most recent fiscal year were $95,766,439




Aggregate
      market value of voting and non-voting common equity held by non-affiliates
      of
      the registrant as of June 30, 2006, based upon the closing price of the common
      stock as reported on the NASDAQ Stock Market under the symbol “CAAS”
on such date, was approximately $22,855,706.




23,959,702
      shares of Common Stock outstanding as of February 27, 2007.




2




CHINA
      AUTOMOTIVE SYSTEMS, INC.




FORM
      10-K




INDEX


**Page**PART
                  IItem
                  1. Description of Business
              
              
              4Item
                  1A. Risk Factors
              
              
              12Item
                  1B. Unresolved Staff Comments
              
              
              19Item
                  2. Description of Property
              
              
              19Item
                  3. Legal Proceedings
              
              
              20Item
                  4. Submission of Matters of a Vote of Security Holders
              
              
              20PART
                  IIItem
                  5. Market for Common Equity, Related Stockholder Matters and Issuer
                  Purchases of Equity Securities
              
              
              20Item
                  6. Selected Financial Data
              
              
              22Item
                  7. Management’s Discussion and Analysis of Financial Condition and Results
                  of Operations
              
              
              22Item
                  7A. Quantitative and Qualitative Disclosures About Market
                  Risk
              
              
              46Item
                  8. Financial Statements and Supplementary Data
              
              
              47Item
                  9. Changes in and Disagreements with Accountants on Accounting
                  and
                  Financial Disclosure
              
              
              47Item
                  9A. Controls and Procedures
              
              
              47Item
                  9B Other Information
              
              
              48PART
                  IIIItem
                  10. Directors and Executive Officers of the Registrant
              
              
              48Item
                  11. Executive Compensation Discussion and Analysis
              
              
              52Item
                  12. Security Ownership of Certain Beneficial Owners and Management
                  and
                  Related Stockholder Matters
              
              
              55Item
                  13. Certain Relationships and Related Transactions
              
              
              55Item
                  14. Principal Accountant Fees and Services
              
              
              56PART
                  IVItem
                  15. Exhibits and Financial Statement Schedules
              
              
              57Signatures
              
              
              58Financial
                  Statements
              
              
              60




3





Cautionary
      Statement




This
      Annual Report on Form 10-K contains forward-looking statements within the
      meaning of Section 27A of the Securities Act of 1933, and Section 21E of the
      Securities Exchange Act of 1934. These statements relate to future events or
      the
      Company’s future financial performance. The Company has attempted to identify
      forward-looking statements by terminology including “anticipates,” “believes,”
“expects,” “can,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,”
“plans,” “potential,” “predict,” “should” or “will” or the negative of these
      terms or other comparable terminology. Such statements are subject to certain
      risks and uncertainties, including the matters set forth in this report or
      other
      reports or documents the Company files with the Securities and Exchange
      Commission from time to time, which could cause actual results or outcomes
      to
      differ materially from those projected. Although the Company believes that
      the
      expectations reflected in the forward-looking statements are reasonable, the
      Company cannot guarantee future results, levels of activity, performance or
      achievements. Undue reliance should not be placed on these forward-looking
      statements which speak only as of the date hereof. The Company’s expectations
      are as of the date this Form 10-K is filed, and the Company does not intend
      to
      update any of the forward-looking statements after the date this Annual Report
      on Form 10-K is filed to confirm these statements to actual results, unless
      required by law.




PART
      I




ITEM
      1.
 DESCRIPTION OF BUSINESS.




COMPANY
      HISTORY




China
      Automotive Systems, Inc., “China Automotive” or the “Company”, was incorporated
      in the State of Delaware on June 29, 1999 under the name Visions-In-Glass,
      Inc..




On
      or
      around March 5, 2003, the Company acquired all of the issued and outstanding
      equity interests of Great Genesis Holding Limited, “Genesis”, a corporation
      organized under the laws of the Hong Kong Special Administrative Region, China,
      by issuance of 20,914,250 shares of common stock to certain sellers. After
      the acquisition, the Company continued the operations of Genesis. Genesis
      owns all of the capital stock of Ji Long Enterprises Investment Corp. Ltd.,
      a
      Hong Kong Company, “Ji Long”. Ji Long in turn owns interests in seven
      Sino-joint ventures, which manufacture power steering systems and/or related
      products for different segments of the automobile industry in
      China.




On
      May
      19, 2003, the Company changed its name from Visions-In-Glass, Inc. to China
      Automotive Systems, Inc.




Effective
      July 17, 2006, Hanlin Chen, Qizhou Wu, Andy Yiu Wong Tse, Robert Tung, Haimian
      Cai, William E. Thomson and Guangxun Xu began serving their terms as members
      of
      the Company’s Board of Directors. The newly elected directors appointed Hanlin
      Chen as the Chief Executive Officer and Chairman of the Board of Directors,
      Qizhou Wu as the Chief Operating Officer and Daming Hu as Chief Financial
      Officer.




BUSINESS
      OVERVIEW




Unless
      the context indicates otherwise, the Company uses the terms “the Company”, “we”,
“our” and “us” to refer to Genesis and China Automotive collectively on a
      consolidated basis. The Company is a holding company and has no significant
      business operations or assets other than its interest in Genesis. Through
      Genesis, the Company manufactures power steering systems and other component
      parts for automobiles. All operations are conducted through seven Sino-foreign
      joint ventures in China. Set forth below is an organizational chart as at
      December 31, 2006.




4








China
      Automotive Systems, Inc.


|


(100%)


Great
      Genesis Holdings Limited


|


(100%)


Ji
      Long
      Enterprise Investment Limited










|
              
              |
              |
              |
              |
              |
              |44.5%
              
              81%
              70%
              51%
              60%
              (77.33%)
              (85%)Jingzhou
                  Henglong
              
              Shashi
                  Jiulong
              Shenyang
                  Jinbei
              Zhejiang
                  Henglong
              Universal
                  Sensor
              Wuhu
                Henglong
              Wuhan
                  JielongAutomotive
                  Parts
              
              Power
                  Steering
              Henglong
              &
                  VIE Pump
              Application.,
                  Inc.
              Automotive
              ElectricCo.,
                  Ltd.
              
              Co.,
                  Ltd.
              Automotive
              Co.,
                  Ltd.
              
              Steering
                  System
              Power
                SteeringSteering
                  System
              
              
              Co.,
                  Ltd.
              Co.,
                  Ltd.Co.,
                  Ltd.("Henglong)
              
              ("Jiulong")
              ("Shenyang")
              ("Zhejiang")
              (“USAI”)
              (“Wuhu”)
              (“Jielong”)




Jiulong
      was established in 1993 and mainly engaged in the production of integral power
      steering gears for heavy-duty vehicles.




Henglong
      was established in 1997 and mainly engaged in the production of rack and pinion
      power steering gears for cars and light duty vehicles.




Shenyang
      was established in 2002 and focuses on power steering parts for light duty
      vehicles.




Zhejiang
      was established in 2002 to focus on power steering pumps.




On
      April
      12, 2005, Great Genesis, entered into a joint-venture agreement with Shanghai
      Hongxi Investment Inc., “Hongxi”, a company controlled by Mr. Hanlin Chen, the
      Company’s Chairman, and Sensor System Solution Inc., “Sensor”, to establish a
      joint venture, Universal Sensor Application Inc., “USAI”, in the Wuhan East Lake
      Development Zone. The registered capital of the Joint-venture is $10 million.
      Great Genesis and Hongxi will invest $6 million and $1 million, respectively,
      including cash and land and building, which will account for 60% and 10% of
      the
      total registered capital, respectively. Sensor will invest $3 million in
      technology, accounting for 30% of the total registered capital. As of December
      31, 2006, Great Genesis has contributed $900,337, the equivalent of RMB7,200,000
      and Hongxi has contributed $436,954 in cash, the equivalent of RMB3,500,000.
      Even though the Company had not yet contributed 60% of the total capital, all
      parties had agreed that the Company was a 60% owner during 2006 and on December
      31, 2006. USAI reported a net loss in 2006. Pursuant to the above joint venture
      agreement, Sensor has failed to contribute it's sensor-related technologies
      and
      thereby failed to fulfill it's capital contribution commitment as of March
      20,
      2007. As a result Sensor has withdrawn from USAI and another technology supplier
      is being sought.




On
      April
      14, 2006, Great Genesis, entered into a joint-venture agreement with Hong Kong
      Tongda, “Tongda”, to establish a joint venture, Wuhan Jielong Electric Power
      Steering Co., Ltd., “Jielong”, in the Wuhan East Lake Development Zone. Jielong
      is mainly engaged in the production and sales of electric power steering, “EPS”.
      The registered capital of the joint-venture is $6 million, the equivalent of
      RMB48,000,000. Great Genesis and Tongda will invest $5,100,000 and $900,000,
      respectively, amounting to 85% and 15% of the total registered capital,
      respectively. As of December 31, 2006, Great Genesis and Tongda have contributed
      $765,000 and $135,034 in cash, the equivalent of RMB6,136,830 and RMB1,081,620
      respectively.




5




On
      March
      31, 2006, as amended on May 2, 2006, Great Genesis, entered into a joint-venture
      agreement with Wuhu Chery Technology Co., Ltd., “Chery Technology”, to establish
      a Joint-venture, Wuhu Henglong Automotive Steering System Co., Ltd in the Wuhu
      Technological Development Zone. Wuhu is mainly engaged in the production
      and sales of automobile steering system. The registered capital of the
      Joint-venture is $3,750,387, the equivalent of RMB30,000,000. Great Genesis
      and
      Chery Technology will invest $2,900,300, the equivalent of RMB23,200,000 and
      $848,938, the equivalent of RMB6,800,000 respectively, which will account for
      77.33% and 22.67% of the total registered capital, respectively. As of December
      31, 2006, the capital of $3,750,387, the equivalent of RMB30,000,000, has been
      totally contributed in Wuhu.




The
      Company has business relations with more than sixty vehicle manufacturers,
      including FAW Group and Dongfeng Auto Group, two of the five largest automobile
      manufacturers in China; Shenyang Brilliance Jinbei Co., Ltd., the largest van
      manufacturers in China; Cherry Automobile Co., Ltd, the largest state owned
      car
      manufacturer in China, and Zhejiang Geely Automobile Co., Ltd., the largest
      private owned car manufacturer. In 2005 and 2006, the Company has supplied
      the power steering pumps for SAIC GM Wuling Co., one of the Sino-Foreign joint
      ventures established by General Motors (GM).




The
      Company currently owns two trademarks covering automobile parts and twelve
      Chinese patents covering power steering technology. The Company is in the
      process of integrating new advanced technologies such as electronic chips in
      power steering systems into its current production line and is pursuing
      aggressive strategies in technology to maintain a competitive edge within the
      automobile industry. In 2001, the Company signed a Ten-Year Licensing Agreement
      with Bishop Steering Technology Limited, a leader in automotive steering gear
      technology innovation which is expected to offer advanced technology for
      steering valves within the contract period. In 2003, the Company signed a
      Technology Transfer Agreement with Nanyang Ind. Co. Ltd., a leading steering
      column maker, for the technology necessary for electronic power steering (EPS)
      systems. In addition, the Company established with Tsinghua University a
      steering systems research institute designed to develop Electronic Power
      Steering (EPS) and Electronic Hydraulic Steering Systems (EHPS).




STRATEGIC
      PLAN




The
      Company’s short to medium term strategic plan is to focus on both domestic and
      international market expansion. To achieve this goal and higher profitability,
      the Company focuses on brand recognition, quality control, decreasing costs,
      research and development and strategic acquisitions. Set forth below are the
      Company’s programs:




-
      Brand
      Recognition. Under the Henglong and Jiulong brands, the Company offers four
      separate series of power steering sets and 310 models of power steering sets,
      steering columns, steering oil pumps and steering hoses.




-
      Quality
      Control. The Henglong and Jiulong manufacturing facilities passed the ISO/TS
      16949 System Certification in January 2004, a well-recognized quality control
      system in the auto industry developed by TUVRheindland of Germany.




-
      Decrease Cost. By improving the Company’s production ability and enhancing
      equipment management, optimizing the process and products structure, perfecting
      the supplier system and cutting production cost, the Company’s goal is to
      achieve a more competitive profit margin.




-
      Research and Development. By partnering with Bishop Steering Technology Limited,
      Nanyang Ind. Co. Ltd. and Tsinghua University for the development of advanced
      steering systems, the Company’s objective is to gain increased market share in
      China.




-
      International Expansion. The Company has entered into agreements with several
      international vehicle manufacturers and auto parts modules suppliers and carried
      on preliminary negotiations regarding future development projects.




6




-
      Acquisitions. The Company is exploring opportunities to create long-term growth
      through new ventures or acquisitions of other auto component manufacturers.
      The
      Company will seek acquisition targets that fulfill the following
      criteria:




-
      companies that can be easily integrated into product manufacturing and corporate
      management;




-
      companies that have strong joint venture partners that would become major
      customers; and




-
      companies involved with power steering systems, oil pump or engine-cooling
      systems.




CUSTOMERS




The
      Company’s ten largest customers represent 72.6% of the Company’s total sales for
      the year ended December 31, 2006. The following table sets forth information
      regarding the Company’s ten largest customers.




Name
                of Major Customers
            
            Percentage
                of Total
              Revenue
                in 2006Chery
                Automobile Co., Ltd
            
            
            16.4
            %Brilliance
                China Automotive Holdings Limited
            
            
            13.3
            %Beiqi
                Foton Motor Co., Ltd.
            
            
            11.1
            %Zhejiang
                Geely Holding Co., Ltd
            
            
            10.3
            %Xi’an
                BYD Electric Car Co., Ltd
            
            
            7.2
            %Dongfeng
                Auto Group Co., Ltd
            
            
            4.6
            %China
                FAW Group Corporation
            
            
            3.2
            %Shanxi
                Heavy Auto Co., Ltd
            
            
            2.5
            %Shenyang
                Zhongshun Auto Co., Ltd
            
            
            2.1
            %Great
                Wall Motor Company Limited
            
            
            1.9
            %Total
            
            
            72.6
            %




We
      primarily sell our products to the above-mentioned customers; we also have
      excellent relationships with them, including as their first-ranking supplier
      and
      developer for new product development for new models. While we intend to
      continue to focus on retaining and winning this business, we cannot ensure
      that
      we will succeed in doing so. It is difficult to keep these contracts as a result
      of severe price competition and customers’ diversification of their supply base.
      The Company’s business would be materially and adversely affected if it loses
      one or more of these major customers.




SALES
      AND
      MARKETING




The
      Company’s sales and marketing team has 102 sales persons, which are divided into
      an original equipment manufacturing, (OEM), team, a sales service team and
      a
      working group dedicated to international business. These sales and marketing
      teams provide a constant interface with the Company’s key customers. They are
      located in all major vehicle producing regions to more effectively represent
      the
      Company’s customers’ interests within the Company’s organization, to promote
      their programs and to coordinate their strategies with the goal of enhancing
      overall service and satisfaction. The Company’s ability to support its customers
      is further enhanced by its broad presence in terms of sales offices,
      manufacturing facilities, engineering technology centers and joint
      ventures.




7




The
      Company’s sales and marketing organization and activities are designed to create
      overall awareness and consideration of, and therefore to increase sales of,
      the
      Company’s modular systems and components. To achieve that objective, the Company
      organized delegations to visit the United States, Korea, India and Japan and
      met
      with potential customers. Through these activities, the Company has generated
      potential business interests as a strong base for future
      development.




DISTRIBUTION




The
      Company’s distribution system covers all of China. The Company has established
      sales and service offices with certain significant customers to deal with
      matters related to such customers in a timely fashion. The Company also
      established distribution warehouses close to major customers to ensure timely
      deliveries. The Company maintains strict control over inventories. Each of
      these
      sales and service offices sends back to the Company through e-mail or fax
      information related to the inventory and customers’ needs. The Company
      guarantees product delivery in 8 hours for those customers who are located
      within 200 km from the Company’s distribution warehouses, and 24 hours for
      customers who are located outside of 200 km from the Company’s distribution
      warehouses. Delivery time is a very important competitive factor in terms of
      customer decision making, together with quality, pricing and long-term
      relationships.




EMPLOYEES
      AND FACILITIES




As
      of
      December 31, 2006, the Company employed approximately 2,042 persons,
      including approximately 1,452 by Henglong and Jiulong, approximately 217 by
      Shengyan, approximately 264 by Zhejiang, approximately 43 by USAI and
      approximately 66 by Wuhu.




As
      of
      December 31, 2006, each of Henglong and Jiulong, Shenyang, Zhejiang and Wuhu
      has
      a manufacturing and administration area of 448,612 square meters, 35,354 square
      meters, 27,756 square meters, and 83,705 square meters, respectively.




Hubei
      Province, which is home to Dongfeng, one of the largest automakers in China,
      provides an ample supply of inexpensive but skilled labor to automotive-related
      industries. The annual production of the Company’s main product, power steering
      gears, was approximately 450,000 units, 510,000 units and 800,000 units in
      2004,
      2005 and 2006 respectively. Although the production process continues to rely
      heavily on manual labor, the Company has invested substantially in high-level
      production machinery to improve capacity and production quality. Approximately
      $21.5 million was spent over the last three years on professional-grade
      equipment -- approximately 88% of which is already in place and in use as of
      December 31, 2006.




RAW
      MATERIALS




The
      Company purchases various manufactured components and raw materials for use
      in
      its manufacturing processes. The principal components and raw materials the
      Company purchases include castings, electronic parts, molded plastic parts,
      finished sub-components, fabricated metal, aluminum and steel. The most
      important raw material is steel. The Company enters into purchase
      agreements with local suppliers. The annual purchase plans are determined
      at the beginning of the calendar year but are subject to revision every three
      months as a result of customers’ orders. A purchase order is made according to
      monthly production plans. This protects the Company from building up
      inventory when the orders from customers change.




The
      Company’s purchases from its ten largest suppliers represent in the aggregate
      21.9% of all components and raw materials it purchased for the year ended
      December 31, 2006, with no single supplier providing more than 10% of total
      purchases.




8




All
      components and raw materials are available from numerous sources. The
      Company has not, in recent years, experienced any significant shortages of
      manufactured components or raw materials and normally does not carry inventories
      of these items in excess of what is reasonably required to meet its production
      and shipping schedules.




RESEARCH
      AND DEVELOPMENT




The
      Company has a ten-year consulting and licensing agreement with Bishop Steering
      Technology Ltd, one of the leading design firms in power steering
      systems. Bishop’s technology in power steering systems is currently used by
      carmakers such as BMW and Mercedes Benz. Pursuant to the agreement, the
      Company has implemented the Bishop steering valve technology into the Henglong
      brand R&P power steering gear.




Henglong
      owns a Hubei Provincial-Level Technical Center, which is approved by the Hubei
      Economic Commission. The center has a staff of 122, including 12 senior
      engineers, 2 foreign experts and 68 engineers, primarily focused on steering
      system R&D, tests, production process improvement and new material and
      production methodology application.




In
      addition, the Company has partnered with Tsinghua University to establish a
      steering system research center, called Tsinghua Henglong Automobile Steering
      Research Institute, for the purposes of R&D and experimentation for
      Electronic-controlled Power Steering (EPS).




We
      believe that our engineering and technical expertise, together with our emphasis
      on continuing research and development, allow us to use the latest technologies,
      materials and processes to solve problems for our customers and to bring new,
      innovative products to market. We believe that continued research and
      development activities, including engineering, are critical to maintaining
      our
      pipeline of technologically advanced products. We have aggressively managed
      costs in other portions of our business in order to maintain our total
      expenditures for research and development activities, including engineering,
      at
      approximately $1,100,000, $1,000,000 and $1,500,000 for the years ended
      December 31, 2006, 2005 and 2004, respectively. In 2006, the sales of
      newly developed products accounted for about 9.6% of total sales.




COMPETITION




The
      automotive components industry is extremely competitive. Criteria for the
      Company’s customers include quality, price/cost competitiveness, system and
      product performance, reliability and timeliness of delivery, new product and
      technology development capability, excellence and flexibility in operations,
      degree of global and local presence, effectiveness of customer service and
      overall management capability. The power steering system market is fragmented
      in
      China, and the Company has seven major competitors. Of these competitors, two
      are Sino-foreign joint ventures while the other five are state-owned. Like
      many
      competitive industries, there is downward pressure on selling prices. For the
      year ended December 31, 2006, the selling price of the Company’s principal
      products was reduced by an average of 9.5% compared with 2005.




The
      Company’s major competitors, including Shanghai ZF and FKS, are component
      suppliers to specific automobile manufacturers. Shanghai ZF is the joint venture
      of SAIC and ZF Germany, which is an exclusive supplier to SAIC-Volkswagen and
      SAIC-GM. First Auto FKS is a joint venture between First Auto Group and Japan’s
      Koyo Company and its main customer is FAW-Volkswagen Company.




While
      the
      Chinese Government limits foreign ownership of auto assemblers to 50%, there
      is
      no analogous limitation in the automotive components industry. Thus
      opportunities exist for foreign component suppliers to set up factories in
      China. These overseas competitors employ technology that may be more advanced
      and may have existing relationships with global automobile assemblers, but
      they
      are generally not as competitive as the Company in China in terms of production
      cost and flexibility in meeting client requirements.




CHINESE
      AUTOMOBILE INDUSTRY




The
      Company is a supplier of automotive parts and all of its operations are located
      in China. An increase or decrease in output and sales of Chinese vehicles could
      result in an increase or decrease of the Company’s results of operations.
      According to the latest statistics from the China Association of Automobile
      Manufacturers, CAAM, in 2006, the output and sales volume of domestic made
      vehicles has reached 5,233,100 and 5,176,000 units respectively, with an
      increase of 32.76% and 30.02% compared with the same period of last
      year. The sales volume of national brand vehicles had reached 982,800
      units, representing 25.67% of total passenger vehicles sales, an increase of
      4.13% as compared with 21.54% market share in 2005. The output and sales volume
      of commercial vehicles has reached 2,050,000 and 2,040,000 units respectively
      with an increase of 15.0% and 14.0% over last year. National brand vehicles
      maintained a lead in the commercial vehicle market obtaining more than 96%
      thereof.




9




In
      2006,
      due to the increased sales volume of Chinese vehicles, the Company’s sales of
      steering gear and steering pumps for passenger vehicles increased by 50.5%
      and
      70.6%, respectively, as compared with the corresponding period in 2005, however,
      the Company’s sales of steering gears for commercial vehicles increased by 43.3%
      as compared with the corresponding period in 2005.




The
      Company expects that in 2007, China’s automobile market will develop steadily.




Lei
      Jiang, the Secretary General of the China Association of Automotive
      Manufacturers and Chairman of the Automobile Industry of the China Council
      for
      the promotion of International Trade, predicted that in 2007, there will be
      healthy development for the Chinese auto market, and the output and sales of
      vehicles will increase by approximately 15%. Based on this prediction,
      management believes that the Company’s net sales would increase by
      15%-20%.




CHINESE
      ECONOMY




Management
      believes that the most important factor in understanding the Chinese automobile
      industry is the country’s rapid economic growth. Chinese economic growth
      maintained high levels in 2006. According to data from State Statistical
      Bureau, the Chinese economic growth reached 10.7% in 2006. Because of the growth
      of the Chinese economy and the increased income level of its residents, the
      investment by Chinese enterprises and consumption by Chinese residents will
      continue to increase rapidly.




Management
      believes that the continued investment and consumption growth will have a
      favorable effect on the sales of commercial vehicles and passenger
      vehicles.




HIGHWAY
      DEVELOPMENT




Management
      believes that the continuing development of the highway system will have a
      significant positive impact on the manufacture and sale of private automobiles.
      Statistics from the Ministry of Communications show that 94,000 kilometers
      of
      highway and 4,300 kilometers of expressway were developed in 2006. Total
      highways and expressways now amount to 2,014,000 kilometers and 44,000
      kilometers, respectively.




10




DOING
      BUSINESS IN CHINA




CHINESE
      LEGAL SYSTEM




The
      practical effect of the Chinese legal system on the Company’s 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
      other
      provinces. Similarly, the Chinese accounting laws mandate accounting practices,
      which are not consistent with US Generally Accepted Accounting Principles.
      The
      Chinese accounting laws require that an annual “statutory audit” be performed in
      accordance with Chinese accounting standards and that the books of account
      of
      Foreign Invested Enterprises be maintained in accordance with Chinese accounting
      laws. Article 14 of the People’s Republic of China Wholly Foreign-Owned
      Enterprise Law requires a Wholly Foreign-Owned Enterprise to submit certain
      periodic fiscal reports and statements to designated financial and tax
      authorities. Otherwise, there is risk that its business license will be
      revoked.




Second,
      while the enforcement of substantive rights may appear less clear than those
      in
      the United States, 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 dispute resolution. Because
      the
      terms of the Company’s various Articles of Association provide that all business
      disputes pertaining to Foreign Invested Enterprises will 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 Company’s
      joint venture companies will not assume any advantageous position regarding
      such
      disputes. Any award rendered by this arbitration tribunal is, by the express
      terms of the various 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
      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 is
      no
      assurance that:




-
       The Company 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.




Negative
      impact resulting from economic reform policies or nationalization could result
      in a total investment loss in the Company’s common stock.




Since
      1979, the Chinese Government has reformed its economic system. Because many
      reforms are unprecedented or experimental, they are expected to be refined
      and
      readjusted. Other political, economic and social factors, such as political
      changes, changes in the rates of economic growth, unemployment or inflation,
      or
      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 the Company’s operations.




11




Over
      the
      last few years, China’s economy has registered a high growth rate. Recently,
      there have been indications that the rate of inflation has increased. In
      response, the Chinese Government recently has taken measures to curb the
      excessively expansive economy. These measures included implementation of a
      unitary and well-managed floating exchange rate system based on market supply
      and demand for the exchange rates of Renminbi, restrictions on the availability
      of domestic credit, reduction of the purchasing capability of its citizens,
      and
      centralization of the approval process for purchases of certain limited foreign
      products. These austerity measures alone may not succeed in slowing down the
      economy’s excessive expansion or control inflation, and may result in severe
      dislocations in the Chinese economy. The Chinese Government may adopt additional
      measures to further combat inflation, including the establishment of freezes
      or
      restraints on certain projects or markets.




To
      date
      reforms to China’s economic system have not adversely affected the Company’s
      operations and are not expected to adversely affect the Company’s operations in
      the foreseeable future; however, there can be no assurance that reforms to
      China’s economic system will continue or that the Company 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, reduction in tariff protection and
      other import restrictions.




ITEM
      1A.
 RISK FACTORS.




The
      Company’s business, financial conditions and results of operations could be
      materially and adversely affected by many risk factors. Because of these risk
      factors, actual results might differ significantly from those projected in
      the
      forward-looking statements. Factors that might cause such differences include,
      among others, the following:




Risks
      Related to the Company’s Business and Industry




*Because
      the Company is a holding company with substantially all of its operations
      conducted through its subsidiaries, its performance will be affected by the
      performance of its subsidiaries.*




The
      Company has no operations independent of those of Great Genesis and its
      subsidiaries, and its principal assets are its investments in Great Genesis
      and
      its subsidiaries. As a result, the Company is dependent upon the performance
      of
      Great Genesis and its subsidiaries and will be subject to the financial,
      business and other factors affecting Great Genesis as well as general economic
      and financial conditions. As substantially all of the Company’s operations are
      and will be conducted through its subsidiaries, it will be dependent on the
      cash
      flow of its subsidiaries to meet its obligations.




Because
      virtually all of the Company’s assets are and will be held by operating
      subsidiaries, the claims of its stockholders will be structurally subordinate
      to
      all existing and future liabilities and obligations, and trade payables of
      such
      subsidiaries. In the event of the Company’s bankruptcy, liquidation or
      reorganization, the Company’s assets and those of its subsidiaries will be
      available to satisfy the claims of its stockholders only after all of the
      Company’s and its subsidiaries’ liabilities and obligations have been paid in
      full.




*With
      the automobile parts markets being highly competitive and many of the Company’s
      competitors having greater resources than it does, the Company may not be able
      to compete successfully.*




12




The
      automobile parts industry is a highly competitive business. Criteria for the
      Company’s customers include:




·  Quality;




·  Price/cost
      competitiveness;




· System
      and product
      performance;




·  Reliability
      and timeliness of
      delivery;




· New
      product and technology
      development capability;




· Excellence
      and flexibility in
      operations;




· Degree
      of global and local
      presence;




· Effectiveness
      of customer service;
      and




· Overall
      management capability.




The
      Company’s competitors include independent suppliers of parts, as well as
      suppliers formed by spin-offs from its customers, who are becoming more
      aggressive in selling parts to other vehicle manufacturers. Depending on the
      particular product, the number of the Company’s competitors varies
      significantly. Many of the Company’s competitors have substantially greater
      revenues and financial resources than it does, as well as stronger brand names,
      consumer recognition, business relationships with vehicle manufacturers, and
      geographic presence than it has. The Company may not be able to compete
      favorably and increased competition may substantially harm its business,
      business prospects and results of operations.




Internationally,
      the Company faces different market dynamics and competition. The Company may
      not
      be as successful as its competitors in generating revenues in international
      markets due to the lack of recognition of its products or other factors.
      Developing product recognition overseas is expensive and time-consuming and
      the
      Company’s international expansion efforts may be more costly and less profitable
      than it expects. If the Company is not successful in its target markets, its
      sales could decline, its margins could be negatively impacted and the Company
      could lose market share, any of which could materially harm the Company’s
      business, results of operations and profitability.




*The
      cyclical nature of automotive production and sales could result in a reduction
      in automotive sales, which could adversely affect the Company’s business and
      results of operations.*




The
      Company’s business relies on automotive vehicle production and sales by its
      customers, which are highly cyclical and depend on general economic conditions
      and other factors, including consumer spending and preferences. They also can
      be
      affected by labor relations issues, regulatory requirements, and other factors.
      In addition, in the last two years, the price of automobiles in China has
      generally declined. As a result, the volume of automotive production in China
      has fluctuated from year to year, which give rise to fluctuations in the demand
      for the Company’s products. Any significant economic decline that results in a
      reduction in automotive production and sales by the Company’s customers would
      have a material adverse effect on its results of operations. Moreover, if the
      prices of automobiles do not remain low, then demand for automobile parts could
      fall and result in lower revenues and profitability.




*Increasing
      costs for manufactured components and raw materials may adversely affect the
      Company’s profitability.*




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




*Pricing
      pressure by automobile manufacturers on their suppliers may adversely affect
      the
      Company’s business and results of operations.*




Recently,
      pricing pressure from automobile manufacturers has been prevalent in the
      automotive parts industry in China. Virtually all vehicle manufacturers seek
      price reductions each year, including requiring suppliers to pay a “3-R
      Guarantees “ service charge for repair, replacement and refund in an amount
      equal to one percent of the total amount of parts supplied. Although the Company
      has tried to reduce costs and resist price reductions, these reductions have
      impacted the Company’s sales and profit margins. If the Company cannot offset
      continued price reductions through improved operating efficiencies and reduced
      expenditures, price reductions will have a material adverse effect on the
      Company’s results of operations.




13




*The
      Company’s business, revenues and profitability would be materially and adversely
      affected if it loses any of its large customers.*




For
      the
      year ended December 31, 2006, approximately 16.4% of the Company’s sales were to
      Chery Automobile Co., Ltd, approximately 13.3% were to Brilliance China
      Automotive Holdings Limited, approximately 11.1% were to Beiqi Foton Motor
      Co.,
      Ltd, and approximately 10.3% were to Zhejiang Geely Holding Co., Ltd, the
      Company’s four largest customers. The loss of, or significant reduction in
      purchases by, one or more of these major customers could adversely affect the
      Company’s business.




*The
      Company may be subject to product liability and warranty and recall claims,
      which may increase the costs of doing business and adversely affect the
      Company’s financial condition and liquidity.*




The
      Company may be exposed to product liability and warranty claims if its products
      actually or allegedly fail to perform as expected or the use of its products
      results, or is alleged to result, in bodily injury and/or property damage.
      The
      Company started to pay to its customers’ increased after-sales service expenses
      due to consumer rights protection policies of “recall” issued by the Chinese
      Government in 2004, such as the recalling flawed vehicles policy. Beginning
      in
      2004, automobile manufacturers unilaterally required their suppliers to pay
      a
“3-R Guarantees “ service charge (for repair, replacement and refund) in an
      amount equal to one percent of the total amount of parts supplied. Accordingly,
      the Company has experienced and shall continue to experience higher after sales
      service expenses. Product liability, warranty and recall costs may have a
      material adverse effect on the Company’s financial condition.




*The
      Company is subject to environmental and safety regulations, which may increase
      the Company’s compliance costs and may adversely affect the Company’s results of
      operation.*




The
      Company is subject to the requirements of environmental and occupational safety
      and health laws and regulations in China. The Company cannot provide assurance
      that it has been or will be at all times in full compliance with all of these
      requirements, or that it will not incur material costs or liabilities in
      connection with these requirements. Additionally, these regulations may change
      in a manner that could have a material adverse effect on the Company’s business,
      results of operations and financial condition. 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 the Company’s suppliers may adversely affect its operations by delaying
      delivery or causing delivery failures, which may negatively affect demand,
      sales
      and profitability.*




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




*The
      Company’s business and growth may suffer if it fails to attract and retain key
      personnel.*




The
      Company’s ability to operate its business and implement its strategies
      effectively depends on the efforts of its executive officers and other key
      employees. The Company depends on the continued contributions of its senior
      management and other key personnel. The Company’s future success also depends on
      its ability to identify, attract and retain highly skilled technical staff,
      particularly engineers and other employees with electronics expertise, together
      with managerial, finance and marketing personnel. The Company does not maintain
      a key person life insurance policy on Mr. Hanlin Chen. The loss of the services
      of any of the Company’s key employees or the failure to attract or retain other
      qualified personnel could substantially harm the Company’s business.




14




*The
      Company’s management controls approximately 83.8% of its outstanding common
      stock and may have conflicts of interest with its minority stockholders.*




Members
      of the Company’s management beneficially own approximately 83.8% of the
      outstanding shares of the Company’s common stock. As a result, these majority
      stockholders have control over decisions to enter into any corporate transaction
      and have the ability to prevent any transaction that requires the approval
      of
      stockholders, which could result in the approval of transactions that might
      not
      maximize stockholders’ value. Additionally, these stockholders control the
      election of members of the Company’s board, have the ability to appoint new
      members to the Company’s management team and control the outcome of matters
      submitted to a vote of the holders of the Company’s common stock. The interests
      of these majority stockholders may at times conflict with the interests of
      the
      Company’s other stockholders.




*There
      is a limited public float of the Company’s common stock, which can result in its
      stock price being volatile and prevent the realization of a profit on resale
      of
      the Company’s common stock*




There
      is
      a limited public float of the Company’s common stock. Of the Company’s
      outstanding common stock, approximately 16.2% is considered part of the public
      float. The term “public float” refers to shares freely and actively tradable on
      the NASDAQ SmallCap Market and not owned by officers, directors or affiliates,
      as such term is defined under the Securities Act. Due to the Company’s
      relatively small public float and the limited trading volume of its common
      stock, purchases and sales of relatively small amounts of the Company’s common
      stock can have a disproportionate effect on the market price for the Company’s
      common stock. As a result, the market price of the Company’s common stock can be
      volatile. This stock price volatility could prevent a stockholder seeking to
      sell Company common stock from being able to sell it at or above the price
      at
      which the stock was bought.




*Provisions
      in the Company’s certificate of incorporation and bylaws and the General
      Corporation Law of Delaware may discourage a takeover attempt.*




Provisions
      in the Company’s certificate of incorporation and bylaws and the General
      Corporation Law of Delaware, the state in which the Company is organized, could
      make it difficult for a third party to acquire the Company, even if doing so
      might be beneficial to the Company’s stockholders. Provisions of the Company’s
      certificate of incorporation and bylaws impose various procedural and other
      requirements, which could make it difficult for stockholders to effect certain
      corporate actions and possibly prevent transactions that would maximize
      stockholders’ value.




Risks
      Related to Doing Business in China and other International
      Countries




*Because
      the Company’s operations are all located outside of the United States and are
      subject to Chinese laws, any change of Chinese laws may adversely affect the
      Company’s business.*




All
      of
      the Company’s operations are outside the United States and in China, which
      exposes it to risks, such as exchange controls and currency restrictions,
      currency fluctuations and devaluations, changes in local economic conditions,
      changes in Chinese laws and regulations, exposure to possible expropriation
      or
      other Chinese government actions, and unsettled political conditions. These
      factors may have a material adverse effect on the Company’s operations or on the
      Company’s business, results of operations and financial condition.




*The
      Company’s international expansion plans subject it to risks inherent in doing
      business internationally.*




The
      Company’s long-term business strategy relies on the expansion of the Company’s
      international sales outside China by targeting markets, such as the United
      States. Risks affecting the Company’s international expansion include challenges
      caused by distance, language and cultural differences, conflicting and changing
      laws and regulations, foreign laws, 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
      the
      Company’s international expansion efforts, which could in turn materially and
      adversely affect the Company’s business, operating results and financial
      condition.




15




*The
      Company faces risks associated with currency exchange rate fluctuations, any
      adverse fluctuation may adversely affect the Company’s operating margins.*




Although
      the Company is incorporated in the United States, the majority of its current
      revenues is in Chinese currency. Conducting business in currencies other than
      US
      dollars subjects the Company to fluctuations in currency exchange rates that
      could have a negative impact on the Company’s reported operating results.
      Fluctuations in the value of the US dollar relative to other currencies impact
      the Company’s revenues, cost of revenues and operating margins and result in
      foreign currency translation gains and losses. Historically, the Company has
      not
      engaged in exchange rate hedging activities. Although the Company may implement
      hedging strategies to mitigate this risk, these strategies may not eliminate
      the
      Company’s exposure to foreign exchange rate fluctuations and involve costs and
      risks of their own, such as ongoing management time and expertise, external
      costs to implement the strategy and potential accounting implications.




*If
      relations between the United States and China worsen, the Company’s stock price
      may decrease and the Company may have difficulty accessing the U.S. capital
      markets.*




At
      various times during recent years, the United States and China have had
      disagreements over political and economic issues. Controversies may arise in
      the
      future between these two countries. Any political or trade controversies between
      the United States and China could adversely affect the market price of the
      Company’s common stock and the Company’s ability to access US capital markets.




*The
      Chinese Government could change its policies toward private enterprise, which
      could adversely affect the Company’s business.*




The
      Company’s business is subject to political and economic uncertainties in China
      and may be adversely affected by its political, economic and social
      developments. Over the past several years, the Chinese Government has pursued
      economic reform policies including the encouragement of private economic
      activity and greater economic decentralization. The Chinese Government may
      not
      continue to pursue these policies or may alter them to the Company’s detriment
      from time to time. Changes in policies, laws and regulations, or in their
      interpretation or the imposition of confiscatory taxation, restrictions on
      currency conversion, restrictions or prohibitions on dividend payments to
      stockholders, devaluations of currency or the nationalization or other
      expropriation of private enterprises could have a material adverse effect on
      the
      Company’s business. Nationalization or expropriation could result in the total
      loss of the Company’s investment in China.




*The
      economic, political and social conditions in China could affect the Company’s
      business.*




All
      of
      the Company’s business, assets and operations are located in China. The economy
      of China differs from the economies of most developed countries in many
      respects, including government involvement, level of development, growth rate,
      control of foreign exchange, and allocation of resources. The economy of China
      has been transitioning from a planned economy to a more market-oriented economy.
      Although the Chinese Government has implemented measures recently emphasizing
      the utilization of market forces for economic reform, the reduction of state
      ownership of productive assets and the establishment of sound corporate
      governance in business enterprises, a substantial portion of productive assets
      in China is still owned by the Chinese Government. In addition, the Chinese
      Government continues to play a significant role in regulating industry by
      imposing industrial policies. It also exercises significant control over China’s
      economic growth through the allocation of resources, controlling payment of
      foreign currency-denominated obligations, setting monetary policy and providing
      preferential treatment to particular industries or companies. Therefore, the
      Chinese Government’s involvement in the economy could adversely affect the
      Company’s business operations, results of operations and/or the financial
      condition.




16




*The
      significant but uneven growth in the economy of China in the past 20 years
      could
      have an adverse effect on the Company’s business and results of operations.*




The
      Chinese Government has implemented various measures from time to time to control
      the rate of economic growth. Some of these measures benefit the overall economy
      of China, but may have a negative effect on the Company.




*Government
      control of currency conversion and future movements in exchange rates may
      adversely affect the Company’s operations and financial results.*




The
      Company receives substantially all of its revenues in Renminbi, the currency
      of
      China. A portion of such revenues will be converted into other currencies to
      meet the Company’s foreign currency obligations. Foreign exchange transactions
      under the Company’s capital account, including principal payments in respect of
      foreign currency-denominated obligations, continue to be subject to significant
      foreign exchange controls and require the approval of the State Administration
      of Foreign Exchange in China. These limitations could affect the Company’s
      ability to obtain foreign exchange through debt or equity financing, or to
      obtain foreign exchange for capital expenditures.




The
      Chinese Government controls its foreign currency reserves through restrictions
      on imports and conversion of Renminbi into foreign currency. Although the
      exchange rate of the Renminbi to the US dollar has been stable since January
      1,
      1994, and the Chinese Government has stated its intention to maintain the
      stability of the value of Renminbi, there can be no assurance that exchange
      rates will remain stable. The Renminbi could devalue against the US dollar.
      The
      Company’s financial condition and results of operations may also be affected by
      changes in the value of certain currencies other than the Renminbi in which
      the
      Company’s earnings and obligations are denominated. In particular, a devaluation
      of the Renminbi is likely to increase the portion of the Company’s cash flow
      required to satisfy the Company’s foreign currency-denominated
      obligations.




*Because
      the Chinese legal system is not fully developed, the Company’s legal protections
      may be limited.*




The
      Chinese legal system is based on written statutes and their interpretation
      by
      the Supreme People’s Court. Although the Chinese government introduced new laws
      and regulations to modernize its business, securities and tax systems on January
      1, 1994, China does not yet possess a comprehensive body of business law.
      Because Chinese laws and regulations are relatively new, interpretation,
      implementation and enforcement of these laws and regulations involve
      uncertainties and inconsistencies and it may be difficult to enforce contracts.
      In addition, as the Chinese legal system develops, changes in such laws and
      regulations, their interpretation or their enforcement may have a material
      adverse effect on the Company’s business operations. Moreover, interpretative
      case law does not have the same precedential value in China as in the United
      States, so legal compliance in China may be more difficult or
      expensive.




*It
      may be difficult to serve the Company with legal process or enforce judgments
      against the Company’s management or the Company.*




All
      of
      the Company’s assets are located in China and three out of the Company’s
      directors and officers are non-residents of the United States, and all or
      substantial portions of the assets of such non-residents are located outside
      the
      United States. As a result, it may not be possible to effect service of process
      within the United States upon such persons to originate an action in the United
      States. Moreover, there is uncertainty that the courts of China would enforce
      judgments of U.S. courts against the Company, its directors or officers based
      on
      the civil liability provisions of the securities laws of the United States
      or
      any state, or an original action brought in China based upon the securities
      laws
      of the United States or any state.




17




**Risks
      Related to the Standby Equity Distribution Agreement (“SEDA”)**





*Future
      sales by the Company’s stockholders may adversely affect its stock price and its
      ability to raise funds in new stock offerings.*





Sales
      of
      the Company’s common stock in the public market following the SEDA could lower
      the market price of its common stock. Sales may also make it more difficult
      for
      the Company to sell equity securities or equity-related securities in the future
      at a time and price that management deems acceptable, or at all. Of the
      23,959,702 shares of common stock outstanding as of February 27 **,** 2007,
      all such shares are, or will be, freely tradable without restriction, unless
      held by our “affiliates.” Some of these shares may be resold under
      Rule 144.





*Existing
      stockholders could experience significant dilution from the Company’s sale of
      shares under the SEDA.*





The
      Company’s financial needs will be partially provided from the SEDA. The issuance
      of shares of the Company’s common stock under the SEDA, at below-market prices,
      will have a dilutive impact on its other stockholders and the issuance or even
      potential issuance of such shares could have a negative effect on the market
      price of its common stock. As a result, the Company’s net income per share could
      decrease in future periods, and the market price of the Company’s common stock
      could decline. In addition, the lower the Company’s stock price, the more shares
      of common stock it will have to issue under the SEDA to draw down the full
      amount. If the Company’s stock price is lower, then its existing stockholders
      would experience greater dilution.





*Under
      the SEDA, Cornell Capital Partners will pay less than the then-prevailing market
      price of the Company’s common stock.*





The
      common stock to be issued under the SEDA will be issued at a 1.5% discount
      to
      the lowest daily Volume Weighted Average Price, VWAP, of the Company’s common
      stock during the five consecutive trading day period immediately following
      the
      date the Company notifies Cornell Capital Partners that it desires to access
      the
      SEDA; provided, that the price per share paid by Cornell Capital Partners will
      in no event be less than a minimum of 90% of the closing bid price for the
      Company’s common stock on the trading day immediately preceding the date that it
      delivers an advance request. Further, Cornell Capital Partners will retain
      4.5%
      of each advance under the SEDA. Based on this discount, Cornell Capital Partners
      will have an incentive to sell immediately to realize the gain on the 1.5%
      discount. These sales could cause the price of the Company’s common stock to
      decline, based on increased selling of its common stock.





*The
      sale of the Company’s stock under the SEDA could encourage short sales by third
      parties, which could contribute to the future decline of the Company’s stock
      price.*





In
      many
      circumstances, the provisions of a SEDA have the potential to cause a
      significant downward pressure on the price of a company’s common stock. This is
      especially the case if the shares being placed into the market exceed the
      market’s ability to take up the increased stock or if the Company has not
      performed in such a manner to show that the equity funds raised will be used
      for
      growth. Such an event could place further downward pressure on the price of
      the
      Company’s common stock. The Company may request numerous drawdowns pursuant to
      the terms of the SEDA. Even if the Company uses the SEDA to invest in ways
      that
      are materially beneficial to it, the opportunity exists for short sellers and
      others to contribute to the future decline of the Company’s stock price. If
      there are significant short sales of stock, the price decline that would result
      from this activity in turn may cause long holders of the stock to sell their
      shares thereby contributing to sales of stock in the market. If there is an
      imbalance on the sell side of the market for the Company’s common stock, the
      price will decline.





It
      is not
      possible to predict those circumstances whereby short sales could materialize
      or
      the extent to which the stock price could drop. In some companies that have
      been
      subjected to short sales the stock price has dropped significantly. This could
      happen to the Company’s stock price.




18




*Cornell
      Capital Partners may sell shares of the Company’s common stock after it delivers
      an advance notice during the pricing period, which could cause the Company’s
      stock price to decline.*





Cornell
      Capital Partners is deemed to beneficially own the shares of common stock
      corresponding to a particular advance on the date that the Company delivers
      an
      advance notice to Cornell Capital Partners, which is prior to the date the
      stock
      is delivered to Cornell Capital Partners. Cornell Capital Partners may sell
      such
      shares any time after the Company delivers an advance notice. Accordingly,
      Cornell Capital Partners may sell such shares during the pricing period. Such
      sales may cause the Company’s stock price to decline and if so would result in a
      lower VWAP during the pricing period, which would result in the Company having
      to issue a larger number of shares of common stock to Cornell Capital Partners
      in respect of the advance.





*The
      Company may not be able to obtain a cash advance under the SEDA if Cornell
      Capital Partners holds more than 9.9% of the Company’s common
      stock.* ******





In
      the
      event Cornell Capital Partners holds more than 9.9% of our then-outstanding
      common stock, the Company will be unable to obtain a cash advance under the
      SEDA. A possibility exists that Cornell Capital Partners may own more than
      9.9%
      of the Company’s outstanding common stock at a time when it would otherwise plan
      to request an advance under the SEDA. In that event, if the Company is unable
      to
      obtain additional external funding, it could fail to achieve the corporate
      objectives that it had hoped to use the cash to achieve.




ITEM
      1B.
 UNRESOLVED STAFF COMMENTS.




Not
      Applicable.




ITEM
      2.
 DESCRIPTION OF PROPERTY.




The
      Company’s headquarters are located at No. 1 Henglong Road, Yu Qiao Development
      Zone Shashi District, Jing Zhou City Hubei Province, PRC. Set forth below are
      the manufacturing facilities operated by each joint venture. The Company has
      long-term rights, forty to fifty years, to use the land and owns all of the
      land
      improvements.




Name
                of Entity
            
            Product
            
            Total
                Area (M2)
            
            Building
                Area (M2)
            
            Original
                Cost of Equipment
            
            SiteHenglong
            
            
            Automotive
                Parts
            
            
            395,741
            
            
            20,226
            
            $
            17,383,308
            
            
            Jingzhou
                City, Hubei Province13,393
            
            
            13,707
            
            
            -
            
            
            Wuhan
                City, Hubei ProvinceJiulong
            
            
            Power
                Steering Gears
            
            
            39,478
            
            
            23,728
            
            
            9,851,256
            
            
            Jingzhou
                City, Hubei ProvinceShenyang
            
            
            Automotive
                Steering Gears
            
            
            35,354
            
            
            16,369
            
            
            1,958,812
            
            
            Shenyang
                City, Liaoning ProvinceZhejiang
            
            
            Steering
                Pumps
            
            
            27,756
            
            
            7,262
            
            
            3,369,420
            
            
            Zhuji
                City, Zhejiang ProvinceUSAI
            
            
            Sensor
                Modular
            
            
            —
            
            
            —
            
            
            368,205
            
            
            Wuhan
                City, Hubei ProvinceWuhu
            
            
            Automotive
                Steering Gears
            
            
            83,705
            
            
            15,197
            
            
            8,472
            
            
            Wuhu
                City, Anhue ProvinceJielong
            
            
            ElectricPowerSteering
            
            
            —
            
            
            —
            
            
            33,000
            
            
            Wuhan
                City, Hubei ProvinceTotal
            
            
            
            
            
            595,427
            
            
            96,489
            
            $
            32,972,473




19




The
      Company is not involved in investments in (i) real estate or interests in real
      estate, (ii) real estate mortgages, and (iii) securities of or interests in
      persons primarily engaged in real estate activities, as all of its land rights
      are used for production purposes.




ITEM
      3.
 LEGAL PROCEEDINGS.




The
      Company is not a party to any pending or to the best of the Company’s knowledge,
      any threatened legal proceedings. No director, officer or affiliate of the
      Company, or owner of record of more than five percent (5%) of the securities
      of
      the Company, or any associate of any such director, officer or security holder
      is a party adverse to the Company or has a material interest adverse to the
      Company in reference to pending litigation.




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




During
      the fiscal year 2006, we held a shareholder meeting, elected directors and
      approved the engagement of Schwartz Levitsky Feldman LLP as independent
      auditor.




**PART
      II**




ITEM
      5.
 MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES
      OF EQUITY SECURITIES.




(a)
      MARKET PRICES OF COMMON STOCK




The
      Company’s common stock has been traded on the NASDAQ Small Cap market under the
      symbol “CAAS”. The high and low bid intra-day prices of the common stock in 2006
      and 2005 were reported on NASDAQ for the time periods indicated on the table
      below. Accordingly, the table below contains the high and low bid closing
      prices of the common stock as reported on the NASDAQ for the time periods
      indicated.




Price
                Range2006
            
            2005High
            
            Low
            
            High
            
            LowFirst
                Quarter
            
            $
            14.04
            
            $
            6.57
            
            $
            12.46
            
            $
            8.53Second
                Quarter
            
            
            11.19
            
            
            6.41
            
            
            9.8
            
            
            6.14Third
                Quarter
            
            
            8.14
            
            
            6.52
            
            
            7.85
            
            
            4.1Fourth
                Quarter
            
            $
            12.49
            
            $
            6.68
            
            $
            10.00
            
            $
            4.27





The
      above
      quotations reflect inter-dealer prices, without retail mark-up, markdown or
      commission, and may not represent actual transactions.




20




(b)
      STOCKHOLDERS




The
      Company’s common shares are issued in registered form. Securities Transfer
      Corporation in Frisco, Texas is the registrar and transfer agent for the
      Company’s common stock. As of February 27, 2007, there were 23,959,702 shares of
      the Company’s common stock outstanding and the Company had approximately 76
      stockholders of record.




(c)
      DIVIDENDS




The
      Company has never declared or paid any cash dividends on its common stock and
      it
      does not anticipate paying any cash dividends in the foreseeable future. The
      Company currently intends to retain future earnings, if any, to finance
      operations and the expansion of its business. Any future determination to pay
      cash dividends will be at the discretion of the Board of Directors and will
      be
      based upon the Company’s financial condition, operating results, capital
      requirements, plans for expansion, restrictions imposed by any financing
      arrangements and any other factors that the Board of Directors deems
      relevant.




(d)
      SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS




The
      securities authorized for issuance under equity compensation plans at December
      31, 2006 are as follows:




Plan
                category
            
            Number
                of securities to be issued upon exercise of outstanding
                options
            
            Weighted
                average exercise price of outstanding options
            
            Number
                of securities remaining available for future issuanceEquity
                compensation plans approved by security holders
            
            
            2,200,000
            
            $
            6.42
            
            
            2,132,500




The
      stock
      options plan was approved in the 2004 Annual Meeting of Stockholders, and the
      maximum common shares for issuance under this plan are 2,200,000 with a period
      of 10 years.




21




ITEM
      6.
 SELECTED FINANCIAL DATA.




The
      following selected financial data reflects the results of operations and balance
      sheet data for the years ended 2002 to 2006. The data below should be read
      in
      conjunction with, and is qualified by reference to, “Management’s Discussion and
      Analysis of Financial Condition and Results of Operations” and the consolidated
      financial statements and notes thereto included elsewhere in this report. The
      financial information presented may not be indicative of our future
      performance.





**Years
                Ended December 31,**2006
            
            2005
            
            2004
            
            2003
            
            2002(1)**Statement
                of Operations Data:**Net
                sales
            
            $
            95,766,439
            
            $
            63,572,301
            
            $
            58,185,845
            
            $
            53,624,868
            
            $
            —Net
                income
            
            
            4,811,704
            
            
            3,315,478
            
            
            6,867,337
            
            
            3,871,269
            
            
            4,159,000Basic &
                Diluted earnings per share
            
            
            0.21
            
            
            0.15
            
            
            0.30
            
            
            0.18
            
            
            0.20**Balance
                Sheet Data:**Total
                assets
            
            
            152,108,538
            
            
            119,529,723
            
            
            105,486,645
            
            
            95,846,750
            
            
            19,427,000Total
                liabilities
            
            
            75,615,581
            
            
            60,851,575
            
            
            55,776,357
            
            
            51,145,176
            
            
            13,330,000Minority
                interests
            
            
            23,112,667
            
            
            21,751,043
            
            
            17,571,838
            
            
            18,686,712
            
            
            —Shareholders
                equity
            
            $
            53,380,290
            
            $
            36,927,105
            
            $
            32,138,450
            
            $
            26,014,862
            
            $
            6,097,000




(1).
      The
      minority joint venture partners have the right to participate in management
      before January 1, 2003. Pursuant to EITF 96-16, the Company accounted for its
      interest in these joint ventures under the equity method for the years ended
      December 31, 2002 and 2001. During early 2003, the directors of the Company
      and
      the other joint ventures in the Company’s Sino-foreign joint ventures executed
“Act in Concert” agreements, accordingly, the Company has accounted for the
      above joint ventures on a consolidated basis since January 1, 2003 because
      the
      Company has exercised sufficient control over their management and
      operations.




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




The
      following is management’s discussion and analysis of certain significant factors
      which have affected the Company’s financial position and operating results
      during the periods included in the accompanying consolidated financial
      statements, as well as information relating to the plans of its current
      management. This report includes forward-looking statements. These statements
      relate to future events or the Company’s future financial performance. The
      Company has attempted to identify forward-looking statements by terminology
      including “anticipates,” “believes,” “expects,” “can,” “continue,” “could,”
“estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predict,”
“should” or “will” or the negative of these terms or other comparable
      terminology. Such statements are subject to certain risks and uncertainties,
      including the matters set forth in this report or other reports or documents
      the
      Company files with the Securities and Exchange Commission from time to time,
      which could cause actual results or outcomes to differ materially from those
      projected. Although the Company believes that the expectations reflected in
      the
      forward-looking statements are reasonable, the Company cannot guarantee future
      results, levels of activity, performance or achievements. Undue reliance should
      not be placed on these forward-looking statements which speak only as of the
      date hereof. The Company undertakes no obligation to update these
      forward-looking statements. The Company’s expectations are as of the date this
      Form 10-K is filed, and the Company does not intend to update any of the
      forward-looking statements after the date this Annual Report on Form 10-K is
      filed to confirm these statements to actual results, unless required by
      law.




22




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




GENERAL
      OVERVIEW:




China
      Automotive Systems, Inc., including, when the context so requires, its
      subsidiaries and the subsidiaries’ interests in the Sino-foreign joint ventures
      described below, is referred to herein as the “Company”. The Company, through
      its Sino-foreign joint ventures, engaged in the manufacture and sales of
      automotive systems and components in the People’s Republic of China, the “PRC”
or “China”, as described below.




The
      Company owns the following aggregate net interests in seven Sino-foreign joint
      ventures organized in the PRC as of December 31, 2006 .





Percentage
                InterestName
                of Entity
            
            2006
            
            2005
            
            2004Jingzhou
                Henglong Automotive Parts Co., Ltd."Henglong"
            
            
            44.5
            %
            
            44.5
            %
            
            44.5
            %Shashi
                Jiulong Power Steering Gears Co., Ltd."Jiulong"
            
            
            81.0
            %
            
            81.0
            %
            
            81.0
            %Shenyang
                Jinbei Henglong Automotive Steering System Co., Ltd."Shenyang"
            
            
            70.0
            %
            
            70.0
            %
            
            70.0
            %Zhejiang
                Henglong & Vie Pump-Manu Co., Ltd."Zhejiang"
            
            
            51.0
            %
            
            51.0
            %
            
            51.0
            %Universal
                Sensor Application Inc.“USAI”
            
            
            60.0
            %
            
            60.0
            %
            
            —Wuhan
                Jielong Electric Power Steering Co., Ltd. (“Jielong”)
            
            
            85.0
            %
            
            —
            
            
            —Wuhu
                HengLong Auto Steering System Co., Ltd. (“Wuhu”)
            
            
            77.33
            %
            
            —
            
            
            —




Jiulong
      and Henglong were formed in 1993 and 1997 respectively, and they are mainly
      engaged in the production of rack and pinion power steering gear and integral
      power steering gear for cars and light and heavy-duty vehicles. Shenyang and
      Zhejiang were established in 2002 for the production of power steering parts
      and
      power steering pumps, respectively. USAI was established in 2005 and mainly
      engaged in the production and sales of sensor modular. Jielong and Wuhu were
      established in 2006, and they are mainly engaged in the production of rack
      and
      pinion power steering gear for cars and light vehicles and electric power
      steering, “EPS”. During 2006, USAI has entered into small batch production,
      Jielong and Wuhu were in the early technology and production preparation stage,
      and expected to start its small batch production in 2007.




Jingzhou
      Henglong Fulida Textile Co., Ltd. (“Jingzhou”) was formed in February 2003 to
      produce environmental textiles and raw materials, and was owned 51% by the
      Company. Effective August 31, 2004, in order to concentrate on its main
      products, namely steering and automotive parts, the Company disposed of its
      51%
      interest in Jingzhou by entering into an equity exchange agreement with Hubei
      Wanlong Investment Co., Ltd., for its 2.5% equity interest in
      Henglong.




The
      divested non-core business of Jingzhou has been treated as a discontinued
      operation under SFAS No. 144. Jingzhou’s results of operation and related
      charges have been reclassified as discontinued operations in the Company’s
      consolidated statements of operations in 2004.




23




RESULTS
      OF OPERATIONS




The
      following table sets forth for the periods indicated certain items from the
      Company's Consolidated Statements of Income expressed as a percentage of net
      sales and the percentage change in the dollar amount of each such item from
      that
      in the indicated previous year.




Percentage
                on net sales
            
            Change
                in percentageDecember
                31,2006
            
            2005
            
            2004
            
            2005
                to 2006
            
            2004
                to 2005**Income
                from continued operations:**Net
                sales
            
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %
            
            50.6
            %
            
            9.3
            %Cost
                of sales
            
            
            65.6
            
            
            64.7
            
            
            60.2
            
            
            52.9
            
            
            17.3Gross
                profit
            
            
            34.4
            
            
            35.3
            
            
            39.8
            
            
            46.5
            
            
            (2.9
            )Gain
                on other sales(a)
            
            
            0.3
            
            
            0.6
            
            
            1.4
            
            
            (22.4
            )
            
            (54.7
            )Less:
                operating expensesSelling
                expenses (a)
            
            
            8.1
            
            
            9.1
            
            
            6.6
            
            
            33.9
            
            
            50.2General
                and administrative expenses (a)
            
            
            8.2
            
            
            8.0
            
            
            10.6
            
            
            53.3
            
            
            (17.1
            )R
                & D expenses
            
            
            1.1
            
            
            1.5
            
            
            2.6
            
            
            10.3
            
            
            (36.3
            )Depreciation
                and amortization
            
            
            3.9
            
            
            4.1
            
            
            1.5
            
            
            46.5
            
            
            204.0Total
                operating expenses
            
            
            21.3
            
            
            22.7
            
            
            21.3
            
            
            41.4
            
            
            16.7Operating
                income
            
            
            13.3
            
            
            13.2
            
            
            19.9
            
            
            52.3
            
            
            (27.5
            )Other
                income (a)
            
            
            0.1
            
            
            0.2
            
            
            1.5
            
            
            (37.5
            )
            
            (82.4
            )Financial
                expenses
            
            
            (0.9
            )
            
            (1.8
            )
            
            (1.3
            )
            
            (28.6
            )
            
            59.5Income
                before income tax from continued operations
            
            
            12.6
            
            
            11.6
            
            
            20.1
            
            
            63.2
            
            
            (37.0
            )Income
                tax
            
            
            1.7
            
            
            2.2
            
            
            1.1
            
            
            21.7
            
            
            121.8Income
                before minority interests from continued operations
            
            
            10.8
            
            
            9.4
            
            
            19.0
            
            
            72.7
            
            
            (45.8
            )Minority
                interests
            
            
            5.8
            
            
            4.2
            
            
            7.2
            
            
            106.9
            
            
            (35.9
            )Net
                income from continued operations
            
            
            5.0
            
            
            5.2
            
            
            —
            
            
            45.1
            
            
            (51.9
            )**Net
                loss from discontinued operations**Net
                loss from discontinued operations
            
            
            —
            
            
            —
            
            
            (0.04
            )
            
            —
            
            
            (100.0
            )Net
                income
            
            
            5.0
            %
            
            5.2
            %
            
            11.8
            %
            
            45.1
            %
            
            (51.7
            %)




(a)
      For
      the convenience of comparability, the Company has reclassified warranty expenses
      from general and administrative expenses into selling expenses, also
      reclassified non-cash compensation into general and administrative expenses,
      and
      part of non-operating income which was attributable to operating income into
      Gain on other sales, to be consistent with the presentation of its financial
      statement for the year 2006.




24




RESULTS
      OF OPERATIONS: 2006 VERSUS 2005




NET
      SALES




The
      increase in net product
      sales of the Company is summarized as follows:




Increase2006
            
            2005
            
            (Decrease)Item
            
            Amount
                ($)
            
            Amount
                ($)
            
            Amount
                ($)
            
            Percentage %Steering
                gear for commercial vehicles
            
            $
            25,135,726
            
            $
            17,534,929
            
            $
            7,600,797
            
            
            43.3
            %Steering
                gear for passenger vehicles
            
            
            60,248,178
            
            
            40,044,635
            
            
            20,203,543
            
            
            50.5Steering
                pumps
            
            
            10,221,478
            
            
            5,992,737
            
            
            4,228,741
            
            
            70.6Sensor
                modular
            
            
            161,057
            
            
            -
            
            
            161,057
            
            
            -Total
            
            $
            95,766,439
            
            $
            63,572,301
            
            $
            32,194,138
            
            
            50.6
            %




For
      the
      year ended December 31, 2006, net product sales were $95,766,439, as compared
      to
      $63,572,301 for the year ended December 31, 2005, an increase of $32,194,138
      or
      50.6%. The increase in net sales in 2006 as compared to 2005 was a result of
      several factors.




(1)
      Increases in the income of Chinese residents and the growth of consumption
      led
      to an increase in the sales of passenger vehicles and the increase in the
      Company’s sales of steering gear and pumps was due to these factors. As a
      result, sales of steering gear and pumps for domestic passenger vehicles for
      the
      year ended December 31, 2006 increased 50.5% and 70.6% over the same periods
      of
      2005, respectively.





(2)
      Increased investments in China led to an increase in sales of commercial
      vehicles. For the year ended December 31, 2006, sales of steering gears and
      accessories for commercial vehicles increased by 43.3% as compared to the same
      period of 2005, mainly due to the Company having expanded its market share
      by
      adopting technical innovation.





(3)
      Through technological improvement to the Company’s production lines, the
      technological contents in, and production efficiency, of the Company’s products
      were raised, thus satisfying market needs.




Based
      on the above reasons, the Company’s increase of net sales was 50.6% in 2006,
      which exceeded the anticipated increase of 15%-20%. In 2007, the Company
      intends to strive to increase net sales by 15%-20% by expanding its sales market
      both domestically and internationally. In the domestic market, the Company
      will strive to reach the sales targets for new model 323 sedan of Hainan Mazda
      Co., Ltd., LIONCEL sedan of Southeast Motor Co., Ltd. and ZX sedan of Dongfeng
      Peugeot Citroen Automobile Company Ltd. As for the international market, the
      Company will strive to reach the sales targets for the City Mini system and
      the
      commercial system of TATA motors, one of the biggest automakers in
      India.




GAIN
      ON
      OTHER SALES




Gain
      on
      other sales consisted of net amount retained from sales of materials and other
      assets. For the year ended December 31, 2006, gain on other sales were $279,216,
      as compared to $359,986 for the year ended December 31, 2005, a decrease of
      $80,770 or 22.4%. Sales of materials for the year ended December 31, 2006 were
      $295,826, which decreased by $23,579
      or 7.4% , as
      compared with $319,405 for the same period of 2005, due to decreased sales
      volume of materials. Loss from sales of other assets for the year ended December
      31, 2006 was $16,610, which decreased by $57,191,
      as compared with profit from sales of other assets of $40,581 for the same
      period of 2005.




25




GROSS
      PROFIT FROM PRODUCT SALES




For
      the
      year ended December 31, 2006, the gross profit was $32,909,814, as compared
      to
      $22,466,823 for the year ended December 31, 2005, an increase of $10,422,991
      or
      46.5%, as a result of following factors:




1.
       Increased product sales: In the domestic passenger vehicles and commercial
      vehicles markets, the output and sales in 2006 greatly increased as compared
      to
      2005 as a result of rapid and steady growth in consumption demand and government
      investment. Accordingly, the Company’s sales of steering parts of 2006 increased
      by 50.6% as compared with the corresponding period in 2005. Increased product
      sales contributed $11,454,944 or 51.0% to the increase on gross profit.




2.
       Lower price. The year 2006 was still a “low price” year for the Chinese
      auto industry with an average price reduction of 5.6% during that period, and
      low prices have become the norm for many automobile manufacturers. To expand
      its
      market share, the Company also reduced the prices of its principal products
      by
      9.5% on average in 2006. Lower prices led a decreased gross profit of $6,013,393
      or 26.8% in 2006.




3.
       Costs of goods sold: The advanced production equipment, which the Company
      acquired recently, has achieved the expected positive effects. In 2006,
      manufacturing efficiency was improved, and cost control over the production
      process was enhanced, resulting in a cost reduction of the Company’s products by
      8.8% on average. The effect of cost reductions was to increase the Company’s
      gross profit by $5,001,440 or 22.3% for the year ended December 31,
      2006.




In
      2006,
      the overall gross margin decreased to 34.4% from 35.3% in 2005 because the
      decline in selling price was higher than the cost reductions.




It
      is
      estimated that the sales of passenger vehicles and commercial vehicles will
      increase in quantity at the rate of 15% in 2007 as a result of rapid and steady
      growth in consumption demand and government investment. The Company will want
      to
      seize the opportunity to stabilize the commercial vehicle market and expand
      the
      passenger vehicles market, and to increase its gross margin steadily by
      increasing output and sales.




In
      2007,
      the Chinese automobile manufacturers will continue to use price reductions
      to
      keep and enhance their market share. China National Information Center made
      a
      projection for the Chinese automobile market in 2007 that automobile prices
      will
      decline approximate 5%-7% as compared to 2006, and the Company, as an auto
      parts
      supplier, would be adversely affected with a reduction in its gross margins.
      The
      Company estimates that auto parts prices will be cut back following similar
      reductions in automobile prices. The Company intends to take the following
      measures to reduce costs in order to meet its target of 30% gross
      profit.




1.
       Reduce manufacturing costs by optimizing product design and production
      techniques. During 2007, the Company’s technical personnel will improve product
      design and production techniques to reduce wastage in the production process
      and
      improve manufacturing efficiency, thus reducing costs. The Company estimates
      the
      manufacturing costs will be reduced by 1.5% as compared to 2006 as a result
      of
      the optimized product design and production techniques.




2.
       Reduce the cost of raw materials. In 2007, the Company plans to continue
      controlling the costs of raw materials by two means: Firstly, volume purchase
      of
      major raw materials will be made through a bidding process, and for purchases
      of
      other smaller quantities of non major materials, “target prices” will be set to
      guide such purchases. Secondly, to set “target profit” to further control
      purchase cost of raw materials. The Company estimated that material cost will
      be
      reduced by 1.6% as a result of these measures.




26




SELLING
      EXPENSES




For
      the
      years ended December 31, 2006 and 2005, selling expenses are summarized as
      follows:




Increase2006
            
            2005(a)
            
            (Decrease)
            
            PercentageItem
            
            Amount
                ($)
            
            Amount
                ($)
            
            Amount
                ($)
            
            %Salaries
                and wages
            
            $
            1,489,699
            
            $
            182,165
            
            $
            1,307,534
            
            
            717.8
            %Supplies
                expense
            
            
            34,062
            
            
            11,570
            
            
            22,492
            
            
            194.4Travel
                expense
            
            
            302,052
            
            
            347,072
            
            
            (45,020
            )
            
            (13.0
            )Transportation
                expense
            
            
            1,495,765
            
            
            856,087
            
            
            639,678
            
            
            74.7After
                sales service expense
            
            
            3,770,432
            
            
            3,960,468
            
            
            (190,036
            )
            
            (4.8
            )Rent
                expense
            
            
            230,240
            
            
            214,532
            
            
            15,708
            
            
            7.3Office
                expense
            
            
            103,172
            
            
            76,232
            
            
            26,940
            
            
            35.3Advertising
                expense
            
            
            30,297
            
            
            15,484
            
            
            14,813
            
            
            95.7Entertainment
                expense
            
            
            230,939
            
            
            86,718
            
            
            144,221
            
            
            166.3Insurance
                expense
            
            
            5,618
            
            
            18,062
            
            
            (12,444
            )
            
            (68.9
            )Other
                expense
            
            
            79,792
            
            
            36,288
            
            
            43,504
            
            
            119.9Total
            
            $
            7,772,068
            
            $
            5,804,678
            
            $
            1,967,390
            
            
            33.9
            %




(a)
      For
      the convenience of comparability, the warranty reserve of $1,219,108, which
      was
      classified under general and administrative expenses in 2005, has been merged
      into after sales service expense under selling expenses, to be consistent with
      the presentation of the Company’s financial statement for the year
      2006.




Selling
      expenses were $7,772,068 for the year ended December 31, 2006, as compared
      to $
      5,804,678 for 2005, an increase of $1,967,390 or 33.9%. Significant expense
      items that increased by more than $100,000 in 2006 as compared to 2005 were
      salaries and wages, transportation expense, and entertainment expenses.




The
      increase in salaries and wages expense was due to bonuses paid to sales staff
      for exceeding the sales target of 2006, while in 2005 there was no bonus paid
      because they failed to achieve the sales target for that year.




The
      increase in transportation expense was due to increased sales and a rise in
      the
      price of oil, which led to increases in domestic transportation
      prices.




The
      increase in entertainment expenses was due to increased customer
      visits.




After
      sales service expense for the year ended December 31, 2006 decreased by $190,036
      or 4.8% as compared with the same period of last year, mainly due to the Company
      strengthening quality control in the production process and resulting in the
      enhancement of product quality.




27




GENERAL
      AND ADMINISTRATIVE EXPENSES




For
      the
      years ended December 31, 2006 and 2005, general and administrative expenses
      are
      summarized as follows:




2006
            
            2005(a)
            
            Increase
                (Decrease)
            
            PercentageItem
            
            Amount
                ($)
            
            Amount
                ($)
            
            Amount
                ($)
            
            %Salaries
                and wages
            
            $
            2,788,494
            
            $
            1,777,985
            
            $
            1,010,509
            
            
            56.8
            %Travel
                expenses
            
            
            316,565
            
            
            413,630
            
            
            (97,065
            )
            
            (23.5
            )Office
                expenses
            
            
            379,345
            
            
            188,483
            
            
            190,862
            
            
            101.3Supplies
                expenses
            
            
            232,853
            
            
            351,103
            
            
            (118,250
            )
            
            (33.7
            )Repairs
                expenses
            
            
            226,779
            
            
            100,450
            
            
            126,329
            
            
            125.8Entertainment
                expenses
            
            
            142,496
            
            
            84,661
            
            
            57,835
            
            
            68.3Labor
                insurance expenses
            
            
            761,971
            
            
            593,940
            
            
            168,031
            
            
            28.3Labor
                union dues expenses
            
            
            33,360
            
            
            55,045
            
            
            (21,685
            )
            
            (39.4
            )Board
                of directors expense
            
            
            100,476
            
            
            39,475
            
            
            61,001
            
            
            154.5Taxes
            
            
            453,337
            
            
            170,094
            
            
            283,243
            
            
            166.5Provision
                for bad debts
            
            
            995,440
            
            
            90,214
            
            
            905,226
            
            
            1,003.4Impairment
                of inventories
            
            
            (1,520
            )
            
            248,907
            
            
            (250,427
            )
            
            (100.6
            )Training
                expenses
            
            
            43,498
            
            
            60,897
            
            
            (17,399
            )
            
            (28.6
            )Listing
                expenses
            
            
            875,103
            
            
            590,010
            
            
            285,093
            
            
            48.3Others
                expenses
            
            
            461,990
            
            
            329,494
            
            
            132,496
            
            
            40.2Total
            
            $
            7,810,187
            
            $
            5,094,388
            
            $
            2,715,799
            
            
            53.3
            %




(a)
      For
      the convenience of comparability, warranty reserve of $1,219,108, which was
      classified under general and administrative expenses in 2005, has been
      reclassified into after sales service expense under selling expenses, and
      non-cash compensation of $68,850 has been merged into salaries under general
      and
      administrative expenses, to be consistent with the presentation of the Company’s
      financial statement for the year 2006.




General
      and administrative expenses were $7,810,187 for the year ended December 31,
      2006, as compared to $5,094,388 for the year ended December 31, 2005, an
      increase of $2,715,799 or 53.3%.




The
      expense items that increased more than $100,000 in 2006 as compared to 2005
      were
      salaries and wages, office expenses, repair expenses, labor insurance expenses,
      taxes, provision for bad debts and listing expenses. Significant expense items
      that decreased more than $100,000 in 2006 were supplies expenses and impairment
      of inventories. Listing expenses consisted of the costs associated with legal,
      accounting and auditing fees for operating a public company.




The
      increase in salaries and wages expense was due to bonuses paid to management
      for
      their exceeding the business target of 2006, while in 2005 there was no bonus
      paid because they failed to achieve the business target for that
      year.




The
      increase in office expenses was attributable to additional management
      organization and staff due to expanded business, and corresponding increases
      in
      office expenses such as utility, meeting costs, entertainment and transportation
      costs. The two joint-ventures which were established in 2006 also increased
      office expenses.




The
      increase in repairs expense was due to a more significant repair on property,
      plant and equipment in 2006.




The
      increase in labor insurance expenses was attributable to additional employees
      due to expanded business.




The
      increase in tax expenses was due to payment of more real estate tax due to
      acquisition of additional real estate property.




The
      increase in the provision for bad debts was due to increased accounts receivable
      arising from increased sales. Management believes that additional provision
      for
      bad debts should be made to avoid credit loss.




28




The
      increase in listing expenses was due to increased costs associated with legal,
      accounting and auditing fees for operating a public company, as a result of
      expanded business.




The
      decrease in supplies expenses was attributed to our control on consumption
      of
      supplies. Slightly damaged supplies are now repaired instead of
      replaced.




The
      decrease in impairment of inventories was attributable to further control on
      supplies, which accelerated turnover; reduced idled supplies, and led to a
      decrease in provision for loss in value in inventories.




RESEARCH
      AND DEVELOPMENT EXPENSES




Research
      and development expenses were $1,066,050 for the year ended December 31, 2006,
      as compared to $966,782 for the year ended December 31, 2005, an increase of
      $99,268 or 10.3%, as a result of the Company’s enhanced research and development
      activities on steering columns.




DEPRECIATION
      AND AMORTIZATION EXPENSE




For
      the
      year ended December 31, 2006, depreciation and amortization expenses excluded
      from that recorded under cost of sales were $3,776,003, as compared to
      $2,577,944 for the year ended December 31, 2005, an increase of $1,198,059
      or
      46.5%, as a result of the Company’s increasing ownership of property, plant and
      equipment and intangible assets, which resulted in additional depreciation
      and
      amortization expenses of $679,489 and $518,570 respectively.




INCOME
      FROM OPERATIONS




Income
      from operations was $12,764,722 for the year ended December 31, 2006, as
      compared to $8,383,017 for the year ended December 31, 2005, an increase of
      $4,381,705 or 52.3%, mainly consisting of a decrease of $80,770 or 22.4% from
      net sales from materials and others; an increase of $10,442,991 or 46.5% from
      gross profit from increased product sales, and a decrease of operating profit
      of
      $5,980,516 or 41.4% as a result of increased costs and expenses.




OTHER
      INCOME




Other
      income was $94,257 for the year ended December 31, 2006, as compared to $150,809
      for the year ended December 31, 2005, a decrease of $56,552 or 37.5%, primarily
      as a result of decreased government subsidies.




Interest
      subsidies mean the refunds by the Chinese Government of interest charged by
      banks to companies which are entitled to such subsidies. This kind of subsidies
      applies only to loan interest related to production facilities expansion. During
      2003 and 2004, the Company had used this special loan to improve technologically
      its production line in order to enlarge capability and enhance quality. The
      expansion project was completed and new facilities were put into use at the
      end
      of 2004 and 2005 respectively.




During
      2005 and 2006, the experts sent by the Chinese Government reviewed and assessed
      the actual usage of technologically improved production facilities on site
      in
      order to confirm whether the improvement has achieved its expected goal of
      production expansion and quality enhancement. Whether or not a company can
      receive interest subsidies from the Chinese Government depends on the company’s
      achieving the two goals set forth above after the technological
      improvement.




FINANCIAL
      EXPENSES




Financial
      expenses were $832,844 for the year ended December 31, 2006, as compared to
      $1,166,167 for the year ended December 31, 2005, a decrease of $333,323 or
      28.6%, primarily as a result of a decrease on note discounting expenses. During
      2006, the Company generated cash from stock issuance, which led to a reduction
      in cash generated from note discounting.




29




INCOME
      BEFORE INCOME TAXES




Income
      before income taxes was $12,026,135 for the year ended December 31, 2006, as
      compared to $7,367,659 for the year ended December 31, 2005, an increase of
      $4,658,476 or 63.2%, consisting of increased income from operations of
      $4,381,705 or 52.3%, decreased other income of $56,552 or 37.5%, and decreased
      finance expenses of $333,323 or 28.6%.




INCOME
      TAXES




Income
      tax expense was $1,669,081 for the year ended December 31, 2006, as compared
      to
      $1,371,863 for the year ended December 31, 2005, an increase of $297,218 or
      21.7%, mainly because of:




1.
      Increased income before income taxed resulted in increased income tax of
      $798,858




2.
      One of
      the Company’s Sino-foreign joint ventures, Zhejiang, has finished its tax
      holiday by December 31, 2005. In 2006, Zhejiang has an income tax payable of
      $426,468.




3.
      The
      Company has received an income tax refund of $928,108 during 2006. In 2005,
      because the income tax paid by the Company was less than that in 2004, the
      Company did not qualify to receive any income tax refund for domestic equipment
      purchased. In accordance with the relevant regulations of income taxes
      stipulated by the Ministry of Finance and Administration of Taxation, 40% of
      domestic equipment purchases can be refundable from increased income taxes
      for
      the purchasing year over those of the previous year.




INCOME
      BEFORE MINORITY INTEREST




Income
      before minority interest was $10,357,054 for the year ended December 31, 2006,
      as compared to $5,995,796 for the year ended December 31, 2005, an increase
      of
      $4,361,258 or 72.7%, in income before income taxes of $4,658,476 or 63.2%,
      and a
      decrease of $297,218 or 21.7% due to increased income tax expenses.




MINORITY
      INTEREST




The
      Company recorded minority interests’ share in the earnings of the Sino-foreign
      joint ventures aggregating $5,545,350 for the year ended December 31, 2006,
      and
      compared to $2,680,318 for the year ended December 31, 2005, an increase of
      $2,865,032 or 106.9%.




The
      Company owns different equity interests in seven Sino-foreign joint ventures,
      through which it conducts its operations. All the operating results of these
      seven Sino-foreign joint ventures were consolidated in the Company’s financial
      statements of December 31, 2006 and 2005. The Company records the minority
      interests' share in the earnings of the respective Sino-foreign joint ventures
      for each period.




In
      2006,
      minority interest increased greatly as compared to 2005, primarily as income
      from Henglong, one of the Company’s joint ventures, which was owned 55.5% by
      minority interest holders increased greatly.




NET
      INCOME




Net
      income was $4,811,704 for the year ended December 31, 2006, as compared to
      $3,315,478 for the year ended December 31, 2005, an increase of $1,496,226
      or
      45.1%, consisting of increased income before minority interest of $4,361,258
      or
      72.7%, and a increased minority interest of $2,865,032 or 106.9%, which
      decreased net income.




30






RESULTS
      OF OPERATIONS: 2005 VERSUS 2004




NET
      SALES
      FROM PRODUCT




The
      increase in net product sales of the Company is summarized as
      follows:




2005
            
            2004
            
            Increase
                (Decrease)Item
            
            Amount
                ($)
            
            Amount
                ($)
            
            Amount
                ($)
            
            %Steering
                gear for commercial vehicles
            
            $
            17,534,929
            
            $
            26,656,495
            
            
            ($9,121,566
            )
            
            (34.2
            %)Steering
                gear for passenger vehicles
            
            
            40,044,635
            
            
            27,269,558
            
            
            12,775,077
            
            
            46.9Steering
                pumps
            
            
            5,992,737
            
            
            4,259,792
            
            
            1,732,945
            
            
            40.6Total
            
            $
            63,572,301
            
            $
            58,185,845
            
            $
            5,386,456
            
            
            9.3
            %




For
      the
      year ended December 31, 2005, net sales were $63,572,301, as compared to
      $58,185,845 for the year ended December 31, 2004, an increase of $5,386,456
      or
      9.3%. The increase in net sales in 2005 as compared to 2004 was a result of
      several factors.




1.
       Primarily, the increase in sales was due to an increase in sales of
      passenger vehicles. In 2005, the unfavorable conditions of price decline and
      sales turndown for passenger vehicles which commenced in 2004 have been
      reversed. Therefore, the Company has adjusted its marketing strategies
      accordingly and concentrated on manufacturing and selling of steering gears
      for
      passenger vehicles and steering pumps, which led to sales from steering gears
      and pumps for the year ended December 31, 2005 increasing 46.9% and 40.6% over
      the same period of 2004, respectively.




2.
       During 2005, sales of steering gear and accessories for commercial
      vehicles decreased by 34.2% as compared to 2004, as a result of the adjustment
      of the real estate and coal markets by the Government, which resulted in a
      significant slowdown in growth in demand for commercial vehicles, accordingly
      the Company as a supplier of steering gears for commercial vehicles was also
      affected.




GAIN
      ON
      OTHER SALES




Gain
      on
      other sales consisted of the net amount retained of sales of materials and
      other
      assets. For the year ended December 31, 2005, gain on other sales was $359,986,
      as compared to $794,621 for the year ended December 31, 2004, a decrease of
      $434,635 or 54.7%. Sales of materials for the year ended December 31, 2005
      were
      $319,405, which decreased by $379,702
      or 54.3% , as
      compared with $699,107 for the same period of 2004, due to decreased sales
      volume of materials. Profit from sales on other assets for the year ended
      December 31, 2005 were $40,581, which decreased by $54,933
      or 57.5%, as compared with $95,514 for the same period of 2004.




GROSS
      PROFIT FROM PRODUCT




For
      the
      year ended December 31, 2005, the gross profit from product was $22,466,823,
      as
      compared to $23,143,493 for the year ended December 31, 2004, a decrease of
      $676,670 or 2.9%, as a result of following factors:




1.
       Decreased sales: In the domestic commercial vehicles market, the output
      and sales in 2005 have greatly decreased as compared to 2004 as a result of
      a
      number of factors, including increased prices of gasoline and raw materials,
      the
      Government’s influence on rectifying the over-sized and over-loaded commercial
      vehicle market, the adjustment of the real estate and coal markets by the
      Government, etc. During 2005, sales of steering gears for commercial vehicles
      decreased by 34.2% as compared to 2004, which led to a decrease of gross profit
      of $3,283,764.




31




In
      2005,
      the demand of the domestic passenger vehicles market has recovered to a steady
      and rapid growth trend after “the blowout period” in 2002 and 2003 and a
      significant drop in 2004. Therefore, the Company has adjusted its marketing
      strategies accordingly and concentrated on manufacturing and selling of steering
      gears for passenger vehicles and steering pumps, which led to sales for the
      year
      ended December 31, 2005 increasing 46.9% and 40.6% over the same period of
      2004
      respectively, and the gross profit increasing $5,155,144. The gross profit
      for
      the year ended December 31, 2005 increased $1,871,380 as compared to the same
      period of 2004, because increased sales of steering gear and steering pumps
      for
      passenger vehicles more than compensated for decreased sales of steering gear
      for commercial vehicles.




2.
       Lower prices. The year 2005 was still a “low price” year for the Chinese
      auto industry with an average price reduction of 10.2% during that period,
      and
      low prices have become the norm for many automobile manufacturers. To keep
      its
      market share, the Company also reduced the prices of its principal products:
      steering gear by 10.6%, steering pumps by 28.3%, and steering accessories by
      4.9% at the request of its customers. Lower prices lead a decrease of gross
      profit of $8,342,905 in 2005.




3.
       Costs of goods sold: The advanced production equipment, which the Company
      acquired in 2003 has achieved the expected positive effects. In 2005,
      manufacturing efficiency was improved, and cost control over the production
      process was enhanced, resulting in a cost reduction of the Company’s main
      products, steering gears were reduced by 5%; steering pumps were reduced by
      1%
      and steering accessories were reduced by 6%. The effect of these cost reductions
      was to increase the company’s gross profit by $5,794,856 for the year ended
      December 31, 2005.




In
      2005,
      the overall gross margin decreased to 35% from 40% in 2004 because the decline
      in selling price was higher than cost reduction.




SELLING
      EXPENSES




For
      the
      years ended December 31, 2005 and 2004, selling expenses are summarized as
      follows:




2005(a)
            
            2004(a)
            
            Increase
                (Decrease)
            
            PercentageItem
            
            Amount
                ($)
            
            Amount
                ($)
            
            Amount
                ($)
            
            %Salaries
                and wages
            
            $
            182,165
            
            $
            872,720
            
            
            ($690,555
            )
            
            (79.1
            %)Supplies
                expense
            
            
            11,570
            
            
            29,698
            
            
            (18,128
            )
            
            (61.0
            )Travel
                expense
            
            
            347,072
            
            
            300,082
            
            
            46,990
            
            
            15.7Transportation
                expense
            
            
            856,087
            
            
            793,474
            
            
            62,613
            
            
            7.9After
                sales service expense
            
            
            3,960,468
            
            
            1,591,078
            
            
            2,369,390
            
            
            148.9Rent
                expense
            
            
            214,532
            
            
            103,451
            
            
            111,081
            
            
            107.4Office
                expense
            
            
            76,232
            
            
            78,979
            
            
            (2,747
            )
            
            (3.5
            )Advertising
                expense
            
            
            15,484
            
            
            18,666
            
            
            (3,182
            )
            
            (17.0
            )Entertainment
                expense
            
            
            86,718
            
            
            37,617
            
            
            49,101
            
            
            130.5Insurance
                expense
            
            
            18,062
            
            
            18,813
            
            
            (751
            )
            
            (4.0
            )Other
                expense
            
            
            36,288
            
            
            20,576
            
            
            15,712
            
            
            76.4Total
            
            $
            5,804,678
            
            $
            3,865,154
            
            $
            1,939,524
            
            
            50.2
            %




32




(a)
      For
      the convenience of comparability, warranty reserve of $1,219,108 and $391,350,
      which were classified under general and administrative expenses in the years
      2005 and 2004, respectively, has been merged into after sales service expenses
      under selling expenses, to be consistent with the presentation of the Company’s
      financial statement for the year 2006.




Selling
      expenses were $5,804,678 for the year ended December 31, 2005, as compared
      to
      $3,865,154 for 2004, an increase of $1,939,524 or 50.2%. Significant expense
      items that increased by more than $50,000 in 2005 as compared to 2004 were
      transportation expense, after sales service expense and rent expense.




The
      increase in transportation expense was due to increased sales and the rise
      in
      the price of oil, which led to increases in domestic transportation prices.




After
      sales service expense includes “3-R Guarantees” service charge and estimated
      warranty reserve. After sales service expense for the year ended December 31,
      2005 was increased $2,369,390 or 148.9% as compared with the same period of
      last
      year, consisting of an increased “3-R Guarantees” service charge of $1,541,632
      or 128.5%, and an increased warranty reserve of $827,758 or 211.5%.




The
      increase in “3-R Guarantees” service charge was due to the consumer rights
      protection policies of "recall" issued by the Chinese Government in 2004, which
      was fully implemented in 2005, including the recalling of flawed vehicles
      policy. Accordingly, the automobile manufacturers introduced a policy
      unilaterally requiring the automotive parts suppliers to pay a "3-R Guarantees
      "
      service charge (for repair, replacement and refund) in an amount equal to one
      percent (1%) of the total value of parts supplied.




Warranty
      reserves represent the Company’s obligation to repair or replace defective
      products under certain conditions. The estimate of the warranty reserves is
      based on historical experience. In 2005, the warranty rate was determined to
      be
      2.78% of net sales, while in 2004 it was determined to be 0.9% of net sales.
      The
      significant increase in warranty reserves was due to the increased rate of
      warranty reserves adjusted by the Company.




The
      Company increased its warranty rate mainly due to the following
      factors:




1.
      The
      Company extended the term of service from one year to three years in order
      to
      improve its product competitiveness in the market. Management estimated that
      it
      could result in an increase of warranty reserves.




2.
      In
      2005 the Chinese Government had fully implemented the consumer rights protection
      policies of "recall" which began in 2004 (including the recalling of flawed
      vehicles policy), which led to increased warranty reserves.




The
      increase in rent expense was due to the addition of new service branches to
      enhance service quality, which was increased nearly 50% as compared to the
      prior
      year. All the new offices in new service branches were rented, which led to
      increased rent expense.




Significant
      expense items that decreased more than $50,000 in 2005 as compared to 2004
      were
      salaries and wages. The decrease in salaries and wages was due to the failure
      of
      sales personnel to achieve the sales growth target of 20%. Therefore, the
      Company reduced their sales bonus.




33




GENERAL
      AND ADMINISTRATIVE EXPENSES




For
      the
      years ended December 31, 2005 and 2004, general and administrative expenses
      are
      summarized as follows:




2005(a)
            
            2004(a)
            
            Increase
                (Decrease)
            
            PercentageItem
            
            Amount
                ($)
            
            Amount
                ($)
            
            Amount
                ($)
            
            %Salaries
                and wages
            
            $
            1,777,985
            
            $
            1,952,067
            
            
            ($174,082
            )
            
            (8.9
            %)Travel
                expenses
            
            
            413,630
            
            
            377,452
            
            
            36,178
            
            
            9.6Office
                expenses
            
            
            188,483
            
            
            196,058
            
            
            (7,575
            )
            
            (3.9
            )Supplies
                expenses
            
            
            351,103
            
            
            329,323
            
            
            21,780
            
            
            6.6Repairs
                expenses
            
            
            100,450
            
            
            235,400
            
            
            (134,950
            )
            
            (57.3
            )Entertainment
                expenses
            
            
            84,661
            
            
            37,966
            
            
            46,695
            
            
            123.0Labor
                insurance expenses
            
            
            593,940
            
            
            1,105,911
            
            
            (511,971
            )
            
            (46.3
            )Labor
                union dues expenses
            
            
            55,045
            
            
            84,663
            
            
            (29,618
            )
            
            (35.0
            )Board
                of directors expense
            
            
            39,475
            
            
            56,330
            
            
            (16,855
            )
            
            (29.9
            )Taxes
            
            
            170,094
            
            
            196,619
            
            
            (26,525
            )
            
            (13.5
            )Provision
                for bad debts
            
            
            90,214
            
            
            136,205
            
            
            (45,991
            )
            
            (33.8
            )Impairment
                of inventories
            
            
            248,907
            
            
            187,871
            
            
            61,036
            
            
            32.5Training
                expenses
            
            
            60,897
            
            
            68,272
            
            
            (7,375
            )
            
            (10.8
            )Listing
                expenses
            
            
            590,010
            
            
            823,852
            
            
            (233,842
            )
            
            (28.4
            )Others
                expenses
            
            
            329,494
            
            
            354,645
            
            
            (25,151
            )
            
            (7.1
            )$
            5,094,388
            
            $
            6,142,634
            
            
            ($1,048,246
            )
            
            (17.1
            %)




(a)
      For
      the convenience of comparability, warranty reserve of $1,219,108 and $391,350,
      which were classified under general and administrative expenses in the years
      2005 and 2004, respectively, has been reclassified into after sales service
      expenses under selling expenses, and non-cash compensation of $68,850 and
      $55,125 has been merged into salaries under general and administrative expenses,
      to be consistent with the presentation of the Company’s financial statement for
      the year 2006.




General
      and administrative expenses were $5,094,388 for the year ended December 31,
      2005, as compared to $6,142,634 for the year ended December 31, 2004, a decrease
      of $1,048,246 or 17.1%.




Significant
      expense items that decreased more than $100,000 in 2005 were salaries and wages,
      repairs expense, labor insurance expense and listing expenses. Listing expenses
      consisted of the costs associated with legal, accounting and auditing fees
      for
      operating a public company.




The
      decrease in salaries and wages was due to the failure of management to achieve
      a
      net income growth target. Therefore, the Company reduced their management
      bonuses.




The
      decrease in repair expenses was a result of the Company’s comprehensive
      maintenance of all the operating sites and equipment in 2004, while in 2005
      the
      Company carried out normal maintenance for only part of its operating sites
      and
      equipment.




The
      decrease in labor insurance expenses was due to Henglong and Jiulong, two of
      the
      Company’s subsidiaries, changing their calculation base for endowment insurance
      expenses set by the local Government policy, which was 20% of the minimum salary
      ratified by the authority in 2005. In 2004, the endowment insurance expenses
      were recorded as 20% of the salary actually paid.




The
      decrease in listing expenses was due to the Company’s payment of $70,000 of
      reverse merger costs for the acquisition of a controlling interest in a public
      company in 2004, while there were no such expenses in 2005. In addition, the
      Company also reduced its consulting service expenses and general and
      administrative expenses for the year ended December 31, 2005.




34




Although
      the entertainment expenses did not increase by more than $100,000, they
      increased by 123% to $84,661 in 2005, due to there are more visitors visiting
      the Company as compared to last year, including Government officers, technology
      experts, and economists etc. .




RESEARCH
      AND DEVELOPMENT EXPENSES




Research
      and development expenses were $966,782 for the year ended December 31, 2005,
      as
      compared to $1,518,512 for the year ended December 31, 2004, a decrease of
      $551,730 or 36.0%, as a result of the Company’s R&D department focusing on
      applications of prior purchased technologies and hence reducing the R&D
      expenses for the year ended December 31, 2005.




DEPRECIATION
      AND AMORTIZATION EXPENSE




For
      the
      year ended December 31, 2005, the depreciation and amortization expenses
      excluded from that recorded in cost of sales were $2,577,944, as compared to
      $848,009 for the year ended December 31, 2004, an increase of $1,729,935 or
      204.0%. The main reasons are:




1.
       The new office building constructed in 2004 was completed and came into
      use in 2005, which led to an additional depreciation of approximately
      $310,000.




2.
       The equipment purchased in 2004 was delivered and came into use in 2005,
      which led to additional depreciation of approximately $1,320,000.




INCOME
      FROM OPERATIONS




Income
      from operations was $8,383,017 for the year ended December 31, 2005, as compared
      to $11,563,805 for the year ended December 31, 2004, a decrease of $3,180,788
      or
      27.5%, consisting of a decrease of net sales from material and others of
      $434,635 or 54.7%, a decrease of gross profit from product sales of $676,670
      or
      2.9%, and increased costs and expenses of $2,069,483 or 16.7%.




OTHER
      INCOME




Other
      income consisted of Government subsidy income and income arising from the write
      off of accounts payable




For
      the
      year ended December 31, 2005, other income was $150,809, as compared to $856,939
      for the same period of 2004, a decrease of $706,130 or 82.4%, mainly due to
      decreased income arising from the write off of accounts payable.




During
      2004, the Company recorded $680,980 income arising from the write off of amounts
      payable related to trial products obtained from various suppliers 2 or 3 years
      ago for the purpose of product development. It was determined by the Company’s
      management in 2004 that these amounts payable would no longer be payable and
      since these recoveries happened very infrequently and did not relate to the
      normal operations of the company in 2004, we recorded them in other income
      rather than income from operations. There was no such income during
      2005.




FINANCIAL
      EXPENSES




Financial
      expenses were $1,166,167 for the year ended December 31, 2005, as compared
      to
      $730,962 for the year ended December 31, 2004, an increase of $435,205 or 59.5%,
      primarily as a result of an increase of interest payments of $134,180 due to
      increased amount of loans and increased interest rates, and an increase of
      $301,025 due to increased note discount expenses.




35




INCOME
      BEFORE INCOME TAXES




Income
      before income taxes was $7,367,659 for the year ended December 31, 2005, as
      compared to $11,689,782 for the year ended December 31, 2004, a decrease of
      $4,322,123 or 37.0%, consisting of decreased income from operations of
      $3,180,788 or 27.5%, decreased other income of $706,130 or 82.4%, and increased
      finance expenses of $435,205 or 59.5%.




INCOME
      TAXES




Income
      tax expense was $1,371,863 for the year ended December 31, 2005, as compared
      to
      $618,400 for the year ended December 31, 2004, an increase of $753,463 or
      121.8%, mainly because of:




(1)
       The Chinese Government provides enterprise income tax preferences to joint
      ventures for purchasing domestic equipment, and the regulations are as follows:
      The allowable tax credit of an enterprise with foreign investment or foreign
      enterprise shall not exceed its newly increased enterprise income tax of the
      purchasing year over that of the year before. If the amount of newly increased
      enterprise income tax is not sufficient for tax credit, the remaining part
      of
      investment outside tax credit shall be refundable from the newly increased
      tax
      of the next year over that of the year before the purchasing year. However,
      the
      period for continuous tax credit shall not exceed five years.




Two
      of
      the Company’s Sino-foreign joint ventures, Henglong and Jiulong, received an
      income tax benefit of $901,600 in 2004 for purchase of domestic equipment,
      which
      has been reflected as a reduction to income tax expense in the Company’s
      consolidated statements of operations for the year ended December 31, 2004.
      In
      2005, as a result of the fact that income taxes in Henglong and Jiulong were
      less than 2004, they were not entitled to the tax refund benefit
      policy.




(2) The
      tax holiday of Shenyang, one of the Company’s Sino-foreign joint ventures,
      matured in 2005, therefore increasing the Company’s income taxes by
      $177,226.




(3)
      The
      consolidated income before income taxes of Jiulong in 2005 was less than that
      in
      2004, which led to a decrease of $325,363 in income taxes.




INCOME
      BEFORE MINORITY INTEREST




Income
      before minority interest was $5,995,796 for the year ended December 31, 2005,
      as
      compared to $11,071,382 for the year ended December 31, 2004, a decrease of
      $5,075,586 or 45.8%, due to decreased income before income taxes of $4,322,123
      or 37%, and increased income tax expenses of $753,463 or 121.8%.




MINORITY
      INTEREST




The
      Company recorded the minority interests’ share in the earnings of the
      Sino-foreign joint ventures aggregating $2,680,318 for the year ended December
      31, 2005, as compared to $4,182,454 for the year ended December 31, 2004, a
      decrease of $1,502,136 or 35.9%.




The
      Company owned equity interests in five Sino-foreign joint ventures, through
      which it conducts its operations. All of the operating results of these five
      Sino-foreign joint ventures were consolidated in the Company’s financial
      statements of December 31, 2005 and 2004. USAI has not generated any operating
      income/loss for the year ended December 31,2005. The equity interest of Jingzhou
      was sold effective August 31, 2004. The Company records the minority interests’
share in the earnings of the respective Sino-foreign joint ventures for each
      period.




As
      compared with 2004, the decreased minority interest for the year ended December
      31, 2005 consisted of a decrease of $1,144,880 caused by decreased income before
      minority interest of Sino-foreign joint ventures, and a decrease of $357,256
      caused by decreased minority interest percentage in Sino-foreign joint
      ventures.




36




NET
      INCOME FROM CONTINUED OPERATIONS.




Net
      income was $3,315,478 for the year ended December 31, 2005, as compared to
      $6,888,928 for the year ended December 31, 2004, a decrease of $3,573,450 or
      51.9%, consisting a decreased income before minority interest of $5,075,586
      or
      45.8%, and a decreased minority interest of $1,502,136 or 35.9%, which increased
      net income.




NET
      LOSS
      FROM DISCONTINUED OPERATIONS




Effective
      August 31, 2004, in order to concentrate on its main products, namely steering
      and other automotive parts, the Company disposed of its 51% interest in Jingzhou
      by entering into the Exchange Agreement with HBWL **,** which is
      controlled by Mr. Hanlin Chen, the Company’s Chairman. Pursuant to the Exchange
      Agreement, the 51% equity interest in Jingzhou owned by Ji Long was exchanged
      for 2.5% of Hubei Wanlong’s equity interest in Henglong based on their
      respective fair market values as determined by an independent appraisal firm.
      Accordingly, the Company does not own any Jingzhou equity.




The
      divested non-core business of Jingzhou has been treated as a discontinued
      operation under SFAS No. 144. The net loss of $21,591 from discontinued
      operations of Jingzhou was included in the consolidated statements of operations
      of 2004.




NET
      INCOME




Net
      income was $3,315,478 for the year ended December 31, 2005, as compared to
      $6,867,337 for the year ended December 31, 2004, a decrease of $3,551,859 or
      51.7%, consisting of decreased net income from continued operations of
      $3,573,450 or 51.9%, and decreased net loss from discontinued operations of
      $21,591.




LIQUIDITY
      AND CAPITAL RESOURCES:




Capital
      resources and use of cash




The
      Company has historically financed its liquidity requirements from a variety
      of
      sources, including short-term borrowings under bank credit agreements, bankers’
acceptance, issuances of capital stock and internally generated cash. As of
      December 31, 2006, the Company had cash and cash equivalents of $27,418,500,
      as
      compared to $12,374,944 as of December 31, 2005, an increase of $15,043,556
      or
      121.6%.




The
      Company had working capital of $29,136,373 as of December 31, 2006, as compared
      to $8,006,688 as of December 31, 2005, an increase of $21,129,685 or
      263.9%.




The
      Company can obtain bank loans and banker’s acceptance bills line of credit
      agreement, which will have a one year term . On the condition that the Company
      can provide adequate mortgage security and does not violate the terms of the
      line of credit agreement , it can extend the one year term.




The
      Company had bank loans maturing in less than one year of $15,384,615 and
      bankers’ acceptances of $15,130,653 as of December 31, 2006, including
      $1,246,175 which was not part of the line of credit and was mortgaged by notes
      receivable.




The
      Company currently expects to be able to obtain similar bank loans and bankers’
acceptance bills in the future if it can provide adequate mortgage security
      following the termination of the above mentioned agreements. If the Company
      is
      not able to do so, it will have to refinance such debt as it becomes due or
      repay that debt to the extent it has cash available from operations or from
      the
      proceeds of additional issuances of capital stock. Due to depreciation, the
      value of the mortgages securing the above-mentioned bank loans and banker's
      acceptance bills will be devalued by $3,820,792. If the Company wishes to obtain
      the same amount of bank loans and banker's acceptance bills, it will have
      to provide $3,820,792 additional mortgages. The Company can obtain a
      reduced line of credit with a reduction of $1,996,560 if it cannot provide
      additional mortgages ($3,820,792 at 52% mortgage rates). The Company anticipates
      that the reduction of bank loans will not have a material adverse effect on
      its
      liquidity. On March 20, 2006, the Company has entered into a $15,000,000 equity
      line through a Standby Equity Distribution Agreement with Cornell Capital
      Partners, LP. As of December 31, 2006, the Company has adequate working capital,
      as well as $9,000,000 available under the above-mentioned equity line of credit.
      The Company views these capitals as providing an ample available source of
      back-up liquidity in case of an unanticipated event.




37




Financing
      activities:





(a)
      Bank
      loans




As
      of
      December 31, 2006, the principal outstanding under the Company’s credit
      facilities and lines of credit was as follows:




Bank
            
            Amount
                available
            
            Amount
                borrowedComprehensive
                credit facilities*
            
            
            Bank
                of China
            
            $
            9,487,179
            
            $
            11,249,170Comprehensive
                credit facilities
            
            
            China
                Construction Bank
            
            
            8,974,359
            
            
            7,051,282Comprehensive
                credit facilities
            
            
            CITIC
                Industrial Bank
            
            
            2,564,102
            
            
            2,564,102Comprehensive
                credit facilities
            
            
            Shanghai
                Pudong Development Bank
            
            
            5,128,205
            
            
            4,699,538Comprehensive
                credit facilities
            
            
            Jingzhou
                Commercial Bank
            
            
            6,410,256
            
            
            2,560,769Comprehensive
                credit facilities
            
            
            Industrial
                and Commercial Bank of China
            
            
            1,410,256
            
            
            1,144,231Total
            
            
            
            
            $
            33,974,359
            
            $
            29,269,092




*
      The
      Bank of China has renewed its line of credit agreement with the Company. The
      Company will repay $1,761,999 without replacing the amount available. As
      discussed above, the Company anticipates it will not have a material adverse
      effect on its liquidity.




The
      Company may request banks to issue notes payable or bank loans within its credit
      line using a 364-day revolving line.




The
      Company refinanced its short-term debt during early 2006 at annual interest
      rates of 5.58% to 7.25%, and for terms of six to twelve months. Pursuant to
      the
      refinancing arrangement, the Company pledged $18,918,617 of equipment,
      $5,134,718 land use right and $3,706,462 building as security for its
      comprehensive credit facility with Bank of China; pledged $2,616,218 land use
      and $2,188,744 building as security for its comprehensive credit facility with
      CITIC Industrial Bank; pledged $1,534,256 land use right and $6,656,397 building
      as security for its comprehensive credit facility with Shanghai Pudong
      Development Bank; pledged $8,572,115 land use right as security for its
      comprehensive credit facility with Jingzhou Commercial Bank; pledged $1,380,683
      land use right and $932,767 building as security for its comprehensive credit
      facility with Industrial and Commercial Bank of China; and pledged $1,034,872
      land use right and $3,207,872 building as security for its comprehensive credit
      facility with China Construction Bank.




(b)
      Financing from investors:




On
      March
      20, 2006, the Company entered into a Standby Equity Distribution Agreement
      with
      Cornell Capital Partners, LP for a total amount of $15 million. The Company
      has
      utilized $6,000,000 as of December 31, 2006. Under the agreement, Cornell
      Capital Partners, LP has committed to provide funding to be drawn down over
      a
      stated period at the Company’s discretion.




38




If
      the
      Company fails to obtain the same or similar terms for any debt or equity
      refinancing to meet its debt obligations, e.g. the financing terms with China
      Construction Bank have changed into security mortgages instead of a guarantee,
      it will result in a shortage of approximately $4,700,000. The Company intends
      to
      pledge more equipment, but there is no assurance that it will succeed, or if
      the
      Company fails to obtain extensions of the maturity dates of these obligations
      as
      they become due, its overall liquidity and capital resources will be adversely
      affected.




Cash
      Requirements:




The
      following table summarizes the Company’s expected cash outflows resulting from
      financial contracts and commitments. The Company has not included information
      on
      its recurring purchases of materials for use in its manufacturing operations.
      These amounts are generally consistent from year to year, closely reflecting
      the
      Company’s levels of production, and are not long-term in nature being less than
      three months.




Payment
                Due DatesTotal
            
            Less
                than 1 year
            
            1-3
                years
            
            3-5
                years
            
            More
                than 5 yearsShort-term
                bank loan
            
            $
            15,384,615
            
            $
            15,384,615
            
            $
            —
            
            $
            —
            
            $
            —Notes
                payable
            
            
            15,130,653
            
            
            15,130,653
            
            
            —
            
            
            —
            
            
            —Other
                contractual purchase commitments, including information
                technology
            
            
            6,046,684
            
            
            4,481,999
            
            
            1,344,685
            
            
            220,000
            
            
            —Total
            
            $
            36,561,952
            
            $
            34,997,267
            
            $
            1,344,685
            
            $
            220,000
            
            $
            —





Short-term
      bank loans:




The
      following table summarizes the contract information of short-term borrowings
      between the banks and the Company during 2006:




**Bank**
            
            **Purpose**
            
            **Borrowing
                Date**
            
            **Borrowing
                Term (Year)**
            
            **Annual
                Percentage Rate**
            
            **Date
                of Interest Payment**
            
            **Date
                of payment**
            
            **Amount**Bank
                of China
            
            Working
                Capital
            
            7-Feb-06
            
            1
            
            5.58%
            
            Pay
                monthly
            
            7-Feb-07
            
            $641,026Bank
                of China
            
            Working
                Capital
            
            8-Mar-06
            
            1
            
            5.58%
            
            Pay
                monthly
            
            7-Mar-07
            
            1,923,077Bank
                of China
            
            Working
                Capital
            
            16-May-06
            
            1
            
            5.58%
            
            Pay
                monthly
            
            15-May-07
            
            2,564,103Jingzhou
                Commercial Bank
            
            Working
                Capital
            
            28-Mar-06
            
            1
            
            7.25%
            
            Pay
                monthly
            
            28-Mar-07
            
            1,282,050CITIC
                Industrial Bank
            
            Working
                Capital
            
            15-Jun-06
            
            1
            
            5.58%
            
            Pay
                monthly
            
            14-Jun-07
            
            2,564,103Shanghai
                Pudong Development Bank
            
            Working
                Capital
            
            14-Sep-06
            
            1
            
            6.12%
            
            Pay
                monthly
            
            13-Sep-07
            
            2,564,103China
                Construction Bank
            
            Working
                Capital
            
            20-Jan-06
            
            1
            
            5.58%
            
            Pay
                monthly
            
            19-Jan-07
            
            2,564,103China
                Construction Bank
            
            Working
                Capital
            
            16-Feb-06
            
            1
            
            5.58%
            
            Pay
                monthly
            
            15-Feb-07
            
            1,282,050Total
            
            
            
            
            
            
            
            
            
            
            
            
            
            $15,384,615




39




The
      Company must use the loans for the purpose described in the table. If the
      Company fails, it will be charged a penalty interest at 100% of the specified
      loan rate. The Company has to pay interest under the interest rate described
      in
      the table on the 20th of each month. If the Company fails, it will be charged
      a
      compounded interest at the specified rate. The Company has to repay the
      principal outstanding on the specified date in the table. If it fails, it will
      be charged a penalty interest at 50% of the specified loan rate. Management
      believes that the Company had complied with such financial covenants as of
      December 31, 2006, and will continue to comply with them.




The
      following table summarizes the contract information of issuing notes payable
      between the banks and the Company:


**Purpose**
              
              **Term
                  (Month)**
              
              **Due
                  Date**
              
              **Amount
                  Payable**
                **on
                  Due Date**Working
                  Capital
              
              
              3-6
              
              
              Jan,
                  2007
              
              $
              4,771,945Working
                  Capital
              
              
              3-6
              
              
              Feb,
                  2007
              
              
              2,580,769Working
                  Capital
              
              
              3-6
              
              
              Mar,
                  2007
              
              
              1,537,051Working
                  Capital
              
              
              6
              
              
              April,
                  2007
              
              
              2,046,974Working
                  Capital
              
              
              6
              
              
              May,
                  2007
              
              
              1,550,690Working
                  Capital
              
              
              6
              
              
              Jun,
                  2007
              
              
              2,643,224Total
              
              
              
              
              
              
              
              $
              15,130,653




The
      Company must use the loan for the purpose described in the table. If it fails,
      the banks will no longer issue the notes payable, and it may have an adverse
      effect on the Company’s liquidity and capital resources. The Company has to
      deposit sufficient cash in the designated account of the bank on the due date
      of
      notes payable for payment to the suppliers. If the bank has advanced payment
      for
      the Company, it will be charged a penalty interest at 150% of the specified
      loan
      rate. Management believes that the Company had complied with such financial
      covenants as of December 31, 2006, and will continue to comply with them.




The
      Company had approximately $6,046,684 of capital commitment as of December 31,
      2006, arising from equipment purchases for expanding production capacity. The
      Company intends to pay off $4,481,999 in 2007 using its working capital.
      Management believes that it will not have a material adverse effect on the
      Company’s liquidity.




Cash
      flows:





(a)
      Operating activities




40


The
      Company’s operations provided cash of $7,969,150 during the year ended December
      31, 2006, $12,320,207 during the same period of 2005, and $21,365,367 for during
      same period of 2004.




Net
      cash
      generated from operations in 2006 decreased by $4,351,057 compared with that
      in
      2005, primarily due to increased accounts and notes receivable. First, cash
      outflow increased by $9,300,000 along with increased accounts receivables,
      mainly due to an increase in sales this year of 50.6% as compared to the same
      period of 2005. The credit terms on sale of goods between customers and the
      Company generally range from 3 - 4 months, which resulted in increased accounts
      receivable as sales increased. This is a normal capital circulation and the
      Company believes that it will not have a material adverse effect on future
      cash
      flows. Second, cash outflow increased by $7,600,000 along with increased notes
      receivable, mainly due to the Company having sufficient working capital this
      year and reducing the discount on notes receivable to save interest expenses.
      Since the notes receivable were based on bank credit standing, they may turn
      into cash any time the Company elects. Therefore, the increase of notes
      receivable will not have a material adverse effect on the Company’s future
      operating activities.




Cash
      generated from operations in 2005 decreased by $9,045,160 as compared to that
      in
      2004, primarily due to a decreased operational income of $5,000,000 as a result
      of the Government’s policy on investment control. The Company’s accounts
      receivable increased $3,400,000 due to the deferred payment from automobile
      manufacturers which also suffered a shortage of cash as a result of the
      Government’s policy on investment control. In 2004, the Company recovered the
      advance to a related party, Sino-American Inc., which increased its working
      capital.




(b)
      Investing activities




The
      Company expended net cash of $1,219,103 in investment activities during the
      year
      ended December 31, 2006, $12,618,696 during the same period of 2005, and
      $18,230,256 during the same period of 2004.




Net
      cash
      used in investment activities in 2006 decreased by $11,399,593 compared to
      that
      in 2005, primarily due to the receipt of other receivable of $5,700.000, and
      a
      decrease of $3,600,000 in equipment purchase payments as a result of delayed
      equipment and plant construction. During 2006, the Company paid instalments
      for
      equipment, with the remaining $5,500,000 to be paid in subsequent years.
      Management believes that these investing activities will not have a
      material adverse effect on the Company’s liquidity.




Cash
      used
      in investment activities in 2005 decreased by $5,611,560 compared to that in
      2004, primarily due to payment for a large number of equipment during 2004
      which
      was ordered in 2003 for production facilities expansion. During 2005, the
      Company reduced equipment purchases due to the Government’s policy on investment
      control.




(c)
      Financing activities




The
      Company obtained net cash of $7,470,971 through financing activities during
      the
      year ended December 31, 2006, $180,954 during the same period of 2005, and
      expended net cash of $2,701,354 for the same period of 2004.




Net
      cash
      obtained from financing activities during 2006 increased by $7,290,017 as
      compared to that during the year ended December 31, 2005, as a result of
      following factors:




(1)
      During the year ended December 31, 2006, the Company raised $10,300,000 of
      cash
      by issuing 1,216,675 shares of common stock to institutional investors, and
      raised an additional $100,000 in cash through the exercise of options by
      independent directors. During the year ended December 31, 2005, the Company
      did
      not issue any shares.




(2)
      Net
      cash provided in financing activities increased during the period as a result
      of
      an increase in capital investment by minority shareholders in joint
      ventures: The minority shareholders in joint ventures contributed $1,420,926
      during the year ended December 31, 2006, including Shanghai Hongxi Investment
      Inc., the minority shareholder of USAI ,investing $436,954; HongKong Tongda,
      the
      minority shareholder of Jielong, investing $135,034; and Wuhu Chery Technology
      Co., Ltd., the minority shareholder of Wuhu, investing $848,938 by cash. During
      the year ended December 31, 2005, there was no such capital contribution in
      minority shareholders in Sino-foreign joint ventures.




41




(3)
      The
      Company’s joint ventures paid minority shareholders of Sino-foreign joint
      ventures more dividends in the year 2006 as compared to year 2005. Net cash
      obtained from financing activities during 2005 increased by $2,882,308 as
      compared to that during the year ended December 31, 2004, as a result of a
      decrease in dividends paid to minority shareholders of Sino-foreign joint
      ventures, and a decrease in repayment of a director’s loan due to insufficient
      working capital which occurred as a result of the Government’s policy on
      investment control.




OFF-BALANCE
      SHEET ARRANGEMENTS




At
      December 31, 2006 and 2005, the Company did not have any transactions,
      obligations or relationships that could be considered off-balance sheet
      arrangements.




COMMITMENTS
      AND CONTINGENCIES




The
      following table summarizes the Company’s contractual payment obligations and
      commitments as of December 31, 2006:





**Payment
                Obligations by Period**2007
            
            2008
            
            2009
            
            2010
            
            Thereafter
            
            TotalObligations
                for service agreement
            
            $
            110,000
            
            $
            110,000
            
            $
            110,000
            
            $
            110,000
            
            $
            110,000
            
            $
            550,000Obligations
                for purchasing agreement
            
            
            4,371,999
            
            
            1,124,685
            
            
            —
            
            
            —
            
            
            —
            
            
            5,496,684Total
            
            $
            4,481,999
            
            $
            1,234,685
            
            $
            110,000
            
            $
            110,000
            
            $
            110,000
            
            $
            6,046,684




SUBSEQUENT
      EVENTS




On
      January 17, 2007, the Company raised $1,200,000 in a private placement (PIPE)
      to
      Cornell Capital Partners, LP, “Investor”, by issuing 108,121 shares of common
      stock.




Pursuant
      to the joint venture agreement entered into with Sensor as set out in note
      2
      regarding the formation of USAI, Sensor has failed to contribute its
      sensor-related technologies and thereby failed to fulfill its capital
      contribution commitment as of March 20, 2007, Sensor agreed to withdraw from
      USAI and another technology supplier is being sought. There is no effect on
      the
      Company's existing production, but it may materially affect USAI's future
      development.




INFLATION
      AND CURRENCY MATTERS




In
      the
      most recent decade, the Chinese economy has experienced periods of rapid
      economic growth as well as relatively high rates of inflation, which in turn
      has
      resulted in the periodic adoption by the Chinese Government of various
      corrective measures designed to regulate growth and contain inflation.




Foreign
      operations are subject to certain risks inherent in conducting business abroad,
      including price and currency exchange controls, and fluctuations in the relative
      value of currencies. The Company conducts virtually all of its business in
      China
      and, accordingly, the sale of its products is settled primarily in RMB. As
      a
      result, devaluation or currency fluctuation of the RMB against the US$ would
      adversely affect the Company’s financial performance when measured in US
      dollars.




42




Until
      1994, the Renminbi experienced a significant devaluation against US dollars
      but
      since then the value of the Renminbi relative to the US dollar has remained
      stable. In addition, the Renminbi is not readily convertible into US dollars
      or
      other foreign currencies. All foreign exchange transactions continue to take
      place either through the Bank of China or other banks authorized to buy and
      sell
      foreign currencies at the exchange rate quoted by the People’s Bank of
      China.




RECENT
      ACCOUNTING PRONOUNCEMENTS




In
      November 2004, the FASB issued SFAS No. 151, “Inventory Costs — An Amendment of
      Accounting Research Bulletin No. 43, Chapter 4” (SFAS 151). SFAS 151 clarifies
      that abnormal amounts of idle facility expense, freight, handling costs and
      spoilage should be expensed as incurred and not included in overhead as an
      inventory cost. The new statement also requires that allocation of fixed
      production overhead costs to conversion costs should be based on normal capacity
      of the production facilities. The provisions in SFAS 151 must be applied
      prospectively and became effective for the Company beginning January 1, 2006.
      The Company adopted this statement beginning in the first quarter of
      2006.




In
      December 2004, the FASB issued SFAS No. 152 “Accounting for Real Estate
      Time-Sharing Transactions - an amendment of FASB Statements No. 66 and 67”
(“SFAS 152”). This statement amends FASB Statement No. 66 “Accounting for Sales
      of Real Estate” to reference the financial accounting and reporting guidance for
      real estate time-sharing transactions that is provided in AICPA Statement of
      Position 04-2 “Accounting for Real Estate Time-Sharing Transactions” (“SOP
      04-2”). SFAS 152 also amends FASB Statement No. 67 “Accounting for Costs and
      Initial Rental operations of Real Estate Projects” to state that the guidance
      for incidental operations and costs incurred to sell real estate projects does
      not apply to real estate time-sharing transactions, with the accounting for
      those operations and costs being subject to the guidance in SOP 04-2. The
      provisions of SFAS 152 are effective in fiscal years beginning after June 15,
      2005. The Company adopted this statement beginning in the third quarter of
      2006.




In
      December 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-Based
      Payment” (“SFAS 123R”). This statement requires financial statement recognition
      of compensation cost related to share-based payment transactions. Share-based
      payment transactions within the scope of SFAS 123R include stock options,
      restricted stock plans, performance-based awards, stock appreciation rights,
      and
      employee share purchase plans. The provisions of SFAS 123R are effective for
      the
      first fiscal year beginning after June 15, 2005. However, in April 2005, the
      SEC
      deferred the effective date of SFAS 123R for SEC registrants to the first
      interim period beginning after June 15, 2005. Accordingly, the Company adopted
      this statement beginning in the first quarter of 2006.




In
      December 2004, the FASB issued SFAS No. 153 “Exchanges of Nonmonetary Assets, an
      amendment of Accounting Principles Board Opinion No. 29” (“SFAS 153”). This
      statement amends Accounting Principles Board Opinion (APB) No. 29, “Accounting
      for Nonmonetary Transactions” to eliminate the exception for nonmonetary
      exchanges of similar productive assets and replaces it with a general exception
      for exchanges of nonmonetary assets that have no commercial substance. Under
      SFAS 153, if a nonmonetary exchange of similar productive assets meets a
      commercial-substance criterion and fair value is determinable, the transaction
      must be accounted for at fair value resulting in recognition of any gain or
      loss. SFAS 153 was effective for nonmonetary transactions in fiscal periods
      beginning after June 15, 2005. The Company adopted this statement beginning
      in
      the first quarter of 2006.




In
      March
      2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset
      Retirement Obligations, an Interpretation of FASB Statement No. 143” (“FIN 47”).
      Under FIN 47, we are required to recognize a liability for the fair value of
      a
      conditional asset retirement obligation if the fair value of the liability
      can
      be reasonably estimated. Any uncertainty about the amount and/or timing of
      future settlement should be factored into the measurement of the liability
      when
      sufficient information exists. FIN 47 also clarifies when an entity would have
      sufficient information to reasonably estimate the fair value. The provisions
      of
      FIN 47 were required to be applied no later than the end of fiscal years ending
      after December 15, 2005. The Company adopted this statement beginning in the
      first quarter of 2006.




43




In
      May
      2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections —
a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS 154”). This
      statement changes the requirements for the accounting for and reporting of
      a
      change in accounting principle and applies to all voluntary changes in
      accounting principle. It also applies to changes required by an accounting
      pronouncement in the unusual instance that the pronouncement does not include
      specific transition provisions. When a pronouncement includes specific
      transition provisions, those provisions should be followed. APB No. 20 required
      that most voluntary changes in accounting principle be recognized by including
      in net income, of the period of the change the cumulative effect of changing
      to
      the new accounting principle. This statement requires retrospective application
      to prior period financial statements of changes in accounting principle, unless
      it is impracticable to determine either the period-specific effects or the
      cumulative effect of the change. The provisions of SFAS 154 are effective for
      fiscal years beginning after December 15, 2005. The Company adopted this
      statement beginning in the first quarter of 2006.




In
      February 2006, the FASB issued SFAS No. 155, “Accounting for Certain
      Hybrid Financial Instruments” (“SFAS 155”). This Statement amends FASB
      Statements No. 133, Accounting for Derivative Instruments and Hedging
      Activities, and No. 140, Accounting for Transfers and Servicing of
      Financial Assets and Extinguishments of Liabilities. This Statement resolves
      issues addressed in Statement 133 Implementation Issue No. D1, “Application
      of Statement 133 to Beneficial Interests in Securitized Financial Assets.” SFAS
      No. 155 permits fair value remeasurement for any hybrid financial
      instrument that contains an embedded derivative that otherwise would require
      bifurcation, clarifies which interest-only strips and principal-only strips
      are
      not subject to the requirements of Statement 133, and establishes a requirement
      to evaluate interests in securitized financial assets to identify interests
      that
      are freestanding derivatives or that are hybrid financial instruments that
      contain an embedded derivative requiring bifurcation. It also clarifies that
      concentrations of credit risk in the form of subordination are not embedded
      derivatives and amends Statement 140 to eliminate the prohibition on a
      qualifying special-purpose entity from holding a derivative financial instrument
      that pertains to a beneficial interest other than another derivative financial
      instrument. This Statement is effective for all financial instruments acquired
      or issued after the beginning of an entity’s first fiscal year that begins after
      September 15, 2006. The Company has not yet determined the impact of the
      adoption of SFAS No. 155 on its financial statements, if any.




In
      March
      2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
      Assets” (“SFAS 156”). This Statement amends FASB Statement No. 140, Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities, with respect to the accounting for separately recognized servicing
      assets and servicing liabilities. This Statement requires an entity to recognize
      a servicing asset or servicing liability each time it undertakes an obligation
      to service a financial asset by entering into a servicing contract in indicated
      situations; requires all separately recognized servicing assets and servicing
      liabilities to be initially measured at fair value, if practicable; permits
      an
      entity to choose relevant subsequent measurement methods for each class of
      separately recognized servicing assets and servicing liabilities; at its initial
      adoption, permits a one-time reclassification of available-for-sale securities
      to trading securities by entities with recognized servicing rights, without
      calling into question the treatment of other available-for-sale securities
      under
      Statement 115, provided that the available-for-sale securities are identified
      in
      some manner as offsetting the entity’s exposure to changes in fair value of
      servicing assets or servicing liabilities that a servicer elects to subsequently
      measure at fair value; and requires separate presentation of servicing assets
      and servicing liabilities subsequently measured at fair value in the statement
      of financial position and additional disclosures for all separately recognized
      servicing assets and servicing liabilities. The Company has determined that
      the
      adoption of SFAS No. 156 did not have a material impact on Consolidated
      Financial Statements.




In
      September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, (“SFAS
      157”), to define fair value, establish a framework for measuring fair value in
      accordance with generally accepted accounting principles and expand disclosures
      about fair value measurements. SFAS 157 requires quantitative disclosures using
      a tabular format in all periods (interim and annual) and qualitative disclosures
      about the valuation techniques used to measure fair value in all annual periods.
      The provisions of this Statement shall be effective for financial statements
      issued for fiscal years beginning after November 15, 2007 and interim periods
      within those fiscal years. The Company will be required to adopt the provisions
      of this statement as of January 1, 2008. The Company is currently evaluating
      the
      impact of adopting SFAS 157.




44




In
      September 2006, the FASB issued Statement No. 158, “Employers’ Accounting for
      Defined Benefit Pension and Other Postretirement Plans - An amendment of FASB
      Statements No. 87, 88, 106, and 132(R)” (“SFAS 158”). This Statement enhances
      disclosure regarding the funded status of an employer’s defined benefit
      postretirement plan by (a) requiring companies to include the funding status
      in
      comprehensive income, (b) recognize transactions and events that affect the
      funded status in the financial statements in the year in which they occur,
      and
      (c) at a measurement date of the employer’s fiscal year-end. Statement No. 158
      effective for fiscal years ending after December 15, 2008, and is not expected
      to apply to the Company.




In
      February 2007, FASB issued SFAS No. 159, The Fair Value Option for Financial
      Assets and Financial Liabilities Including an Amendment of FASB Statement No.
      115 (“ SFAS 159”). SFAS 159 permits entities to choose to measure many financial
      instruments and certain other items at fair values. SFAS 159 is effective
      for fiscal years after November 15, 2007. The Company is currently evaluating
      the impact of adopting SFAS 159 on our financial statements.





**SIGNIFICANT
      ACCOUNTING POLICIES AND CRITICAL ACCOUNTING ESTIMATES**




Our
      significant accounting policies are more fully described in Note 1 to our
      consolidated financial statements. Certain of our accounting policies require
      the application of significant judgment by management in selecting the
      appropriate assumptions for calculating financial estimates. By their nature,
      these judgments are subject to an inherent degree of uncertainty. These
      judgments are based on our historical experience, terms of existing contracts,
      our evaluation of trends in the industry, information provided by our customers
      and information available from other outside sources, as appropriate.




We
      consider an accounting estimate to be critical if:




·  It
      requires us to make assumptions about matters that were uncertain at the time
      we
      were making the estimate, and




·  Changes
      in the estimate or different estimates that we could have selected would have
      had a material impact on our financial condition or results of operations.




The
      table
      below presents information about the nature and rationale for the Company
      critical accounting estimates:




**Balance
                Sheet Caption**
            
            **Critical
                Estimate Item**
            
            **Nature
                of Estimates**
              **Required**
            
            **Assumptions/Approaches**
              **Used**
            
            **Key
                Factors**Accrued
                liabilities and other long-term liabilities
            
            Warranty
                obligations
            
            Estimating
                warranty requires us to forecast the resolution of existing claims
                and
                expected future claims on products sold. VMs are increasingly seeking
                to
                hold suppliers responsible for product warranties, which may impact
                our
                exposure to these costs.
            
            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.
            
            · VM
                  sourcing
              
              · VM
                policy decisions
                regarding warranty claimsProperty,
                plant and equipment, intangible assets and other long-term
                assets
            
            Valuation
                of long- lived assets and investments
            
            We
                are required from time-to-time to review the recoverability of certain
                of
                our assets based on projections of anticipated future cash flows,
                including future profitability assessments of various product lines.
            
            We
                estimate cash flows using internal budgets based on recent sales
                data,
                independent automotive production volume estimates and customer
                commitments.
            
            · Future
                production
                estimates
              
              · Customer
                preferences and
                decisions





45




In
      addition, there are other items within our financial statements that require
      estimation, but are not as critical as those discussed above. These include
      the
      allowance for doubtful accounts receivable and reserves for excess and obsolete
      inventory. Although not significant in recent years, changes in estimates used
      in these and other items could have a significant effect on our consolidated
      financial statements.




ITEM
      7A.
      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.




The
      Company is subject to market risk exposures of varying correlations and
      volatilities, including credit risk, foreign exchange rate risk, interest rate
      risk and inventory price risk.




CREDIT
      RISK: The Company’s financial instruments that are exposed to concentration of
      credit risk consist primarily of cash and cash equivalents, and accounts
      receivable from customers




Cash
      and
      cash equivalents are deposited with major state-owned banks in the PRC.
      Management has not evaluated the credit risk from banks based on its notion
      that
      state-owned banks command considerable funds with good reputation.




The
      Company’s business activity is primarily with customers in the PRC. The Company
      periodically performs credit analysis and monitors the financial condition
      of
      its clients in order to minimize credit risk. Because of the increase of its
      activities and business, and the increase of customers’ accounts receivable,
      there is no assurance that the foresaid measures will be completely effective.
      The Company has approximately $41,000,000 in accounts receivable as of December
      31, 2006. The Company’s revenues and/or operating cash flow would be materially
      and adversely affected if a 3% allowance for doubtful accounts is introduced,
      which will mean a reduction of approximately $1,230,000 revenues for the
      Company.




CURRENCY
      EXCHANGE RATE RISK: The Company’s currency exchange rate risks consist primarily
      of currency from financing. The Company’s financing activities were settled in
      US dollars and deposited in its bank account in US dollars, while the Company
      conducts virtually all of its business and investment activity in China and
      the
      value of its business is effectively denominated in Renminbi. The Company
      converts US dollars into RMB to conduct its investment activities and business.
      The Company does not hedge its RMB - US dollar exchange rate exposure. If RMB
      appreciates against US Dollars, the Company’s revenues and/or operating cash
      flow might be adversely affected. The Company has dollar holdings of
      approximately $7,400,000 as at December 31, 2006, if the exchange rate between
      RMB and US Dollars were to increase by 10%, the Company would potentially suffer
      a loss of approximately $740,000. Currently, the Company has not chosen any
      financial instruments (hedges) that can provide offsets or limits to its
      exposures.




MARKET
      INTEREST RATE RISK: The Company has $34,000,000 short-term revolving credit
      lines with annual interest expenses of $2,000,000 if these lines are fully
      utilized at current rates. Bank loan rates in China have a history of volatility
      and have been rising recently, and if market interest rates increase by 10%,
      such increases could result in increased loan interest for the
      company.




RISK
      OF
      INVENTORY PRICES: The risk to inventory prices of the Company comes from the
      upward movement in prices of raw materials and the downward movement of selling
      prices. Management believes the latter one is more material. In recent years,
      price fluctuation on raw materials was not excessive, but selling prices for
      steering gears have fluctuated significantly. During the years 2004 to 2006,
      selling prices for steering gears have decreased approximately 10% each year
      on
      an average basis. As of December 31, 2006, the Company’s finished goods amount
      was approximately $7,500,000. If selling prices of steering gears decrease
      by
      10% in 2007, then the income of the Company will decrease by $750,000.




46




ITEM
      8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.




(a)
      FINANCIAL STATEMENTS




The
      following financial statements are set forth at the end hereof.




1.
       Report of Independent Auditors




2.
       Consolidated Balance Sheets as of December 31, 2006 and 2005




3.
       Consolidated Statements of Operations for the years ended December 31,
      2006, 2005 and 2004




4.
       Consolidated Statements of Comprehensive Income (Loss) for the years ended
      December 31, 2006, 2005 and 2004




5.
       Consolidated Statements of Changes in Stockholders’ Equity for the years
      ended December 31, 2006, 2005 and 2004




6.
       Consolidated Statements of Cash Flows for the years ended December 31,
      2006, 2005 and 2004




7.
       Notes to Consolidated Financial Statements.




(b) Selected
      quarterly financial data for the past two years appears in the following
      table:





Quarterly
                Results of OperationsFirst
            
            Second
            
            Third
            
            Fourth2006
            
            2005
            
            2006
            
            2005
            
            2006
            
            2005
            
            2006
            
            2005Net
                Sales
            
            $
            20,964,452
            
            $
            13,976,450
            
            $
            24,747,912
            
            $
            16,763,309
            
            $
            22,399,673
            
            $
            14,262,933
            
            $
            27,654,402
            
            $
            18,569,609Gross
                Profit
            
            
            6,945,197
            
            
            5,030,341
            
            
            9,271,145
            
            
            5,966,751
            
            
            8,133,159
            
            
            5,508,916
            
            
            8,560,313
            
            
            5,960,815Operating
                Income
            
            
            2,619,649
            
            
            1,638,777
            
            
            3,144,980
            
            
            1,694,404
            
            
            3,398,569
            
            
            2,794,094
            
            
            3,601,524
            
            
            2,255,742Net
                Income
            
            
            1,094,398
            
            
            866,183
            
            
            751,636
            
            
            502,054
            
            
            1,532,123
            
            
            1,076,912
            
            
            1,433,547
            
            
            870,229Earnings
                Per Share
            
            $
            0.05
            
            $
            0.04
            
            $
            0.03
            
            $
            0.02
            
            $
            0.07
            
            $
            0.05
            
            $
            0.06
            
            $
            0.04




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




Not
      applicable.




ITEM
      9A.
      CONTROLS AND PROCEDURES.




(a)
      Evaluation of disclosure controls and procedures:




As
      of
      December 31, 2006, the end of the period covered by this report, the Company’s
      chief executive officer and its chief financial officer reviewed and evaluated
      the effectiveness of the Company’s disclosure controls and procedures, as
      defined in Exchange Act Rule 13a-15(e) and 15d-15(e). As of the end of that
      period, based on that evaluation, the Company’s chief executive officer and
      chief financial officer concluded that from October 1, 2006 to date, the
      disclosure controls and procedures were effective in ensuring that material
      information the Company must disclose in the reports that it files or submits
      under the Securities Exchange Act of 1934, as amended, the “Exchange Act”, is
      recorded, processed, summarized, and reported on a timely basis, and that
      information required to be disclosed by the Company in reports that it files
      or
      submits under the Exchange Act is accumulated and communicated to the Company’s
      chief executive officer and chief financial officer as appropriate to allow
      timely decisions regarding required disclosure.




(b)
      Changes in internal controls over financial reporting:




As
      previously reported, we identified various control weaknesses, identified below,
      in our internal controls over financial reporting. Commencing October 1, 2006,
      we had remedied by increasing our review procedures, both during and at the
      end
      of each quarter, to try our bests to ensure that information required to be
      disclosed, both financial and non-financial, was recorded, processed, summarized
      and reported in a timely fashion. In addition, as noted below, we continued
      to
      make progress in our remediation plans related to these control weaknesses
      and
      had adopted interim procedures to further support the existing controls. In
      2006, under the guidance of our disclosure committee, the internal auditors
      had
      further enhanced controls including, but not limited to, the following: (1)
      check revenue and expenses recorded to confirm their consistency in
      classification, accuracy and completeness, (2) review to ensure all inter
      company transactions in the period are in compliance with relevant accounting
      principles, (3) review accounting estimates for reasonableness, including
      amortization and depreciation terms for long-term assets, impairment reserve
      of
      assets and warranty reserve, (4) confirm that all accounting units had counted
      inventory, capital assets and construction materials, etc. and had disclosed
      the
      results in financial reports, and recorded any differences appropriately in
      accordance with GAAP, (5) review expenditures to determine whether they should
      be classified as capital expenditures or as current expenses in the period,
      and
      (6) confirm that significant accounting policies had been adhered to and were
      in
      accordance with GAAP. Prior to the completion of our periodic filings with
      the
      SEC, the above-mentioned information would be collected and communicated to
      management, including the CEO and CFO.




The
      following table summarizes the status of the remediation plans as of
      December 31, 2006:




**Control
                Deficiency Noted in Form 10-K and 10Q**
            
            **Remediation
                Plans**
            
            **Current
                Status of Remediation Plans**Inappropriatepresentation of reclassifications, other income and warranty reserves
                in
                financial statements.
            
            Implement
                additional oversight to ensure the financial statements comply with
                US
                GAAP
              
              ·Management
                is increasing the number of qualified accountants on its global accounting
                staff by actively recruiting additional certified public accountants
                to
                ensure the financial statements would be in compliance with US
                GAAP.
              
              ·Management
                has committed to provide the finance staff with additional support
                and
                training in order to enable them to identify unusual or complex
                transactions requiring further consideration by technical accounting
                experts or others within the organization.
              
              ·Management
                will conduct training sessions throughout the organization to explain
                the
                accounting policies and procedures and require that accounting
                conclusions, assumptions and estimates be better documented and supported
                by such accounting policies or relevant accounting literature in
                accordance with US GAAP.
              
              ·Management
                and the audit committee will assess the effectiveness of the Company’s
                adherence to the accounting policies through ongoing monitoring
                activities.
            
            ·The
                Company has hired several qualified accountants at both its headquarters
                and various operating units. Additional hiring efforts are
                ongoing.
              
              ·Trainings
                on a variety of accounting and reporting related topics have occurred
                and
                additional trainings have been carried out during the fourth quarter
                of
                2006.
              
              ·To
                address identified weaknesses, Management continues to perform the
                following procedures:
              
              -More
                transactions are reviewed by the chief accounting officer particularly
                in
                those areas where control weaknesses have been identified;
              
              -Management
                has strengthened its requirement and review of the documentation
                supporting the accounting for transactions;
              
              -External
                experts are being retained, when deemed necessary, to assist in preparing
                and reviewing the appropriate accounting documentation.
              
              ·After
                the Company has fully implemented the remediation plan, we will be
                relying
                on the management procedures indicated above to mitigate the risk
                of this
                control deficiency.




47




·Management
                will have all subsidiaries adopt management process
                consistently.
              
              ·Management
                has finalized control processes and will test periodically and assess
                their effectiveness in order to minimize further breakdown of controls.
              
              ·Management
                recognizes that many of the remedial actions it has taken or will
                take
                require continuous monitoring and evaluation for effectiveness, which
                will
                depend on maintaining a strong internal audit function. Until such
                time as
                the Company is able to identify a suitable candidate to lead its
                internal
                audit function, it will look to external experts to supplement its
                existing staff.
            
            ·Management
                conducted training sessions with the finance staff of each division
                to
                implement these policies and to increase staff’s awareness and focus on
                the issues covered by the new policies and will continue to monitor
                their
                progress.
              
              ·Management
                will provide training to reinforce the new accounting policies in
                February
                2007.
              
              ·In
                early January 2007, senior members of the Company’s executive management
                attended a training session focusing on management control and business
                ethics. Other members of the executive management team will attend
                this
                training in June 2007. The entire salaried workforce will be trained
                in
                December 2007.
              
              ·The
                Company is still actively seeking to fill the leadership role in
                the
                internal audit function.




ITEM
      9B.
      OTHER INFORMATION.




None.




PART
      III




ITEM
      10.
      DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.




The
      following table and text set forth the names and ages of all directors and
      executive officers of the Company as of December 31, 2006. The Board of
      Directors is comprised of only one class. All of the directors will serve until
      the next annual meeting of stockholders and until their successors are elected
      and qualified, or until their earlier death, retirement, resignation or removal.
      Also provided herein are brief descriptions of the business experience of each
      director and executive officer during the past five years and an indication
      of
      directorships held by each director in other companies subject to the reporting
      requirements under the federal securities laws.




**Name**
            
            **Age**
            
            **Position(s)**Hanlin
                Chen
            
            49
            
            Chief
                Executive Officer and Chairman of the BoardQizhou
                Wu
            
            42
            
            Chief
                Operating Officer and DirectorDaming
                Hu
            
            48
            
            Chief
                Financial OfficerTse,
                Yiu Wong Andy
            
            36
            
            Sr.
                VP, DirectorShengbin
                Yu
            
            53
            
            Sr.
                VPShaobo
                Wang
            
            44
            
            Sr.
                VPRobert
                Tung
            
            50
            
            DirectorDr.
                Haimian Cai
            
            43
            
            DirectorWilliam
                E. Thomson
            
            65
            
            DirectorGuangxun
                Xu
            
            56
            
            Director




48




(a)
            BIOGRAPHIES
                OF DIRECTORS AND EXECUTIVE
                OFFICERS:




Hanlin
      Chen has served as chairman of the board and CEO since March 2003. Mr. Chen
      is a
      standing board member of the Political Consulting Committee of Jingzhou city
      and
      vice president of Foreign Investors Association of Hubei Province. He was the
      general manager of Jiulong from 1993 to 1997. Since 1997, he has been the
      Chairman of the Board of Henglong. Mr. Chen graduated from Barrington University
      with an MBA Degree.




Qizhou
      Wu
      has served as the Chief Operating Officer since March 2003. He was the Managing
      Vice General Manager of Jiulong from 1993 to 1999 and GM of Henglong from 1999
      to 2002. Mr. Wu graduated from Tsinghua University in Beijing with a Masters
      degree in Automobile Engineering.




Daming
      Hu
      has served as the Chief Financial Officer of the Company since March 2003.
      He is
      in charge of corporate account planning, reporting and tax planning. Mr. Hu
      was
      the Finance Manager of Jiulong from 1996 to 1999 and Finance Manager of Heng
      Long from 1999 to 2002.  Mr.
      Hu graduated from Zhongnan University of Economics and Law as an accountant
      bachelor.




Tse,
      Yiu
      Wong Andy has served as Sr. VP of the Company since March 2003. He has also
      served as the general manager of the Henglong and Jiulong joint ventures and
      the
      chairman of the board of Shenyang since 2003. He was the vice GM of Jiulong
      from
      1993 to 1997 and the vice GM of Henglong. Mr. Tse has over 10 years of
      experience in automotive parts sales and strategic development. Mr. Tse has
      an
      MBA from the China People University.




Shengbin
      Yu has served as Sr. VP of the Company and had overall charge of the production
      since March 2003. Mr. Yu was the Vice-G.M. of Jiulong from 1993 to 1996 and
      Executive Vice-G.M. of Henglong from 1997 to 2003.




Shaobo
      Wang has served as Sr. VP of the Company and had overall charge of the
      technology since March 2003. He was the Vice-G.M. of Jiulong from 1993 to 2003.
      Mr. Wang graduated from Tsinghua University in Beijing with a Masters degree
      in
      Automobile Engineering.




Robert
      Tung has been a Director of the Company since September 2003 and a member of
      the
      Company’s Audit and Nominating Committees. Mr. Tung is currently the President
      of Multi-Media Communications, Inc., and Executive Vice President of Super
      Microbial Sciences International, LLC. Mr. Tung holds a M.S. in Chemical
      Engineering from the University of Virginia and B.S. degrees in Computer Science
      and Chemical Engineering from the University of Maryland and National Taiwan
      University, respectively.




Dr.
      Haimian Cai has been a Director since September 2003 and a member of the
      Company’s Compensation and Nominating Committees. Dr. Cai is a technical
      specialist in the automotive industry. Prior to that, Dr. Cai was a staff
      engineer in ITT Automotive Inc. Dr. Cai has written more than fifteen technical
      papers and co-authored a technical book regarding the power of metallurgy
      industry for automotive application. Dr. Cai has more than ten patents including
      pending patents. Dr. Cai holds a B.S. Degree in Automotive Engineering from
      Tsinghua University and a M.S. and Ph. D. in manufacturing engineering from
      Worcester Polytechnic Institute.




William
      E. Thomson, CA, has been a Director of the Company since September 2003 and
      is a
      member of the Company’s Audit, Compensation and Nominating Committees. Mr.
      Thomson has been the president of Thomson Associates, Inc., a leading merchant
      banking and crisis management company, since 1978. Mr. Thomson’s current
      additional directorships include: Nasdaq - Atlast Pain & Injury Solutions,
      Inc. (Healthcare),Maxus Technology Inc. (eWaste Management Solutions);
      TSX-Venture Exchange - Open EC Technologies (Software); TSX-Score Media Inc.
      (Media); Private-ReWorks Inc. (Environmental/Agriculture), Electrical Contacts
      Ltd. (Electrical Contacts), Redpearl funding Corporation (IT Financing), Wright
      Environmental Management Inc. (Waste Management Solutions). YTW Growth Capital
      Management Corporation (CPC facilitation), Han Wind Energy (BVI) (Sustainable
      Energy), Summit Energy Management (Oil and Gas, Paradox Financial Solutions
      Inc.
      (Supply Chain Financing), Debt Freedom Canada Inc. (Financing), Confederazione
      degli Imprenditory Italianinel Mondo Canada - Confederation of Italian
      Entrepreneurs Worldwide Canada.




49




Mr.
      Guangxun Xu currently serves as the leader of NASDAQ Listing Services Limited,
      a
      company he founded in April 2004, with a professional career in the finance
      field spanning over 25 years. His practice focuses on providing package services
      on US and UK listings, advising on and arranging for Private Placements, PIPEs
      and IPOs, pre-IPO restructuring, M&A, Corporate and Project Finance, IPOs,
      corporate governance, post-IPO IR and compliance, Risk Control, etc. Prior
      to
      founding NASDAQ Listing Services Limited, Mr. Xu served as a managing director
      with the NASDAQ Stock Market International, Asia for over 10 years. He holds
      an
      MBA from Middlesex University, London. He is a member of the Company’s Audit,
      Compensation and Nominating.




(b)
            COMPENSATION
                FOR DIRECTORS AND OTHER MATTERS




The
      compensation that directors receive for serving on the Board of Directors for
      the fiscal year 2006 was as follows:




Name
            
            Fees
                earned or paid in cash
            
            Stock
                awards
            
            Option
                awards
            
            Non-equity
                incentive plan compensation
            
            Change
                in pension value and nonqualified deferred compensation
                earnings
            
            All
                other compensation
            
            Total($)
            
            ($)
            
            ($)
            
            ($)
            
            ($)
            
            ($)
            
            ($)Haimian
                Cai
            
            $
            28,000
            
            $
            -
            
            $
            43,875
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            71,875William
                E. Thomson
            
            
            28,000
            
            
            -
            
            
            43,875
            
            
            -
            
            
            -
            
            
            -
            
            
            71,875Robert
                Tung
            
            
            28,000
            
            
            -
            
            
            43,875
            
            
            -
            
            
            -
            
            
            -
            
            
            71,875Guangxun
                Xu
            
            $
            16,000
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            16,000




In
      accordance with SFAS No. 123R, the cost of the above mentioned stock options
      and
      warrants issued to directors was measured on the grant date based on their
      fair
      value. The fair value is determined using the Black-Scholes option pricing
      model.




All
      other
      directors did not receive compensation for their service on the Board of
      Directors.




(c)
            AUDIT
                COMMITTEE AND INDEPENDENT DIRECTORS




The
      Company has a standing Audit Committee of the Board of Directors established
      in
      accordance with Section 3(a)(58)(A) of the Exchange Act, as amended. The Audit
      Committee consists of the following individuals, all of whom the Company
      considers to be independent, as defined under the SEC’s rules and regulations
      and the Nasdaq’s definition of independence: Robert Tung, Guangxun Xu, and
      William Thomson. Mr. William Thomson is the Chairman of the Audit Committee.
      The
      Board has determined that Mr. William Thomson is the Audit Committee financial
      expert, as defined in Item 401(h)(2)of Regulation S-K, serving on the Company’s
      audit committee.




50




(d)
            COMPENSATION
                COMMITTEE




The
      Company has a standing Compensation Committee of the Board of Directors. The
      Compensation Committee is responsible for determining compensation for the
      Company’s executive officers. Three of the Company’s independent directors, as
      defined under the SEC’s rules and regulations and the Nasdaq’s definition of
      independence, Guangxun Xu, Haimian Cai and William Thomson, serve on the
      Compensation Committee. Dr. Haimian Cai is the Chairman of the Compensation
      Committee.




(e)
            NOMINATING
                COMMITTEE




The
      Company has a standing Nominating Committee of the Board of Directors. Director
      candidates are nominated by the Nominating Committee. The Nominating Committee
      will consider candidates based upon their business and financial experience,
      personal characteristics, and expertise that are complementary to the background
      and experience of other Board members, willingness to devote the required amount
      of time to carry out the duties and responsibilities of Board membership,
      willingness to objectively appraise management performance, and any such other
      qualifications the Nominating Committee deems necessary to ascertain the
      candidates’ ability to serve on the Board. The Nominating Committee will not
      consider nominee recommendations from security holders, other than the
      recommendations received from a security holder or group of security holders
      that beneficially owned more than five (5) percent of the Company’s outstanding
      common stock for at least one year as of the date the recommendation is made.
      Three of the Company’s independent directors, as defined under the SEC’s rules
      and regulations and the Nasdaq’s definition of independence, Robert Tung,
      Guangxun Xu and Haimian Cai, serve on the Nominating Committee. Mr. Robert
      Tung
      is the Chairman of the Nominating Committee.




(f)
            STOCKHOLDER
                COMMUNICATIONS




Stockholders
      interested in communicating directly with the Board of Directors, or individual
      directors, may email the Company’s independent director William Thomson at
      Bill.Thomson@chl.com.cn. Mr. Thomson will review all such correspondence and
      will regularly forward to the Board copies of all such correspondence that
      deals
      with the functions of the Board or committees thereof or that he otherwise
      determines requires their attention. Directors may at any time review all of
      the
      correspondence received that is addressed to members of the Board of Directors
      and request copies of such correspondence. Concerns relating to accounting,
      internal controls or auditing matters will immediately be brought to the
      attention of the Audit Committee and handled in accordance with procedures
      established by the Audit Committee with respect to such matters.




(g)
            FAMILY
                RELATIONSHIPS




Mr.
      Hanlin Chen and Mr. Tse, Yiu Wong Andy are brothers-in-law.




(h)
            INVOLVEMENT
                IN LEGAL PROCEEDINGS




To
      the
      best of the Company’s knowledge, during the past five years, none of the
      following occurred with respect to a present or former director or executive
      officer of the Company: (1) any bankruptcy petition filed by or against any
      business of which such person was a general partner or executive officer either
      at the time of the bankruptcy or within two years prior to that time; (2) any
      conviction in a criminal proceeding or being subject to a pending criminal
      proceeding, excluding traffic violations and other minor offenses; (3) being
      subject to any order, judgment or decree, not subsequently reversed, suspended
      or vacated, of any court of any competent jurisdiction, permanently or
      temporarily enjoining, barring, suspending or otherwise limiting his involvement
      in any type of business, securities or banking activities; and (4) being found
      by a court of competent jurisdiction, in a civil action, the SEC or the
      Commodities Futures Trading Commission to have violated a federal or state
      securities or commodities law, and the judgment has not been reversed, suspended
      or vacated.




51




(i)
            CODE
                OF ETHICS AND CONDUCT




The
      Board
      of Directors has adopted a Code of Ethics and Conduct which is applicable to
      all
      officers directors and employees. The Code of Ethics and Conduct is filed as
      an
      exhibit to this Form 10-K, which incorporates it by reference from the Form
      10-KSB for year ended December 31, 2003)




(ii)
            SECTION
                  16(a) BENEFICIAL OWNERSHIP COMPLIANCE




Section
      16(a) of the Securities Exchange Act of 1934, as amended, requires the Company’s
      executive officers and directors and persons who own more than 10% of a
      registered class of the Company’s equity securities to file with the Securities
      and Exchange Commission initial statements of beneficial ownership, reports
      of
      changes in ownership and annual reports concerning their ownership of common
      stock and other of the Company’s equity securities, on Forms 3, 4 and 5
      respectively. Executive officers, directors and greater than 10% stockholders
      are required by Commission regulations to furnish the Company with copies of
      all
      Section 16(a) reports they file. To the best of the Company’s knowledge, based
      solely upon a review of the Form 3, 4 and 5 filed, no officer, director or
      10%
      beneficial shareholder failed to file on a timely basis any reports required
      by
      Section 16(a) of the Securities Exchange Act of 1934, as amended.




ITEM
      11.
      EXECUTIVE COMPENSATION DISCUSSION AND ANALYSIS




Compensation
      Discussion And Analysis




The
      Company’s Compensation Committee is empowered to review and approve the annual
      compensation and compensation procedures for the executive officers of the
      Company. The primary goals of the Compensation Committee of our board of
      directors with respect to executive compensation are to attract and retain
      the
      most talented and dedicated executives possible and to align executives’
incentives with stockholder value creation. The Compensation Committee evaluates
      individual executive performance with a goal of setting compensation at levels
      the committee believes are comparable with executives in other companies of
      similar size and stage of development operating in similar industry while taking
      into account our relative performance and our own strategic goals.




We
      have
      not retained a compensation consultant to review our policies and procedures
      with respect to executive compensation. We conduct an annual review of the
      aggregate level of our executive compensation, as well as the mix of elements
      used to compensate our executive officers. We compare compensation levels with
      amounts currently being paid to executives in our industry and most importantly
      with local practices in China. We are satisfied that our compensation levels
      are
      competitive with local conditions.




Elements
      of Compensation




Executive
      compensation consists of following elements:




Base
      Salary. Base salaries for our executives are established based on the scope
      of
      their responsibilities, taking into account competitive market compensation
      paid
      by other companies for similar positions. Generally, we believe that executive
      base salaries should be targeted near the median of the range of salaries for
      executives in similar positions with similar responsibilities at comparable
      companies, in line with our compensation philosophy. Base salaries are reviewed
      annually, and adjusted from time to time to realign salaries with market levels
      after taking into account individual responsibilities, performance and
      experience. We reviewed compensation levels in December 2006.




Discretionary
      Annual Bonus. The Compensation Committee has the authority to award
      discretionary annual bonuses to our executive officers under the Compensation
      Committee Charter. So far, no discretionary bonus has been awarded. Bonuses,
      if
      they are awarded, are intended to compensate officers for achieving financial
      and operational goals and for achieving individual annual performance
      objectives. These objectives vary depending on the individual executive, but
      relate generally to strategic factors such as the financial performance, results
      of operation and per share performance of our common stock.




52


Our
      executive officers are eligible for a discretionary annual bonus, the specific
      amount of which will be determined by the Compensation Committee. The actual
      amount of discretionary bonus is determined following a review of each
      executive’s individual performance and contribution to our strategic goals
      conducted during the first quarter of each fiscal year. The Compensation
      Committee has not fixed a maximum payout for any officers’ annual discretionary
      bonus.




Long-Term
      Incentive Program. We believe that long-term performance is achieved through
      an
      ownership culture that encourages such performance by our key employees through
      the use of stock options. Our stock compensation plan has been established
      to
      provide certain of our employees with incentives to help align those employees’
interests with the interests of stockholders. The Compensation Committee
      believes that the use of stock options offers the best approach to achieving
      our
      compensation goals. We have not adopted stock ownership guidelines. We believe
      that the annual aggregate value of these awards should be set near competitive
      median levels for comparable companies.




Options.
      Our stock option plan authorizes us to grant options to purchase shares of
      common stock to our employees, directors and consultants. Li Jie, our board
      secretary, is the administrator of the stock option plan. The stock options
      plan
      was approved in the 2004 Annual Meeting of Stockholders and the maximum number
      of common shares for issuance under this plan is 2,200,000 with a period of
      10
      years. During 2004, the Company issued options to purchase 7,500 shares of
      common stock to each of its three independent directors. Such share options
      vested immediately upon grant and are exercisable at $4.50 per share over a
      period of two years. On June 28, 2005, the Company issued additional options
      to
      purchase 7,500 shares of common stock to each of its three independent
      directors. Such stock options vested immediately upon grant and are exercisable
      at $6.83 per share over a period of five years. On July 6, 2006, the Company
      issued options to purchase 7,500 shares of common stock to each of its three
      independent directors. Such stock options vested immediately upon grant and
      are
      exercisable at $7.94 per share over a period of five years. The exercise price
      represents the fair market value based on the grant date of the stock options.
      These grants were made to encourage an ownership culture among our independent
      directors. None of our executive officer nor the chief operating officers has
      been granted any stock options.




The
      Company has adopted Statement of Financial Accounting Standards (“SFAS”) No.
      123R, “Accounting for Stock-Based Compensation”, which establishes a fair value
      method of accounting for stock-based compensation plans. In accordance with
      SFAS
      No. 123R, the cost of stock options and warrants issued to employees is measured
      at the grant date based on the fair value. The fair value is determined using
      the Black-Scholes option pricing model. The resulting amount is charged to
      expense on the straight-line basis over the period in which the Company expects
      to receive benefit, which is generally the vesting period.




Stock
      Option Plan. Our Stock Option Plan authorizes us to grant incentive stock
      option, nonstatutory stock option, stock options, cash awards and stock awards
      to our employees, directors and consultants. Mr. Li Jie is the administrator
      of
      the plan. The board of directors will review and approve stock option awards
      to
      executive officers, directors and other key employees based upon a review of
      competitive compensation data, its assessment of individual performance, a
      review of each executive’s existing long-term incentives, and retention
      considerations.




Stock
      Appreciation Rights. We currently do not have any Stock Appreciation Rights
      Plan
      that authorizes us to grant stock appreciation rights.




Other
      Compensation. Other than the annual salary for our executive officers and the
      bonus that may be awarded to them at the discretion of the Compensation
      Committee, we do not have any other benefits and perquisites for our executive
      officers; however, the Compensation Committee in its discretion may provide
      benefits and perquisites to these executive officers if it deems it advisable.




53




Summary
      Compensation Table:





Name
                and principal position
            
            Year
            
            Salary
            
            Bonus
            
            Stock
                awards
            
            Option
                awards
            
            Non-equity
                incentive plan compensation
            
            Change
                in pension value and non-qualified deferred compensation
                earnings
            
            All
                other compensation
            
            Total($)
            
            ($)
            
            ($)
            
            ($)
            
            ($)
            
            ($)
            
            ($)
            
            ($)Hanlin
                Chen
            
            
            2006
            
            $
            100,000
            
            $
            —
            
            
            
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            100,000CEOHu
                Damming
            
            
            2006
            
            $
            60,000
            
            $
            —
            
            
            
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            60,000CFO




Grants
      of
      Plan-Based Awards:




Not
      Applicable.




Outstanding
      Equity Awards at Fiscal Year-End:




Not
      Applicable.




Option
      Exercises and Stock Vested:




Not
      Applicable.




Pension
      Benefits:




Name
            
            Plan
                name
            
            Number
                of years credited service
              (#)
            
            Present
                value of accumulated benefit
              ($)
            
            Payments
                during last fiscal year
              ($)Hanlin
                Chen
              CEO
            
            
            Purchase
                of pension
            
            
            13
            
            $
            30,000
            
            
            —Hu
                Damming
              CFO
            
            
            Purchase
                of pension
            
            
            10
            
            $
            23,000
            
            
            —




Principal executive
      officer and employees of the Company purchase pension insurance in accordance
      with pay 20% of salary amount, which was verified by the Government. Every
      year
      the Government pays to amount of $2,300 to principal executive officer after
      his
      or her retirement.




Nonqualified
      Deferred Compensation:




Not
      Applicable.




54




(b)
      COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION




For
      the
      twelve months ended December 31, 2006, none of our executive officers had a
      relationship that would constitute an interlocking relationship with executive
      officers or directors of another entity or insider participation in compensation
      decisions.




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




As
      used
      in this section, the term beneficial ownership with respect to a security is
      defined by Rule 13d-3 under the Securities Exchange Act of 1934, as amended,
      as
      consisting of sole or shared voting power, including the power to vote or direct
      the vote, and/or sole or shared investment power, including the power to dispose
      of or direct the disposition of, with respect to the security through any
      contract, arrangement, understanding, relationship or otherwise, subject to
      community property laws where applicable. The percentage ownership is based
      on
      23,959, 702 shares of common stock outstanding at February 27,
      2007.




**Name/Title**
            
            **Total
                Number of Shares**
            
            **Percentage
                Ownership**Hanlin
                Chen, CEO, Chairman and President(1)
            
            
            15,371,972
            
            
            64.16
            %Qizhou
                Wu, COO, Director
            
            
            2,195,996
            
            
            9.17
            %Daming
                Hu, CFO
            
            
            —
            
            
            —Li
                Ping Xie(2)
            
            
            15,371,972
            
            
            64.16
            %Tse,
                Yiu Wong Andy, Sr. VP, Director
            
            
            1,129,426
            
            
            4.71
            %Shaobo
                Wang, Sr. VP
            
            
            731,998
            
            
            3.06
            %Shengbin
                Yu, Sr. VP
            
            
            627,429
            
            
            2.62
            %Robert
                Tung, Director
            
            
            7,500
            
            
            0.03
            %Dr.
                Haimian Cai, Director
            
            
            7,500
            
            
            0.03
            %William
                E. Thomson, Director
            
            
            —
            
            
            —Guanxun
                Xu, Director
            
            
            —
            
            
            —All
                Directors and Executive Officers (10 persons)
            
            
            20,071,821
            
            
            83.78
            %




(1) Includes
      2,091,425 shares of common stock beneficially owned by Mr. Chen’s wife, Ms.
      Xie.




(2) Includes
      13,280,547 shares of common stock beneficially owned by Ms. Xie’s husband, Mr.
      Chen.




In
      July
      2004, the Company adopted a stock option plan subject to shareholders approval,
      which was approved at the Company’s annual general meeting on June 28, 2005. The
      stock option plan provides for the issuance to the Company’s officers,
      directors, management and employees of options to purchase shares of the
      Company’s common stock.




ITEM
      13.
      CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.




Effective
      August 31, 2004, in order to concentrate on its main products, namely steering
      and automotive parts, the Company disposed of its 51% interest in Jingzhou
      by
      entering into the Exchange Agreement with HBWL, which is controlled by Mr.
      Hanlin Chen, the Chairman of the Company. Pursuant to the Exchange Agreement,
      the 51% equity interest in Jingzhou owned by Ji Long was exchanged for 2.5%
      of
      HBWL’s equity interests in Henglong based on their respective fair market values
      as determined by an independent appraisal firm. The difference between the
      fair
      value and the book value resulting from the disposition of the joint venture
      interest in Jingzhou was debited to additional paid-in capital. With respect
      to
      consideration paid by the Company in excess of the Chairman’s basis in his
      investment, such excess has been charged to additional paid-in capital as a
      distribution to the Chairman, resulting in the acquired 2.5% equity interests
      in
      Henglong being recorded by the Company at the Chairman’s original cost basis.
      The Company paid approximately $90,000 to Hubei Wanlong in conjunction with
      this
      transaction.




55




Henglong,
      one of the Company’s Joint-ventures, has constructed seven buildings dedicated
      to research and administration for its operations in Wuhan. Due to the unified
      building guidance and planning on floor and building areas by the government
      of
      Wuhan, the actual building areas were greater than the areas the Company
      needed. And in 2005 the Company decided to dispose of two of its seven
      buildings, construction cost at $2,468,574, to WuHan Geological University
      Information S&T Development Co., Ltd. "WuHan Information", a Chinese company
      controlled by Mr. Hanlin Chen, the Chairman of the Company, at fair market
      value of $2,636,444, which was determined by an independent appraisal
      firm.




ITEM
      14.
      PRINCIPAL ACCOUNTANT FEES AND SERVICES.




The
      following table sets forth the aggregate fees for professional audit services
      rendered by Schwartz Levitsky Feldman LLP for the audit of the Company’s annual
      financial statements for the fiscal years 2006 and 2005 and 2004, and fees
      billed for other services provided by Schwartz Levitsky Feldman LLP for fiscal
      years 2006, 2005 and 2004. The Audit Committee has approved all of the following
      fees.




**Fiscal
                Year Ended**2006
            
            2005
            
            2004Audit
                Fees
            
            $
            244,500
            
            $
            190,000
            
            $
            190,000Audit-Related
                Fees(1)
            
            
            19,715
            
            
            9,000
            
            
            —Tax
                Fees (2)
            
            
            7,000
            
            
            5,000Total
                Fees Paid
            
            $
            271,215
            
            $
            204,000
            
            $
            190,000




(1)
      Includes accounting and reporting consultations related to financing and
      internal control procedures.




(2)
      Includes fees for service related to tax compliance services, preparation and
      filing of tax returns and tax consulting services.




Audit
      Committee’s Pre-Approval Policy




During
      fiscal years ended December 31, 2006, 2005 and 2004, the Audit Committee of
      the
      Board of Directors adopted policies and procedures for the pre-approval of
      all
      audit and non-audit services to be provided by the Company’s independent auditor
      and for the prohibition of certain services from being provided by the
      independent auditor. The Company may not engage the Company’s independent
      auditor to render any audit or non-audit service unless the service is approved
      in advance by the Audit Committee or the engagement to render the service is
      entered into pursuant to the Audit Committee’s pre-approval policies and
      procedures. On an annual basis, the Audit Committee may pre-approve services
      that are expected to be provided to the Company by the independent auditor
      during the fiscal year. At the time such pre-approval is granted, the Audit
      Committee specifies the pre-approved services and establishes a monetary limit
      with respect to each particular pre-approved service, which limit may not be
      exceeded without obtaining further pre-approval under the policy. For any
      pre-approval, the Audit Committee considers whether such services are consistent
      with the rules of the Securities and Exchange Commission on auditor
      independence.




56




PART
      IV




ITEM
      15.
      EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.




(a) **List
      of Financial Statements/Schedules**




1.
      Report
      of Independent Auditors




2.
       Consolidated Balance Sheets as of December 31, 2006 and 2005




3.
       Consolidated Statements of Operations for the years ended December 31,
      2006, 2005 and 2004




4.
       Consolidated Statements of Comprehensive Income (Loss) for the years ended
      December 31, 2006, 2005 and 2004




5.
       Consolidated Statements of Changes in Stockholders’ Equity for the years
      ended December 31, 2006, 2005 and 2004




6.
       Consolidated Statements of Cash Flows for the years ended December 31,
      2006, 2005 and 2004




7.
       Notes to Consolidated Financial Statements.




(b)
      EXHIBITS




The
      following is a list of exhibits filed as part of this Annual Report on Form
      10-K. Where so indicated by footnote, exhibits that were previously filed are
      incorporated by reference.




**Exhibit**
              **Number**
            
            **Description**3.1(i)
            
            Certificate
                of Incorporation (incorporated by reference from the filing on Form
                10SB
                File No. 000-33123.)3.1(ii)
            
            Bylaws
                (incorporated by reference from the Form 10KSB for the year ended
                December
                31, 2002.)14
            
            Code
                of Ethics (incorporated by reference from the Form 10-KSB for the
                year
                ended December 31, 2003)21
            
            Schedule
                of Subsidiaries*23
            
            Consent
                of Schwartz Levitsky Feldman LLP., independent
                auditors*




57




31.1
            
            Rule
                13a-14(a) Certification*31.2
            
            Rule
                13a-14(a) Certification*32.1
            
            Section
                1350 Certification*32.2
            
            Section
                1350 Certification*





*
      Filed
      herewith










SIGNATURES






In
      accordance with Section 13 or 15(d) of the Exchange Act, the Company caused
      this
      report to be signed on its behalf by the undersigned, thereunto duly
      authorized.




CHINA
                AUTOMOTIVE SYSTEMS, INC.Dated:
                April 2, 2007
            
            /s/
                Hanlin ChenName:
            Hanlin
                ChenTitle:
            Chairman,
                CEO and President




In
      accordance with the Securities Exchange Act of 1934, this report has been signed
      below by the following persons on behalf of the Company and in the capacities
      and on the dates indicated.




Dated:
                April 2, 2007
            
            /s/
                Hanlin ChenName:
            Hanlin
                ChenTitle:
            Chairman,
                CEO and PresidentDated:
                April 2, 2007/s/
                Daming HuName:
            Daming
                HuTitle:
            CFO





Dated:
                April 2, 2007
            
            /s/
                Qizhou WuName:
            Qizhou
                WuTitle:
            COO,
                DirectorDated:
                April 2, 2007
            
            /s/
                Guanxun XuName:
            Guanxun
                XuTitle:
            Director




58




Dated:
                April 2, 2007
            
            /s/
                Tse Yiu Wong AndyName:
            Tse,
                Yiu Wong AndyTitle:
            Sr.
                VP, DirectorDated:
                April 2, 2007
            
            /s/
                Robert TungName:
            Robert
                TungTitle:
            Director





Dated:
                April 2, 2007
            
            /s/
                Dr. Haimian CaiName:
            Name:
                Dr. Haimian CaiTitle:
            DirectorDated:
                April 2, 2007
            
            /s/
                William E. ThomsonName:
            William
                E. ThomsonTitle:
            Director




59




REPORT
      OF
      INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To
      the
      Board of Directors and Stockholders of China Automotive Systems,
      Inc.:




We
      have
      audited the accompanying consolidated balance sheets of China Automotive
      Systems, Inc. as at December 31, 2006 and 2005 and the related consolidated
      statements of operations, cash flows and changes in stockholders’ equity for the
      years ended December 31, 2006, 2005 and 2004. These consolidated financial
      statements are the responsibility of the management of China Automotive Systems,
      Inc.. Our responsibility is to express opinion on these consolidated financial
      statements based on our audits.




We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the
      consolidated financial statements are free of material misstatement. An audit
      includes examining, on a test basis, evidence supporting the amounts and
      disclosures in the consolidated financial statements. An audit also includes
      assessing the accounting principles used and significant estimates made by
      management, as well as evaluating the overall financial statement presentation.
      We believe that our audits provide a reasonable basis for our
      opinion.




In
      our
      opinion, these consolidated financial statements referred to above present
      fairly, in all material respects, the financial position of China Automotive
      Systems, Inc. as of December 31, 2006 and 2005 and the results of its operations
      and its cash flows for the years ended December 31, 2006, 2005 and 2004 in
      conformity with generally accepted accounting principles in the United States
      of
      America.




Toronto,
      Ontario, Canada




February
                2, 2007, except
              for
                note 26 as to which
              the
                date is March 28, 2007
            /s/
                  Schwartz Levitsky Feldman LLP
              Schwartz
                Levitsky Feldman LLP
              
              Chartered
                Accountants






60




China
      Automotive Systems, Inc. and Subsidiaries


Consolidated
      Balance Sheets


December
      31, 2006 and 2005




December
                31,2006
            
            2005ASSETSCurrent
                assets:Cash
                and cash equivalents
            
            $
            27,418,500
            
            $
            12,374,944Pledged
                cash deposits
            
            
            3,484,335
            
            
            1,185,660Accounts
                and notes receivable, net, including $1,770,933 and $1,829,075 from
                related parties at December 31, 2006 and 2005, net of an allowance
                for
                doubtful accounts of $4,086,218 and $2,856,025 at December 31, 2006
                and
                2005
            
            
            57,234,383
            
            
            41,580,320Advance
                payments and other, including $487,333 and $312,036 to related
                parties at December 31, 2006 and 2005
            
            
            837,014
            
            
            1,029,892Inventories
            
            
            15,464,571
            
            
            12,385,833Total
                current assets
            
            $
            104,438,803
            
            $
            68,556,649Long-term
                Assets:Property,
                plant and equipment, net
            
            $
            40,848,046
            
            $
            39,796,033Intangible
                assets, net
            
            
            3,140,548
            
            
            3,503,217Other
                receivables, net, including $738,510 and $3,966,509 from related
                parties
                at December 31, 2006 and 2005, net of an allowance for doubtful accounts
                of $898,203 and $1,040,169 at December 31, 2006 and 2005
            
            
            966,715
            
            
            6,503,629Advance
                payment for property, plant and equipment, including $488,873 and
                $599,729
                to related parties at December 31, 2006 and 2005
            
            
            2,640,708
            
            
            1,096,121Long-term
                investments
            
            
            73,718
            
            
            74,074Total
                assets
            
            $
            152,108,538
            
            $
            119,529,723LIABILITIES
                AND STOCKHOLDERS' EQUITYCurrent
                liabilities:Bank
                loans
            
            $
            15,384,615
            
            $
            14,814,815Accounts
                and notes payable, including $640,405 and $383,578 to related parties
                at
                December 31, 2006 and 2005
            
            
            37,647,913
            
            
            31,375,599Customer
                deposits
            
            
            146,171
            
            
            157,919Accrued
                payroll and related costs
            
            
            1,506,251
            
            
            1,418,093Accrued
                expenses and other payables
            
            
            11,078,186
            
            
            5,191,617Accrued
                pension costs
            
            
            3,266,867
            
            
            2,653,064Taxes
                payable
            
            
            5,914,362
            
            
            4,172,212Amounts
                due to shareholders/directors
            
            
            358,065
            
            
            766,642Total
                current liabilities
            
            $
            75,302,430
            
            $
            60,549,961Long-term
                liabilities:Advances
                payable
            
            
            313,151
            
            
            301,614Total
                liabilities
            
            $
            75,615,581
            
            $
            60,851,575Minority
                interests
            
            $
            23,112,667
            
            $
            21,751,043Stockholders'
                equity:Preferred
                stock, $0.0001 par value - Authorized - 20,000,000 shares Issued
                and
                outstanding - None
            
            $
            —
            
            $
            —Common
                stock, $0.0001 par value - Authorized - 80,000,000 shares Issued
                and
                Outstanding - 23,851,581 shares and 22,574,543 shares at December
                31, 2006
                and 2005, respectively
            
            
            2,385
            
            
            2,257Additional
                paid-in capital
            
            
            28,651,959
            
            
            18,146,722Retained
                earnings-Appropriated
            
            
            6,209,909
            
            
            4,923,262Unappropriated
            
            
            16,047,237
            
            
            12,522,180Accumulated
                other comprehensive income
            
            
            2,468,800
            
            
            1,332,684Total
                stockholders' equity
            
            $
            53,380,290
            
            $
            36,927,105Total
                liabilities and stockholders' equity
            
            $
            152,108,538
            
            $
            119,529,723




The
      accompanying notes are an integral part of these consolidated financial
      statements.




61




China
      Automotive Systems, Inc. and Subsidiaries


Consolidated
      Statements of Operations


Years
      Ended December 31, 2006, 2005 and 2004




2006
            
            2005
            
            2004Income
                from continuing operationsNet
                product sales, including $3,278,444, $2,290,129 and $1,682,625 to
                related
                parties at December 31, 2006, 2005 and 2004
            
            $
            95,766,439
            
            $
            63,572,301
            
            $
            58,185,845Cost
                of product sold, including $2,850,283, $1,667,685 and $1,703,179
                purchased
                from related parties at December 31, 2006, 2005 and 2004
            
            
            62,856,625
            
            
            41,105,478
            
            
            35,042,352Gross
                profit
            
            $
            32,909,814
            
            $
            22,466,823
            
            $
            23,143,493Add:
                Gain on other sales
            
            
            279,216
            
            
            359,986
            
            
            794,621Less:
                Operating expensesSelling
                expenses
            
            
            7,772,068
            
            
            5,804,678
            
            
            3,865,154General
                and administrative expenses
            
            
            7,810,187
            
            
            5,094,388
            
            
            6,142,634R&D
                expenses
            
            
            1,066,050
            
            
            966,782
            
            
            1,518,512Depreciation
                and amortization
            
            
            3,776,003
            
            
            2,577,944
            
            
            848,009TotalOperating
                expenses
            
            
            20,424,308
            
            
            14,443,792
            
            
            12,374,309Income
                from operations
            
            $
            12,764,722
            
            $
            8,383,017
            
            $
            11,563,805Add:
                Other income, net
            
            
            94,257
            
            
            150,809
            
            
            856,939Financial
                (expenses)
            
            
            (832,844
            )
            
            (1,166,167
            )
            
            (730,962
            )Income
                before income taxes
            
            
            12,026,135
            
            
            7,367,659
            
            
            11,689,782Less:
                Income taxes
            
            
            1,669,081
            
            
            1,371,863
            
            
            618,400Income
                before minority interests
            
            
            10,357,054
            
            
            5,995,796
            
            
            11,071,382Less:Minority
                interests
            
            
            5,545,350
            
            
            2,680,318
            
            
            4,182,454Net
                income from continuing operations
            
            $
            4,811,704
            
            $
            3,315,478
            
            $
            6,888,928Net
                loss from discontinued operations
            
            
            -
            
            
            -
            
            
            (21,591
            )Net
                income
            
            $
            4,811,704
            
            $
            3,315,478
            
            $
            6,867,337Net
                income per common shareNet
                income from continuing operations -
              Basic
                and diluted
            
            $
            0.21
            
            $
            0.15
            
            $
            0.30Net
                income from discontinued operations -
              Basic
                and diluted
            
            
            0.00
            
            
            0.00
            
            
            (0.00
            )Total
                net income per common share
              Basic
                and diluted
            
            $
            0.21
            
            $
            0.15
            
            $
            0.30Weighted
                average number of common shares outstanding -Basic
            
            
            23,198,113
            
            
            22,574,543
            
            
            22,574,543Diluted
            
            
            23,210,675
            
            
            22,588,713
            
            
            22,582,494




The
      accompanying notes are an integral part of these consolidated financial
      statements.




62




China
      Automotive Systems, Inc. and Subsidiaries


Consolidated
      Statements of Comprehensive Income


Years
      Ended December 31, 2006, 2005 and 2004




2006
            
            2005
            
            2004Net
                income
            
            $
            4,811,704
            
            $
            3,315,478
            
            $
            6,867,337Other
                comprehensive income:Foreign
                currency translation gain
            
            
            1,136,116
            
            
            1,329,624
            
            
            7,210Comprehensive
                income
            
            $
            5,947,820
            
            $
            4,645,102
            
            $
            6,874,547




The
      accompanying notes are an integral part of these consolidated financial
      statements.




63




China
      Automotive Systems, Inc. and Subsidiaries


Consolidated
      Statements of Stockholders’ Equity


Years
      Ended December 31, 2006, 2005 and 2004




Common
                Stock
            
            Preferred
                Stock
            
            Additional
                Paid-in CapitalShares
            
            Par
                Value
            
            Shares
            
            Par
                ValueBalance,
                December 31, 2003
            
            
            22,574,543
            
            $
            2,257
            
            
            —
            
            $
            —
            
            $
            18,779,880Foreign
                currency translation
              gain
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Deemed
                distribution to
              shareholders
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (831,837
            )Deemed
                distribution to minority shareholders
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Issuance
                of stock options to
              independent
                directors
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            55,125Net
                income for the year ended December, 31, 2004
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Appropriation
                of retained
              earnings
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Balance,
                December 31, 2004
            
            
            22,574,543
            
            $
            2,257
            
            
            —
            
            $
            —
            
            $
            18,003,168Foreign
                currency translation
              gain
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Deemed
                distribution to shareholders
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            74,704Issuance
                of stock options to
              independent
                directors
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            68,850Net
                income for the year ended December, 31, 2005
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Appropriation
                of retained
              earnings
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Balance,
                December 31, 2005
            
            
            22,574,543
            
            $
            2,257
            
            
            —
            
            $
            —
            
            $
            18,146,722Foreign
                currency translation gain
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Sale
                of common stock
            
            
            1,216,675
            
            
            122
            
            
            —
            
            
            —
            
            
            10,899,872Exercise
                of stock options by independent directors
            
            
            22,500
            
            
            2
            
            
            —
            
            
            —
            
            
            101,248Cash
                paid for retaining fee,commissions
                and placement agent fee in connection with offering
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (627,504
            )Issuance
                of common stock related to financing services
            
            
            37,863
            
            
            4
            
            
            —
            
            
            —
            
            
            449,996Payment
                          of financing services by issuance of common stock in accordance
                          with
                          Cornell Partners, LP.
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (450,000
            )Issuance
                of a warrant to purchase common stock
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            832,639Payment
                  of commissions and placement agent fee by issuance of common stock
                  warrants in accordance with Cornell Partners, LP
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (832,639
            )Issuance
                of stock options to
              independent
                directors
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            131,625Net
                income for the year ended December, 31, 2006
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Appropriation
                of retained
              earnings
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Balance,
                December 31, 2006
            
            
            23,851,581
            
            $
            2,385
            
            $
            —
            
            $
            —
            
            $
            28,651,959


64





China
      Automotive Systems, Inc. and Subsidiaries


Consolidated
      Statements of Stockholders’ Equity (continued)


Years
      Ended December 31, 2006, 2005 and 2004




Retained
                Earnings
            
            Accumulated
                Other Comprehensive IncomeAppropriated
            
            Unappropriated
            
            (Loss)
            
            TotalBalance,
                December 31, 2003
            
            $
            3,775,254
            
            $
            3,461,621
            
            $
            (4,150
            )
            $
            26,014,862Foreign
                currency translation gain
            
            
            —
            
            
            —
            
            
            7,210
            
            
            7,210Deemed
                distribution to shareholders
            
            
            —
            
            
            —
            
            
            —
            
            
            (831,837
            )Deemed
                distribution to minority
              shareholders
            
            
            25,753
            
            
            —
            
            
            —
            
            
            25,753Issuance
                of stock options to
              independent
                directors
            
            
            —
            
            
            —
            
            
            —
            
            
            55,125Net
                income for the year ended
              December
                31,2004
            
            
            —
            
            
            6,867,337
            
            
            —
            
            
            6,867,337Appropriation
                of retained earnings
            
            
            595,332
            
            
            (595,332
            )
            
            —
            
            
            —Balance,
                ended December 31, 2004
            
            $
            4,396,339
            
            $
            9,733,626
            
            $
            3,060
            
            $
            32,138,449Foreign
                currency translation gain
            
            
            —
            
            
            —
            
            
            1,329,624
            
            
            1,
                329,624Deemed
                distribution to shareholders
            
            
            —
            
            
            —
            
            
            —
            
            
            74,704Issuance
                of stock options to
              independent
                directors
            
            
            —
            
            
            —
            
            
            —
            
            
            68,850Net
                income for the year ended
              December
                31,2005
            
            
            —
            
            
            3,315,478
            
            
            —
            
            
            3,315,478Appropriation
                of retained earnings
            
            
            526,923
            
            
            (526,923
            )
            
            —
            
            
            —Balance,
                ended December 31, 2005
            
            $
            4,923,262
            
            $
            12,522,180
            
            $
            1,332,684
            
            $
            36,927,105Foreign
                currency translation gain
            
            
            —
            
            
            —
            
            
            1,136,116
            
            
            1,136,116Sale
                of common stock
            
            
            —
            
            
            —
            
            
            —
            
            
            10,899,994Exercise
                of stock option by independent directors
            
            
            —
            
            
            —
            
            
            —
            
            
            101,250Cash
                paid for retaining fee,commissions
                and placement agent fee in connection with offering
            
            
            —
            
            
            —
            
            
            —
            
            
            (627,504
            )Issuance
                of common stock related to financing services
            
            
            —
            
            
            —
            
            
            —
            
            
            450,000Payment
                of financing services by issuance of common stock inaccordance
                with Cornell Partners, LP
            
            
            —
            
            
            —
            
            
            —
            
            
            (450,000
            )Issuance
                of a warrant to purchase common stock
            
            
            —
            
            
            —
            
            
            —
            
            
            832,639Payment
                of commissions and placement agentfee
                byissuance
                of common stock warrantsin accordance withCornell
                Partners, LP
            
            
            —
            
            
            —
            
            
            —
            
            
            (832,639
            )Issuance
                of stock options to
              independent
                directors
            
            
            —
            
            
            —
            
            
            —
            
            
            131,625Net
                income for the year ended
              December
                31,2006
            
            
            —
            
            
            4,811,704
            
            
            —
            
            
            4,811,704Appropriation
                of retained earnings
            
            
            1,286,647
            
            
            (1,286,647
            )
            
            —
            
            
            —Balance,
                December 31, 2006
            
            $
            6,209,909
            
            $
            16,047,237
            
            $
            2,468,800
            
            $
            53,380,290




The
      accompanying notes are an integral part of these consolidated financial
      statements.




65





China
      Automotive Systems, Inc. and Subsidiaries


Consolidated
      Statements of Cash Flows


Years
      Ended December 31, 2006, 2005 and 2004




Item
            
            2006
            
            2005
              (As
                Restated See Note 4)
            
            2004Cash
                flows from operating activities:Net
                income from continuing operations
            
            $
            4,811,704
            
            $
            3,315,478
            
            $
            6,888,928Adjustments
                to reconcile net income from continuing operations to net cash provided
                by
                operating activities:Minority
                interests
            
            
            5,545,350
            
            
            2,680,318
            
            
            4,182,454Stock-based
                compensation
            
            
            131,625
            
            
            68,850
            
            
            55,125Depreciation
                and amortization
            
            
            6,476,214
            
            
            4,908,243
            
            
            2,006,052Allowance
                for doubtful accounts (Recovered)
            
            
            995,440
            
            
            (74,911
            )
            
            (126,370
            )Other
                operating adjustments
            
            
            3,121
            
            
            0
            
            
            7,208Changes
                in operating assets and liabilities:(Increase)
                decrease in:Pledged
                deposits
            
            
            (2,194,003
            )
            
            656,876
            
            
            (570,468
            )Accounts
                and notes receivable
            
            
            (14,785,434
            )
            
            (3,786,037
            )
            
            846,504Advance
                payments and other
            
            
            219,491
            
            
            1,417,550
            
            
            5,953,500Inventories
            
            
            (2,534,133
            )
            
            (100,143
            )
            
            (2,882,650
            )Increase
                (decrease) in:Accounts
                and notes payable
            
            
            4,932,755
            
            
            2,856,879
            
            
            5,640,160Customer
                deposits
            
            
            (17,355
            )
            
            (69,470
            )
            
            (425,086
            )Accrued
                payroll and related costs
            
            
            32,735
            
            
            47,517
            
            
            (183,809
            )Accrued
                expenses and other payables
            
            
            2,313,144
            
            
            (277,738
            )
            
            2,912,148Accrued
                pension costs
            
            
            498,345
            
            
            214,093
            
            
            922,322Taxes
                payable
            
            
            1,540,213
            
            
            357,466
            
            
            (2,505,976
            )Advances
                payable
            
            
            (62
            )
            
            105,236
            
            
            (169
            )Net
                cash provided by operating activities from continued
                operations
            
            $
            7,969,150
            
            $
            12,320,207
            
            $
            22,719,873Net
                cash (used in) operating activities from discontinued
                operations
            
            
            —
            
            
            —
            
            
            (1,354,506
            )Net
                cash provided by operating activities
            
            $
            7,969,150
            
            $
            12,320,207
            
            $
            21,365,367Cash
                flows from investing activities:(Increase)
                decrease in other receivables
            
            $
            5,873,453
            
            $
            (1,687,647
            )
            $
            316,185Cash
                received from equipment sales
            
            
            461,280
            
            
            280,735
            
            
            2,483,415Cash
                paid to acquire property, plant and equipment
            
            
            (7,378,910
            )
            
            (11,026,397
            )
            
            (20,294,671
            )Cash
                paid to acquire intangible assets
            
            
            (174,926
            )
            
            (185,387
            )
            
            (230,448
            )Cash
                paid in other investing activities
            
            
            —
            
            
            —
            
            
            (626,506
            )Net
                cash (used in) investing activities from continued
                operations
            
            $
            (1,219,103
            )
            $
            (12,618,696
            )
            $
            (18,352,025
            )Net
                cash provided by investing activities from discontinued
                operations
            
            
            —
            
            
            —
            
            
            121,769Net
                cash (used in) investing activities
            
            $
            (1,219,103
            )
            $
            (12,618,696
            )
            $
            (18,230,256
            )Cash
                flows from financing activities:Increase
                in proceeds from bank loans
            
            $
            —
            
            $
            1,200,357
            
            $
            3,975,904Dividends
                paid to the minority interest holders of Joint-venture
                companies
            
            
            (3,894,634
            )
            
            (1,196,451
            )
            
            (4,469,379
            )Increase
                (decrease) in amounts due to shareholders/directors
            
            
            (429,061
            )
            
            177,048
            
            
            (4,639,687
            )Proceeds
                from issuance of common stock
            
            
            10,373,740
            
            
            —
            
            
            —Capital
                Contribution from the minority interest holders of Joint-venture
                companies
            
            
            1,420,926
            
            
            —
            
            
            1,251,085Net
                cash provided by (used in) financing activities from continued
                operations
            
            $
            7,470,971
            
            $
            180,954
            
            $
            (3,882,077
            )Net
                cash provided by financing activities from discontinued
                operations
            
            
            —
            
            
            —
            
            
            1,180,723Net
                cash provided by (used in) financing activities
            
            $
            7,470,971
            
            $
            180,954
            
            $
            (2,701,354
            )Cash
                and cash equivalents effected by foreign currency
            
            $
            822,538
            
            $
            1,327,840
            
            $
            —Net
                change in cash and cash equivalentsNet
                increase in cash and cash equivalents from continued
                operations
            
            $
            15,043,556
            
            $
            1,210,305
            
            $
            485,771Net
                (decrease) in cash and cash equivalents from discontinued
                operations
            
            
            —
            
            
            —
            
            
            (52,014
            )Net
                increase in cash and cash equivalents
            
            $
            15,043,556
            
            $
            1,210,305
            
            $
            433,757Cash
                and cash equivalents, at the beginning of year
            
            
            12,374,944
            
            
            11,164,639
            
            
            10,730,882Cash
                and cash equivalents, at the end of year
            
            $
            27,418,500
            
            $
            12,374,944
            
            $
            11,164,639




The
      accompanying notes are an integral part of these consolidated financial
      statements




66




China
      Automotive Systems, Inc. and Subsidiaries


Consolidated
      Statements of Cash Flows (continued)


Years
      Ended December 31, 2006, 2005 and 2004




SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:




2006
            
            2005
            
            2004Cash
                paid for interest
            
            $
            834,406
            
            $
            915,066
            
            $
            641,277Cash
                paid for income taxes
            
            $
            1,738,773
            
            $
            1,205,523
            
            $
            1,676,290




SUPPLEMENTAL
      DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:




2006
            
            2005
            
            2004Invested
                in technology by minority interest holder of a joint venture
                company
            
            $
            —
            
            $
            (3,066,000
            )
            $
            —Intangible
                assets contributed by minority interest holder of a joint venture
                company
            
            
            —
            
            
            3,066,000
            
            
            —Disposal
                of property, plant and equipment on a cashless basis
            
            
            —
            
            
            (2,468,574
            )
            
            —Other
                receivable in connection with disposal of property, plant and equipment
                on
                a cashless basis
            
            
            —
            
            
            2,636,444
            
            
            —Contribution
                by shareholders in connection with disposal of property, plant and
                equipment on a cashless basis
            
            
            —
            
            
            (
                74,704
            )
            
            —Additional
                interest to minority interest holders in connection with disposal
                of
                property, plant and equipment on a cashless basis
            
            
            —
            
            
            (93,168
            )
            
            —Deemed
                distribution to chairman of the company
            
            
            —
            
            
            —
            
            
            (831,837
            )Issuance
                of common shares on a non-cash basis
            
            
            4
            
            
            —
            
            
            —Financing
                services fee related to issuance of common shares
            
            
            (4
            )
            
            —
            
            
            —Increase
                in capital by minority shareholders of Joint-venture companies on
                a
                non-cash basis
            
            
            921,785
            
            
            —
            
            
            —Dividends
                payable to minority shareholders of Joint-venture companies being
                converted into capital
            
            $
            (921,785
            )
            $
            —
            
            $
            —




The
      accompanying notes are an integral part of these consolidated financial
      statements.




67




China
      Automotive Systems, Inc. and Subsidiaries


Notes
      to
      Consolidated Financial Statements


Years
      Ended December 31, 2006 and 2005




1.
      Organization and Business




China
      Automotive Systems, Inc., “ China Automotive”, was incorporated in the State of
      Delaware on June 29, 1999 under the name Visions-In-Glass, Inc. China
      Automotive, including, when the context so requires, its subsidiaries and the
      subsidiaries’ interests in the Sino-foreign joint ventures described below, is
      referred to herein as the “Company”. The Company, through its Sino-foreign joint
      ventures described below, is primarily engaged in the manufacture and sale
      of
      automotive systems and components in the People’s Republic of China, the “PRC”
or “China”, as described below.




Great
      Genesis Holding Limited, a company incorporated on January 3, 2003 under The
      Companies Ordinance in Hong Kong as a limited liability company, “Great
      Genesis”, is a wholly-owned subsidiary of the Company.  Ji Long Enterprise
      Investment Limited was incorporated on October 8, 1992 under the Companies
      Ordinance in Hong Kong as a limited liability company, “Ji Long”. Ji Long is an
      investment holding company. Effective March 4, 2003, all of the shareholders
      of
      Ji Long exchanged their 100% shareholder interest for a 100% shareholder
      interest in Great Genesis, as a result of which Ji Long became a wholly-owned
      subsidiary of Great Genesis.




The
      Company owns the following aggregate net interests in seven Sino-foreign joint
      ventures organized in the PRC as of December 31, 2006. (Jingzhou Henglong Fulida
      Textile Co., Ltd, “Jingzhou”, was sold in August 2004).




Percentage
                InterestName
                of Entity
            
            2006
            
            2005
            
            2004Jingzhou
                Henglong Automotive Parts Co., Ltd., "Henglong"
            
            
            44.5
            %
            
            44.5
            %
            
            44.5
            %Shashi
                Jiulong Power Steering Gears Co., Ltd., "Jiulong"
            
            
            81.0
            %
            
            81.0
            %
            
            81.0
            %Shenyang
                Jinbei Henglong Automotive Steering System Co., Ltd.,
                ”Shenyang"
            
            
            70.0
            %
            
            70.0
            %
            
            70.0
            %Zhejiang
                Henglong & Vie Pump-Manu Co., Ltd., "Zhejiang"
            
            
            51.0
            %
            
            51.0
            %
            
            51.0
            %Universal
                Sensor Application Inc., “USAI”
            
            
            60.0
            %
            
            60.0
            %
            
            —Wuhan
                Jielong Electric Power Steering Co., Ltd., “Jielong”
            
            
            85.0
            %
            
            —
            
            
            —Wuhu
                HengLong Automotive Steering System Co., Ltd., “Wuhu”
            
            
            77.33
            %
            
            —
            
            
            —




Jiulong
      was established in 1993 and mainly engaged in the production of integral power
      steering gears for heavy-duty vehicles.




Henglong
      was established in 1997 and mainly engaged in the production of rack and pinion
      power steering gears for cars and light duty vehicles.




Shenyang
      was established in 2002 and focuses on power steering parts for light duty
      vehicles.




Zhejiang
      was established in 2002 to focus on power steering pumps.




On
      April
      12, 2005, Great Genesis entered into a Joint-venture agreement with Shanghai
      Hongxi Investment Inc., “Hongxi”, a company controlled by Mr. Hanlin Chen, the
      Company’s Chairman, and Sensor System Solution Inc., “Sensor”, to establish a
      joint venture, Universal Sensor Application Inc., “USAI”, in the Wuhan East Lake
      development zone to engage in production and sales of sensor modulars. The
      registered capital of the Joint-venture is $10 million. Great Genesis and Hongxi
      will invest $6 million and $1 million, respectively, including cash and land
      and
      building, which will account for 60% and 10% of the total registered capital,
      respectively. Sensor will invest $3 million in technology, accounting for 30%
      of
      the total registered capital. Renminbi, RMB, is the currency of the PRC. As
      of
      December 31, 2006, Great Genesis has contributed $900,337, the equivalent of
      RMB7,200,000 and Hongxi has contributed $436,954 in cash, the equivalent of
      RMB3,500,000. Pursuant to the above joint venture agreement, Sensor has failed
      to contribute it's sensor-related technologies and thereby failed to fulfill
      it's capital contribution commitment as of March 20, 2007. As a result Sensor
      has withdrawn from USAI and another technology supplier is being
      sought.




68




On
      April
      14, 2006, Great Genesis entered into a Joint-venture agreement with Hong Kong
      Tongda, “Tongda”, to establish a joint venture, Wuhan Jielong Electric Power
      Steering Co., Ltd., “Jielong”, in the Wuhan East Lake development zone. Jielong
      is mainly engaged in the production and sales of electric power steering, “EPS”.
      The registered capital of the Joint-venture is $6 million, the equivalent of
      RMB48,000,000. Great Genesis and Tongda will invest $5,100,000 and $900,000,
      respectively, amounting to 85% and 15% of the total registered capital,
      respectively. As of December 31, 2006, Great Genesis and Tongda have contributed
      $765,000 and $135,034 in cash, the equivalent of RMB6,136,830 and RMB1,081,620,
      respectively.




On
      March
      31, 2006, as amended on May 2, 2006, Great Genesis, entered into a Joint-venture
      agreement with Wuhu Chery Technology Co., Ltd., “Chery Technology”, to establish
      a Joint-venture, Wuhu Henglong Automotive Steering System Co., Ltd., “Wuhu”, in
      the Wuhu Technological Development Zone. Wuhu is mainly engaged in the
      production and sales of automobile steering system. The registered capital
      of
      the Joint-venture is $3,750,387, the equivalent of RMB30,000,000. Great Genesis
      and Chery Technology invested $2,900,300 and $848,938, respectively, which
      accounts for 77.33% and 22.67% of the total registered capital, respectively.




During
      the year 2006, USAI, Jielong
      and Wuhu were in the early technology and production preparation
      stage.




Jingzhou
      was divested from the Company’s operations as of August 31, 2004, and Jingzhou
      generated revenues of $2,746,389 and a net loss of $42,337, including $20,746
      belonging to minority holders, during the consolidation
      period.




The
      divested non-core business of Jingzhou has been treated as a discontinued
      operation under SFAS No. 144. Jingzhou’s results of operation and related
      charges have been reclassified as discontinued operations in the Company’s
      consolidated statements of operations in 2004.




2.
      Basis
      of Presentation and Significant Accounting Policies




Basis
      of
      Presentation - For the year ended December 31, 2006, 2005 and 2004, the
      accompanying consolidated financial statements include the accounts of the
      Company and its seven subsidiaries, which are mentioned in Note 1. Significant
      inter-company balances and transactions have been eliminated upon consolidation.
      The consolidated financial statements have been prepared in accordance with
      generally accepted accounting principles in the United States of
      America.




D uring
      early 2003, the Directors of the Company and the other joint venture partners
      in
      the Company’s Sino-foreign joint ventures executed “Act in Concert” agreements,
      resulting in the Company having voting control in such Sino-foreign joint
      ventures. Consequently, effective January 1, 2003, the Company changed from
      equity accounting to consolidation accounting for its investments in
      Sino-foreign joint ventures for the year ended December 31, 2003. Prior to
      January 1, 2003, the Company used the equity method pursuant to Emerging Issues
      Task Force Issue No. 96-16, as described as follows.




Henglong
      was formed in 1997, with 44.5% owned by the Company, 36.5% owned by Hubei
      Wanlong Investment Co., Ltd., “HBWL”, controlled by Mr. Hanlin Chen, the
      Company’s Chairman ,19% owned by Jingzhou Jiulong Machinery and Electronic
      Manufacturing Co., Ltd., “JLME”. The highest authority of the joint venture is
      the Board of Directors, which is comprised of five directors, two of which,
      40%,
      are appointed by the Company, two of which, 40%, are appointed by HBWL, and
      one
      of which, 20%, is appointed by JLME. Because of the Company’s control over the
      operation and assets of Henglong, the minority shareholders of Henglong have
      no
      right to select, terminate and set the compensation of management responsible
      for implementing the enterprise’s policies and procedures, nor do they have any
      right to establish operating and capital decisions of Henglong.




Jiulong
      was formed in 1993, with 81% owned by the Company, 10% owned by Jingzhou Jiulong
      Machinery and Electronic Manufacturing Co., Ltd., “JLME”, and 9% owned by
      Jingzhou Tianxin Investment Consulting Co., Ltd., “Tianxin”. The highest
      authority of the joint venture is the Board of Directors, which is comprised
      of
      five directors, four of which, 80%, are appointed by the Company, and one of
      whom, 20%, are appointed by JLME. As for day-to-day operating matters, approval
      by more than two-thirds of the members of the Board of Directors, 67%, is
      required. The Chairman of the Board of Directors is appointed by JLME. The
      general manager is appointed by the Company.




69




Shenyang
      was formed in 2002, with 70% owned by the Company, 30% owned by Shengyang
      Automotive Industry Investment Corporation, “JB Investment”. The highest
      authority of the joint venture is the Board of Directors, which is comprised
      of
      seven directors, four of whom, 57%, are appointed by the Company, and three
      of
      whom, 43%, are appointed by JB Investment. As for day-to-day operating matters,
      approval by more than two-thirds of the members of the Board of Directors,
      67%,
      is required. The Chairman of the Board of Directors is appointed by the Company.
      The general manager is appointed by the Company.




Zhejiang
      was formed in 2002, with 51% owned by the Company and 49% owned by Zhejiang
      Vie
      Group, “ZVG”. The highest authority of the joint venture is the Board of
      Directors, which is comprised of seven directors, four of whom, 57%, are
      appointed by the Company and three of whom, 43%, are appointed by ZVG. As for
      day-to-day operating matters, approval by more than two-thirds of the members
      of
      the Board of Directors, 67%, is required. The Chairman of the Board of Directors
      is appointed by ZVG. The general manager is appointed by the Company.




USAI
      was
      formed in 2005, with 60% owned by the Company, 30% owned by Sensor System
      Solutions Inc. in America, “Sensor”, and 10% owned by Shanghai Hongxi Investment
      Inc., “Hongxi”, controlled by Mr. Hanlin Chen, the Company’s Chairman. The
      highest authority of the joint venture is the Board of Directors, which is
      comprised of three directors, two of whom, 67%, are appointed by the Company,
      one of whom, 33%, is appointed by Sensor. As for day-to-day operating matters,
      approval by more than two-thirds of the members of the Board of Directors,
      67%,
      is required. The Chairman of the Board of Directors is appointed by the Company.
      The general manager is appointed by Sensor. Pursuant to the joint venture
      agreement regarding the formation of USAI, Sensor has failed to contribute
      it's
      sensor-related technologies and thereby failed to fulfill it's capital
      contribution commitment as of March 20, 2007. As a result Sensor has withdrawn
      from USAI and another technology supplier is being sought.




Jielong
      was formed in April 2006, with 85% owned by the Company, 15% owned by Hong
      Kong
      Tongda, “Tongda”. The highest authority of the joint venture is the Board of
      Directors, which is comprised of three directors, two of whom, 67%, are
      appointed by the Company, one of whom, 33%, is appointed by Tongda. As for
      day-to-day operating matters, approval by more than two-thirds of the members
      of
      the Board of Directors, 67%, is required. The Chairman of the Board of Directors
      is appointed by the Company. The general manager is appointed by the
      Company.




Wuhu
      was
      formed in May 2006, with 77.33% owned by the Company, 22.67% owned by Wuhu
      Chery
      Technology Co., Ltd., “Chery Technology”. The highest authority of the joint
      venture is the Board of Directors, which is comprised of five directors, three
      of whom, 60%, are appointed by the Company, two of whom, 40%, is appointed
      by
      Chery Technology. As for day-to-day operating matters, approval by more than
      two-thirds of the members of the Board of Directors, 67%, is required. The
      Chairman of the Board of Directors is appointed by the Company. The general
      manager is appointed by the Company.




With
      the
      exception of Sensor System Solutions Inc., an American listed company, the
      minority partners of each of the joint ventures are all private companies not
      controlled, directly or indirectly, by any PRC municipal government or other
      similar government entity.




Use
      of
      Estimates - The preparation of financial statements in conformity with
      accounting principles generally accepted in the United States requires
      management to make estimates and assumptions that affect the reported amounts
      of
      assets and liabilities, disclosure of contingent assets and liabilities at
      the
      date of the financial statements, and the reported amounts of revenues and
      expenses during the reporting periods. The Company feels that the significant
      items were warranty reserves, long term assets and investment, the realizable
      value of accounts receivable and inventories, useful lives of property, plant
      and equipment, accruals and warranty liabilities. Actual results could differ
      from those estimates.




70




Cash
      and
      Cash Equivalents - Cash and cash equivalents include all highly-liquid
      investments with an original maturity of three months or less at the date of
      purchase.




Pledged
      Cash Deposits - The Company has pledged cash deposits to secure trade financing
      provided by banks.




Accounts
      Receivable - In order to determine the value of the Company’s accounts
      receivable, the Company records a provision for doubtful accounts to cover
      estimated credit losses. Management reviews and adjusts this allowance
      periodically based on historical experience and its evaluation of the
      collectibility of outstanding accounts receivable. The Company evaluates the
      credit risk of its customers utilizing historical data and estimates of future
      performance.




Inventories
      - Inventories are stated at the lower of cost and net realizable value. Cost
      is
      calculated on the moving-average basis and includes all costs to acquire and
      other costs incurred in bring 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
      moving-average cost if it exceeds the net realizable value.




Advance
      Payments - These amounts represent advances or prepayments to acquire various
      assets to be utilized in the future in the Company’s normal business operations.
      Such amounts are paid according to their respective contract terms and are
      classified as a current asset in the consolidated balance sheet.




Property,
      Plant and Equipment - Property, plant and equipment are stated at cost. Major
      renewals and improvements are capitalized; minor replacements and maintenance
      and repairs are charged to operations. Depreciation is provided on the
      straight-line method over the estimated useful lives of the respective assets
      as
      follows:




Category
            
            Estimated
                Useful Life (Years)Land
                use rights and buildings:Land
                use rights
            
            45-50Buildings
            
            25Machinery
                and equipment
            
            6Electronic
                equipment
            
            4Motor
                vehicles
            
            6




Assets
      under construction- represent buildings under construction and plant and
      equipment pending installation-- are stated at cost. Cost includes construction
      and acquisitions, and interest charges arising from borrowings used to finance
      assets during the period of construction or installation and testing. No
      provision for depreciation is made on assets under construction until such
      time
      as the relevant assets are completed and ready for their intended commercial
      use.




Gains
      or
      losses on disposal of property, plant and equipment are determined as the
      difference between the net disposal proceeds and the carrying amount of the
      relevant asset, and are recognized in the consolidated statements of operations
      on the date of disposal.




Interest
      Costs Capitalized - Interest costs incurred in connection with specific
      borrowings for the acquisition, construction or installation of property, plant
      and equipment are capitalized and depreciated as part of the asset’s total cost
      when the respective asset is placed into service.




Intangible
      Assets - Intangible assets, representing patents and technical know-how
      acquired, are stated at cost less accumulated amortization and impairment
      losses. Amortization is calculated on the straight-line method over the
      estimated useful life of 5 to 15 years.




71


Long-Lived
      Assets - The Company has adopted the provisions of Statement of Financial
      Accounting Standards No. 144, “Accounting for the Impairment or Disposal of
      Long-Lived Assets”. Property, plant and equipment and intangible assets are
      reviewed periodically for impairment losses whenever events or changes in
      circumstances indicate that the carrying amount of an asset may not be fully
      recoverable. If required, an impairment loss is recognized as the difference
      between the carrying value and the fair value of the assets.




In
      January 2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible
      Assets”. The Company did not have any goodwill at December 31, 2006 and
      2005.




Impairment
      of long-lived assets is monitored on a continuing basis, and is assessed based
      on the undiscounted cash flows generated by the underlying assets. In the event
      that the carrying amount of long-lived assets exceeds the undiscounted future
      cash flows, then the carrying amount of such assets is adjusted to their fair
      value.




Long-Term
      Investments - Investments in which the Company owns less than 20% of the
      investee company and does not have the ability to exert significant influence
      are stated at cost, and are reviewed periodically for realizability.




Revenue
      from Product Sales Recognition - The Company recognizes revenue when the
      significant risks and rewards of ownership have been transferred to the customer
      pursuant to PRC law, including factors such as when persuasive evidence of
      an
      arrangement exists, delivery has occurred, the sales price is fixed or
      determinable, sales and value added tax laws have been complied with, and
      collectibility is probable. The Company recognizes product sales generally
      at
      the time the product is shipped. Concurrent with the recognition of revenue,
      the
      Company reduces revenue for estimated product returns. Shipping and handling
      costs are included in cost of goods sold. Revenue is presented net of any sales
      tax and value added tax.




Revenue
      from Materials and Other Assets Sales Recognition - Normally, the Company
      purchases materials only for its production. Occasionally, some materials will
      be sold to other suppliers in case of temporary inventory overage of such
      materials and to make a profit on any price difference. The Company is
      essentially the agent in these transactions because it does not have any risk
      of
      product return. When there is any quality or quantity loss, the suppliers are
      obligated to restitution. Income generated from selling materials is recorded
      as
      the net amount retained, that is, the amount billed to the customers less the
      amount paid to suppliers, in the consolidated statement of operations in
      accordance with EITF 99-19.





Revenue
      from other asset sales represents gains or losses from other assets, for
      example, used equipment. Income generated from selling other assets is recorded
      as the sales amount less cost of the assets. The Company has classified such
      revenue from materials and other asset sales into gain on other sales in its
      consolidated statement of operations.




Sales
      Taxes - The Company is subject to value added tax, “VAT”. The applicable VAT tax
      rate is 17% for products sold in the PRC. The amount of VAT liability is
      determined by applying the applicable tax rate to the invoiced amount of goods
      sold less VAT paid on purchases made with the relevant supporting invoices.
      VAT
      is collected from customers by the Company on behalf of the PRC tax authorities
      and is therefore not charged to the consolidated statements of operations.




Product
      Warranties - 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.




72




For
      the
      year ended December 31, 2006 and 2005, the warranties activities were as
      follows:




December
                31,2006
            
            2005Balance
                at the beginning of year
            
            $
            1,787,869
            
            $
            548,390Additions
                during the reporting period
            
            
            3,956,521
            
            
            1,787,870Settlement
                within reporting period, by cash or actual material
            
            
            (2,858,829
            )
            
            (561,931
            )Foreign
                currency translation
            
            
            68,765
            
            
            13,540Balance
                at the end of year
            
            $
            2,954,326
            
            $
            1,787,869




The
      Company has recorded $ 2,954,326 and $1,787,869 product warranty reserves for
      the years ended December 31, 2006 and 2005, which were included in the accrued
      liabilities in the accompanying consolidated financial statements.




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




Interest
      Rate Risk - Bank loans are charged at fixed interest rates.




Income
      Taxes - The Company accounts for income taxes using the liability method whereby
      deferred income taxes are recognized for the tax consequences of temporary
      differences by applying statutory tax rates applicable to future years to
      differences between the financial statement carrying amounts and the tax bases
      of certain assets and liabilities. Changes in deferred tax assets and
      liabilities, if any, include the impact of any tax rate changes enacted during
      the year. A valuation allowance is provided for the amount of deferred tax
      assets that, based on available evidence, are not expected to be realized.




Research
      and Development Costs - Research and development costs are expensed as
      incurred.




Advertising,
      Shipping and Handling Costs - Advertising, shipping and handling costs are
      expensed as incurred.




Income
      Per Share - Basic income per share is calculated by dividing net income by
      the
      weighted average number of common shares outstanding during the period. Diluted
      income per share is calculated based on the treasury stock method, assuming
      the
      issuance of common shares, if dilutive, resulting from the exercise of
      warrants.




Actual
      weighted average shares outstanding used in calculating basic and diluted income
      per share were:




Years
                Ended December 31,2006
            
            2005Weighted
                average shares outstanding
            
            
            23,198,113
            
            
            22,574,543Effect
                of dilutive securities
            
            
            12,562
            
            
            14,170Diluted
                shares outstanding
            
            
            23,210,675
            
            
            22,588,713




73




The
      156,250 shares underlying warrants issued to Cornell Capital Partners, LP on
      March 20, 2006 has not been included in the computation of diluted income per
      share because such inclusion would have had an anti-dilutive
      effect:




Years
                Ended December 31,2006
            
            2005Anti-dilutive
                securities
            
            
            100,421
            
            
            —




Comprehensive
      Income - The Company has adopted the provisions of Statement of Financial
      Accounting Standards No. 130, “Reporting Comprehensive Income” (“SFAS No. 130”).
      SFAS No. 130 establishes standards for the reporting and display of
      comprehensive income, its components and accumulated balances in a full set
      of
      general purpose financial statements. SFAS No. 130 defines comprehensive income
      to include all changes in equity except those resulting from investments by
      owners and distributions to owners, including adjustments to minimum pension
      liabilities, accumulated foreign currency translation, and unrealized gains
      or
      losses on marketable securities.




Fair
      Value of Financial Instruments - The Company believes that the carrying value
      of
      the its cash and cash equivalents, accounts receivable, accounts payable and
      accrued liabilities as of December 31, 2006 approximates their respective fair
      values due to the short-term nature of those instruments. The
      fair
      values of long-term other receivables and advances payable, discounted at 5.90%,
      would be approximately $909,000 and $295,000 respectively as of December 31,
      2006.




Stock-Based
      Compensation - The Company may issue stock options to employees and stock
      options or warrants to non-employees in non-capital raising transactions for
      services and for financing costs.




The
      Company has adopted Statement of Financial Accounting Standards (“SFAS”) No.
      123R, “Accounting for Stock-Based Compensation”, which establishes a fair value
      method of accounting for stock-based compensation plans. In accordance with
      SFAS
      No. 123R, the cost of stock options and warrants issued to employees and
      non-employees is measured at the grant date based on the fair value. The fair
      value is determined using the Black-Scholes option pricing model. The resulting
      amount is charged to expense on the straight-line basis over the period in
      which
      the Company expects to receive benefit, which is generally the vesting period.




Foreign
      Currencies - The Company maintains its books and records in Renminbi, RMB,
      the
      currency of the PRC, its functional currency. Foreign currency transactions
      in
      RMB are reflected using the temporal method. Under this method, all monetary
      items are translated into the functional currency at the rate of exchange
      prevailing at the balance sheet date. Non-monetary items are translated at
      historical rates. Income and expenses are translated at the rate in effect
      on
      the transaction dates. Transaction gains and losses, if any, are included in
      the
      determination of net income for the year.




In
      translating the financial statements of the Company from its functional currency
      into its reporting currency of United States dollars, balance sheet accounts
      are
      translated using the closing exchange rate in effect at the balance sheet date
      and income and expense accounts are translated using an average exchange rate
      prevailing during the reporting period. Adjustments resulting from the
      translation, if any, are included in cumulative other comprehensive income
      (loss) in stockholders’ equity.




74




Reclassifications
      -Certain amounts included in the prior year's consolidated financial statements
      have been reclassified to conform to the current year presentation. Such
      reclassifications did not have any effect on reported net income and are
      immaterial to the consolidated financial statements as a whole.




Certain
      Relationships And Related Transactions-




The
      following related parties are related through common ownership with the major
      shareholders of the Company:




Jingzhou
      Henglong Fulida Textile Co., Ltd. (“Jingzhou”)




Xiamen
      Joylon Co., Ltd. (“Xiamen Joylon”)




Shanghai
      Tianxiang Automotive Parts Co., Ltd. (“Shanghai Tianxiang”)




Shanghai
      Fenglong Materials Co., Ltd. (“Shanghai Fenglong”)




Changchun
      Hualong Automotive Technology Co., Ltd. (“Changchun Hualong”)




Jiangling
      Tongchuang Machining Co., Ltd. (“Jiangling Tongchuang”)




Beijing
      Hualong Century Digital S&T Development Co., Ltd. (“Beijing
      Hualong”)




Jingzhou
      Jiulong Material Co., Ltd. (“Jiulong Material”)




Shanghai
      Hongxi Investment Inc. ( “Hongxi”)




Hubei
      Wiselink Equipment Manufacturing Co., Ltd. (“Hubei Wiselink”)




Jingzhou
      Tongyi Special Parts Co., Ltd. (“Jingzhou Tongyi”)




Jingzhou
      Derun Agricultural S&T Development Co., Ltd. (“Jingzhou Derun”)




Jingzhou
      Tongying Alloys Materials Co., Ltd. (“Jingzhou Tongying”)




WuHan
      Dida Information S&T Development Co., Ltd. (“WuHan Dida”)




Hubei
      Wanlong Investment Co., Ltd. (“Hubei Wanlong”).




Principal
      policies of the Company in
      connection with transactions withthe related parties are as
      follow:




Products
      sold to related parties - The Company sold products to related parties at fair
      market prices, and also granted them credit of three to four months on an open
      account basis. These transactions were consummated under similar terms as the
      Company's other customers.




Materials
      purchases from related parities - The Company purchased materials from related
      parties at fair market prices, and also received credit of three to four months
      on an open account basis. These transactions were consummated under similar
      terms as the Company's other suppliers.




75




Equipment
      and production technology purchased from related parties - The Company purchased
      equipment and production technology from related parties at fair market prices,
      and was required to pay in advance based on the purchase agreement between
      the
      two parties, because such equipment manufacturing and technology development
      was
      required for a long period. These transactions were consummated under similar
      terms as the Company's other suppliers.




3 .
       Recent Accounting Pronouncements




In
      November 2004, the FASB issued SFAS No. 151, “Inventory Costs — An Amendment of
      Accounting Research Bulletin No. 43, Chapter 4” (“SFAS 151”). SFAS 151 clarifies
      that abnormal amounts of idle facility expense, freight, handling costs and
      spoilage should be expensed as incurred and not included in overhead as an
      inventory cost. The new statement also requires that allocation of fixed
      production overhead costs to conversion costs should be based on normal capacity
      of the production facilities. The provisions in SFAS 151 must be applied
      prospectively and became effective for the Company beginning January 1, 2006.
      The Company adopted this statement beginning in the first quarter of
      2006.




In
      December 2004, the FASB issued SFAS No. 152 “Accounting for Real Estate
      Time-Sharing Transactions - an amendment of FASB Statements No. 66 and 67”
(“SFAS 152”). This statement amends FASB Statement No. 66 “Accounting for Sales
      of Real Estate” to reference the financial accounting and reporting guidance for
      real estate time-sharing transactions that is provided in AICPA Statement of
      Position 04-2 “Accounting for Real Estate Time-Sharing Transactions” (“SOP
      04-2”). SFAS 152 also amends FASB Statement No. 67 “Accounting for Costs and
      Initial Rental operations of Real Estate Projects” to state that the guidance
      for incidental operations and costs incurred to sell real estate projects does
      not apply to real estate time-sharing transactions, with the accounting for
      those operations and costs being subject to the guidance in SOP 04-2. The
      provisions of SFAS 152 are effective in fiscal years beginning after June 15,
      2005. The Company adopted this statement beginning in the third quarter of
      2005.




In
      December 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-Based
      Payment” (“SFAS 123R”). This statement requires financial statement recognition
      of compensation cost related to share-based payment transactions. Share-based
      payment transactions within the scope of SFAS 123R include stock options,
      restricted stock plans, performance-based awards, stock appreciation rights,
      and
      employee share purchase plans. The provisions of SFAS 123R are effective for
      the
      first fiscal year beginning after June 15, 2005. However, in April 2005, the
      SEC
      deferred the effective date of SFAS 123R for SEC registrants to the first
      interim period beginning after June 15, 2005. Accordingly, the Company adopted
      this statement beginning in the first quarter of 2006.




In
      December 2004, the FASB issued SFAS No. 153 “Exchanges of Nonmonetary Assets, an
      amendment of Accounting Principles Board Opinion No. 29” (“SFAS 153”). This
      statement amends Accounting Principles Board Opinion (APB) No. 29, “Accounting
      for Nonmonetary Transactions” to eliminate the exception for nonmonetary
      exchanges of similar productive assets and replaces it with a general exception
      for exchanges of nonmonetary assets that have no commercial substance. Under
      SFAS 153, if a nonmonetary exchange of similar productive assets meets a
      commercial-substance criterion and fair value is determinable, the transaction
      must be accounted for at fair value resulting in recognition of any gain or
      loss. SFAS 153 was effective for nonmonetary transactions in fiscal periods
      beginning after June 15, 2005. The Company adopted this statement beginning
      in
      the first quarter of 2006.




In
      March
      2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset
      Retirement Obligations, an Interpretation of FASB Statement No. 143” (“FIN 47”).
      Under FIN 47, we are required to recognize a liability for the fair value of
      a
      conditional asset retirement obligation if the fair value of the liability
      can
      be reasonably estimated. Any uncertainty about the amount and/or timing of
      future settlement should be factored into the measurement of the liability
      when
      sufficient information exists. FIN 47 also clarifies when an entity would have
      sufficient information to reasonably estimate the fair value. The provisions
      of
      FIN 47 were required to be applied no later than the end of fiscal years ending
      after December 15, 2005. The Company adopted this statement beginning in the
      first quarter of 2006.




76




In
      May
      2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections —
a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS 154”). This
      statement changes the requirements for the accounting for and reporting of
      a
      change in accounting principle and applies to all voluntary changes in
      accounting principle. It also applies to changes required by an accounting
      pronouncement in the unusual instance that the pronouncement does not include
      specific transitional provisions. When a pronouncement includes specific
      transitional provisions, those provisions should be followed. APB No. 20
      required that most voluntary changes in accounting principle be recognized
      by
      including in net income, of the period of the change the cumulative effect
      of
      changing to the new accounting principle. This statement requires retrospective
      application to prior period financial statements of changes in accounting
      principle, unless it is impracticable to determine either the period-specific
      effects or the cumulative effect of the change. The provisions of SFAS 154
      are
      effective for fiscal years beginning after December 15, 2005. The Company
      adopted this statement beginning in the first quarter of 2006.




In
      February 2006, the FASB issued SFAS No. 155, “Accounting for Certain
      Hybrid Financial Instruments” (“SFAS 155”). This Statement amends FASB
      Statements No. 133, Accounting for Derivative Instruments and Hedging
      Activities, and No. 140, Accounting for Transfers and Servicing of
      Financial Assets and Extinguishments of Liabilities. This Statement resolves
      issues addressed in Statement 133 Implementation Issue No. D1, “Application
      of Statement 133 to Beneficial Interests in Securitized Financial Assets.” SFAS
      No. 155 permits fair value remeasurement for any hybrid financial
      instrument that contains an embedded derivative that otherwise would require
      bifurcation, clarifies which interest-only strips and principal-only strips
      are
      not subject to the requirements of Statement 133, and establishes a requirement
      to evaluate interests in securitized financial assets to identify interests
      that
      are freestanding derivatives or that are hybrid financial instruments that
      contain an embedded derivative requiring bifurcation. It also clarifies that
      concentrations of credit risk in the form of subordination are not embedded
      derivatives and amends Statement 140 to eliminate the prohibition on a
      qualifying special-purpose entity from holding a derivative financial instrument
      that pertains to a beneficial interest other than another derivative financial
      instrument. This Statement is effective for all financial instruments acquired
      or issued after the beginning of an entity’s first fiscal year that begins after
      September 15, 2006. The Company has not yet determined the impact of the
      adoption of SFAS No. 155 on its financial statements, if any.




In
      March
      2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
      Assets” (“SFAS 156”). This Statement amends FASB Statement No. 140, Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities, with respect to the accounting for separately recognized servicing
      assets and servicing liabilities. This Statement requires an entity to recognize
      a servicing asset or servicing liability each time it undertakes an obligation
      to service a financial asset by entering into a servicing contract in indicated
      situations; requires all separately recognized servicing assets and servicing
      liabilities to be initially measured at fair value, if practicable; permits
      an
      entity to choose relevant subsequent measurement methods for each class of
      separately recognized servicing assets and servicing liabilities; at its initial
      adoption, permits a one-time reclassification of available-for-sale securities
      to trading securities by entities with recognized servicing rights, without
      calling into question the treatment of other available-for-sale securities
      under
      Statement 115, provided that the available-for-sale securities are identified
      in
      some manner as offsetting the entity’s exposure to changes in fair value of
      servicing assets or servicing liabilities that a servicer elects to subsequently
      measure at fair value; and requires separate presentation of servicing assets
      and servicing liabilities subsequently measured at fair value in the statement
      of financial position and additional disclosures for all separately recognized
      servicing assets and servicing liabilities. The Company has determined that
      the
      adoption of SFAS No. 156 did not have a material impact on the Consolidated
      Financial Statements.




In
      September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, (“SFAS
      157”), to define fair value, establish a framework for measuring fair value in
      accordance with generally accepted accounting principles and expand disclosures
      about fair value measurements. SFAS 157 requires quantitative disclosures using
      a tabular format in all periods (interim and annual) and qualitative disclosures
      about the valuation techniques used to measure fair value in all annual periods.
      The provisions of this Statement shall be effective for financial statements
      issued for fiscal years beginning after November 15, 2007 and interim periods
      within those fiscal years. The Company will be required to adopt the provisions
      of this statement as of January 1, 2008. The Company is currently evaluating
      the
      impact of adopting SFAS 157.




77




In
      September 2006, the FASB issued Statement No. 158, “Employers’ Accounting for
      Defined Benefit Pension and Other Postretirement Plans - An amendment of FASB
      Statements No. 87, 88, 106, and 132(R)” (“SFAS 158”). This Statement enhances
      disclosure regarding the funded status of an employer’s defined benefit
      postretirement plan by (a) requiring companies to include the funding status
      in
      comprehensive income, (b) recognize transactions and events that affect the
      funded status in the financial statements in the year in which they occur,
      and
      (c) at a measurement date of the employer’s fiscal year-end. Statement No. 158
      is effective for fiscal years ending after December 15, 2008, and is not
      expected to apply to the Company.




In
      February 2007, FASB issued SFAS No. 159, The Fair Value Option for Financial
      Assets and Financial Liabilities Including an Amendment of FASB Statement No.
      115 (“ SFAS 159”). SFAS 159 permits entities to choose to measure many financial
      instruments and certain other items at fair values. SFAS 159 is effective
      for fiscal years after November 15, 2007. The Company is currently evaluating
      the impact of adopting SFAS 159 on its financial statements.




4.
      Restatement




Subsequent
      to the issuance of the Company’s consolidated financial statements for the year
      ended December 31, 2005, the Company’s management determined that its
      previously issued consolidated statement of cash flows for 2005 required
      restatement to correct the classification of foreign currency cash flow and
      others. The previously issued consolidated statement of cash flows separated
      the
      Cash and cash equivalents effected by foreign currency into operating
      activities, investing activities and financing activities, which was
      inconsistent with SFAS No. 95. Paragraph 25 of SFAS No. 95 stated that, a
      statement of cash flows of an enterprise with foreign transactions or foreign
      operations shall report the reporting currency equivalent of foreign currency
      cash flows using the exchange rates in effect at the time of the cash flows.
      An
      appropriately weighted average exchange rate for the period may be used for
      translation if the result is substantially the same as if the rate at the dates
      of the cash flows were used. The statement shall report the effect of exchange
      rate changes on cash balances held in foreign currencies as a separate part
      of
      the reconciliation of the change in cash and cash equivalents during the
      period.




The
      following is a summary of the impact of the restatement on the originally issued
      consolidated statement of cash flows as at December 31, 2005:




As
                Previously
              Reported
            
            As
              Restated
            
            DifferenceNet
                income
            
            $
            3,315,478
            
            $
            3,315,478
            
            $
            0Adjustments
                to reconcile net income from continuing operations to net cash provided
                by
                operating activities:Cash
                and cash equivalents effected by foreign currency
            
            
            730,896
            
            
            0
            
            
            (730,896
            )Advance
                payments and others
            
            
            1,760,393
            
            
            1,417,550
            
            
            (342,843
            )Net
                cash provided by operating activities
            
            $
            13,393,946
            
            $
            12,320,207
            
            
            ($1,073,739
            )Cash
                received from equipment sales
            
            
            0
            
            
            280,735
            
            
            280,735Cash
                paid to acquire property, plant and equipment
            
            
            (11,088,505
            )
            
            (11,026,397
            )
            
            62,108Cash
                and cash equivalents effected by foreign currency
            
            
            947,661
            
            
            0
            
            
            (947,661
            )Net
                cash provided by investing activities
            
            
            ($12,013,878
            )
            
            ($12,618,696
            )
            
            ($604,818
            )Cash
                and cash equivalents effected by foreign currency
            
            
            (350,717
            )
            
            0
            
            
            350,717Net
                cash provided by financing activities
            
            
            ($169,763
            )
            $
            180,954
            
            $
            350,717Cash
                and cash equivalents effected by foreign currency
            
            $
            0
            
            $
            1,327,840
            
            $
            1,327,840Net
                increase in cash and cash equivalents
            
            
            1,210,305
            
            
            1,210,305
            
            
            0Cash
                and cash equivalents at the beginning of period
            
            
            11,164,639
            
            
            11,164,639
            
            
            0Cash
                and cash equivalents at the end of period
            
            $
            12,374,944
            
            $
            12,374,944
            
            $
            0





78





5.
       Accounts Receivable and Notes Receivable




The
      Company’s accounts receivable at December 31, 2006 and 2005 are summarized as
      follows:




2006
            
            2005Accounts
                receivable
            
            $
            41,174,404
            
            $
            31,866,156Notes
                receivable
            
            
            20,146,197
            
            
            12,570,189Less:
                allowance for doubtful accounts
            
            
            (4,086,218
            )
            
            (2,856,025
            )$
            57,234,383
            
            $
            41,580,320




Notes
      receivable represent accounts receivable in the form of bills of exchange whose
      acceptances and settlements are handled by banks.




The
      activity in the Company’s allowance for doubtful accounts during the years ended
      December 31, 2006 and 2005 are summarized as follows:




2006
            
            2005Balance
                at beginning of year
            
            $
            2,856,025
            
            $
            2,944,990Add:
                amounts provided during the year
            
            
            1,099,092
            
            
            —Add:
                foreign currency translation
            
            
            131,101
            
            
            72,716Less:
                amounts written off in prior year and recovered during the
                year
            
            
            —
            
            
            (161,681
            )Balance
                at end of year
            
            $
            4,086,218
            
            $
            2,856,025





6.
       Other Receivables




The
      Company’s other receivables at December 31, 2006 and 2005 are summarized as
      follows:




2006
            
            2005Other
                receivables
            
            $
            1,864,918
            
            $
            7,543,798Less:
                allowance for doubtful accounts
            
            
            (898,203
            )
            
            (1,040,169
            )Balance
                at end of year end
            
            $
            966,715
            
            $
            6,503,629





79




The
      activity in the Company’s allowance for doubtful accounts of other receivable
      during the years ended December 31, 2006 and 2005 are summarized as
      follows:




December
                31,2006
            
            2005Balance
                at beginning of the year
            
            $
            1,040,169
            
            $
            930,425Add:
                amounts provided during the year
            
            
            (210,861
            )
            
            86,770Add:
                foreign currency translation
            
            
            68,895
            
            
            22,974Balance
                at end of the year
            
            $
            898,203
            
            $
            1,040,169




Other
      receivables consist of amounts advanced to both related and unrelated parties,
      primarily as unsecured demand loans, with no stated interest rate or due date.
      At December 31, 2006, other receivables totaled $966,715, including $738,510
      to
      related parties, net of an allowance for doubtful accounts of $898,203, which
      included $534,503 made to an investee of Jiulong. At December 31, 2005, other
      receivables totaled $6,503,629, including $3,966,509 to related parties, net
      of
      an allowance for doubtful accounts of $1,040,169, which included $313,550 made
      to an investee of Jiulong.




With
      the
      exception of the receivable from the investee of Jiulong of $534,503, which
      was
      fully recorded in the allowance for doubtful accounts, the Company believes
      that
      all other receivables are collectible, as the related parties are in good
      financial condition and are paying their payables to Company pursuant to the
      terms of their respective contracts.




7.
       Inventories




Inventories
      at December 31, 2006 and 2005 are summarized as follows:




December
                31,2006
            
            2005Raw
                materials
            
            $
            5,381,372
            
            $
            3,025,467Work
                in process
            
            
            3,253,192
            
            
            2,559,626Finished
                goods
            
            
            7,548,218
            
            
            7,295,08216,182,782
            
            
            12,880,175Less:
                provision for loss
            
            
            (718,211
            )
            
            (494,342
            )$
            15,464,571
            
            $
            12,385,833




8.
       Property, Plant and Equipment




Property,
      plant and equipment at December 31, 2006 and 2005 are summarized as
      follows:




December
                31,2006
            
            2005Land
                use rights and buildings
            
            $
            17,384,534
            
            $
            16,825,598Machinery
                and equipment
            
            
            33,466,198
            
            
            30,980,053Electronic
                equipment
            
            
            2,945,454
            
            
            2,023,457Motor
                vehicles
            
            
            2,095,169
            
            
            2,179,161Construction
                in progress
            
            
            3,280,279
            
            
            73,40059,171,634
            
            
            52,081,669Less:
                Accumulated depreciation
            
            
            (18,323,588
            )
            
            (12,285,636
            )$
            40,848,046
            
            $
            39,796,033


Depreciation
        charge for the years ended December 31, 2006 and 2005 are $5,816,922 and
        $
        4,761,920 respectively.


80




9.
       Intangible Assets




The
      activity in the Company’s intangible asset account during the year ended
      December 31, 2006 and 2005 are summarized as follows:




December
                31,2006
            
            2005Balance
                at beginning of year
            
            $
            3,503,217
            
            $
            392,552Add:
                Additions during the year -Patent
                technology
            
            
            109,073
            
            
            3,147,867Management
                software license
            
            
            65,852
            
            
            93,827Foreign
                currency translation
            
            
            121,698
            
            
            9,6933,799,840
            
            
            3,643,939Less:
                Amortization for the year
            
            
            (659,292
            )
            
            (140,722
            )Balance
                at end of year
            
            $
            3,140,548
            
            $
            3,503,217




10.
       Accounts Payable




Accounts
      payable at December 31, 2006 and 2005 are summarized as follows:




2006
            
            2005Accounts
                payable
            
            $
            22,517,260
            
            $
            15,615,402Notes
                payable
            
            
            15,130,653
            
            
            15,760,197$
            37,647,913
            
            $
            31,375,599




Notes
      payable represent accounts payable in the form of bills of exchange whose
      acceptances and settlements are handled by banks.




81




The
      Company has pledged cash deposits, notes receivable and certain property, plant
      and machinery to secure trade financing granted by banks.




11.
       Bank Loans




At
      December 31, 2006, the Company, through its Sino-foreign joint ventures, had
      outstanding fixed-rate short-term bank loans of $15,384,615, with weighted
      average interest rate at 5.90% per annum. These loans are secured with some
      of
      the property and equipment of the Company, and are repayable within one year.




At
      December 31, 2005, the Company, through its Sino-foreign joint ventures, had
      outstanding fixed-rate short-term bank loans of $14,814,815 with weighted
      average interest rate at 5.92% per annum. Jiulong, one of the Company’s joint
      ventures, has provided Henglong, another of the Company’s joint ventures, with
      loan guarantees covering bank loans of $3,086,420. Henglong has provided Jiulong
      with loan guarantees covering bank loans of $4,938,272. The remaining balance
      of
      the loans of $6,790,123 was mortgaged with some of the property and equipment
      of
      the Company.




12.
      Accrued pension costs




Since
      the
      Company’s operations are all located in China, all the employees are located in
      China. The Company records pension costs in accordance with the relevant Chinese
      social security laws, that is substantially
      based on20% of salary amount.




The
      activities in the Company’s pension account during the years ended December 31,
      2006 and 2005 are summarized as follows:





**December
                31,****2006**
            
            **2005**Balance
                at beginning of the year
            
            $
            2,653,064
            
            $
            2,438,971Amounts
                provided during the year
            
            
            1,287,609
            
            
            650,576Settlement
                during the year
            
            
            (789,265
            )
            
            (496,704
            )Foreign
                currency translation
            
            
            115,459
            
            
            60,221Balance
                at end of the year
            
            $
            3,266,867
            
            $
            2,653,064




13.
       Amounts Due to Shareholders/Directors




The
      activity in the amounts due to shareholders/directors during the years ended
      December 31, 2006 and 2005 is summarized as follows:




Balance,
                December 31, 2004
            
            $
            589,594Advances
                from shareholders
            
            
            177,048Balance,
                December 31, 2005
            
            
            766,642Add:
                foreign currency translation
            
            
            20,484Repayments
                made to shareholders
            
            
            (429,061
            )Balance,
                December 31, 2006
            
            $
            358,065




At
      December 31, 2006 and 2005, the amounts due to shareholders/directors were
      unsecured, interest free and repayable on demand.




82




14.
      Advances payable




The
      amounts mainly represent advances made by the Chinese government to the Comapny
      as subsidy on interest on loans related to production facilities
      expansion.




The
      balances are unsecured, interest-free and will be repayable to the Chinese
      government if the usage of such advances does not continue to qualify for the
      subsidy (see note 19).




15.
       Minority Interests’ Equity




The
      activities in respect of the amounts of the minority interests’ equity during
      the years ended December 31, 2006 and 2005 are summarized as
      follows:




Balance,
                December 31, 2004
            
            $
            17,571,838Add:
                contribution by minority shareholders
            
            
            3,066,000Minority
                interests’ income
            
            
            2,680,318Additional
                interest to minority interest holders in connection with disposal
                of
                property, plant and equipment on a cashless basis
            
            
            93,168Less:
                dividends declared to the minority interest holders of Joint-venture
                companies
            
            
            (1,660,281
            )Balance,
                December 31, 2005
            
            $
            21,751,043Add:
                contribution by minority shareholders
            
            
            2,332,470Minority
                interest’s income
            
            
            5,545,350Foreign
                currency translation
            
            
            1,468,787Less:
                dividends declared to the minority interest holders of Joint-venture
                companies
            
            
            (7,984,983
            )Balance,
                December 31, 2006
            
            $
            23,112,667




16.
      Share
      Capital




The
      activities in the Company’s share capital account during the years ended
      December 31, 2006 and 2005 are summarized as follows:




Common
                Stock
            
            Par
                Value
            
            NoteBalance,
                December 31, 2005 and 2004
            
            
            22,574,543
            
            $
            2,257Issuance
                of common stock for cash in accordance with the standby equity
                distribution agreement with Cornell Capital Partners, LP
            
            
            1,216,675
            
            
            122
            
            
            Average
                Exercise price at $8.96 per shareExercise
                of stock option by independent directors
            
            
            22,500
            
            
            2
            
            
            Exercise
                price at $4.50 per sharePay
                commissions and placement agent fee in accordance with the standby
                equity
                distribution agreement with Cornell Capital Partners, LP
            
            
            37,863
            
            
            4
            
            
            Exercise
                price at $11.89 per shareBalance,
                December 31, 2006
            
            
            23,851,581
            
            $
            2,385




83




On
      March
      20, 2006, the Company raised gross amount of $5,000,000 in a private placement
      (PIPE) to Cornell Capital Partners, LP (“Investor”) by issuin g 625,000
      shares of common stock.




On March
      20, 2006, pursuant****to
      Placement Agent Agreement,the Investor committed under certain
      conditions to purchase, within the next 24 months after an effective resale
      registration of the Company’s common stock, at the Company’s option, up to $15
      million of the Company’ common stock, at an agreed discount from the fair market
      value. According to  this
      agreement, the Company raised gross amount of $5,900,000 in a number of private
      placements (PIPE) to Cornell Capital Partners, LP (“Investor”) by
      issuin g 591,675
      shares of common stock in four installments from May to December in 2006.




On
        March
        20, 2006, the Company issued 37,863 shares of common stock to Cornell Capital
        Partners, LP and a placement agent in non-capital raising transactions,
        collectively at an exercise price of $11.885 per share as a commitment fee
        and a
        placement agent fee of $450,000 in connection with the establishment of a
        $15,000,000 equity line of credit under a Standby Equity Distribution Agreement
        with Cornell Capital Partners, LP. The exercise value of $450,000 by issuing
        37,863 shares of common stock was regarded as financing expense and has been
        debited to share capital with the excess of exercise value over par value,
        $449,996 being credited to additional paid-in capital.




The
      common stock to be issued under the Standby
      Equity Distribution Agreement (“SEDA”)
      will be issued at a 1.5% discount to the lowest daily Volume Weighted Average
      Price, (“VWAP”), of the Company’s common stock during the five consecutive
      trading day period immediately following the date the Company notifies Cornell
      Capital Partners, LP that it desires to access the SEDA; provided, that the
      price per share paid by Cornell Capital Partners, LP will in no event be less
      than a minimum of 90% of the closing bid price for the Company’s common stock on
      the trading day immediately preceding the date that it delivers an advance
      request. Further, Cornell Capital Partners, LP will retain 4.5% of each advance
      under the SEDA. Based on this discount, Cornell Capital Partners, LP will have
      an incentive to sell immediately to realize the gain on the 1.5% discount.
      These
      sales could cause the price of the Company’s common stock to decline, based on
      increased selling of its common stock. In the event Cornell Capital Partners,
      LP
      holds more than 9.9% of the Company’s then-outstanding common stock, the Company
      will be unable to obtain a cash advance under the SEDA. A possibility exists
      that Cornell Capital Partners, LP may own more than 9.9% of the Company’s
      outstanding common stock at a time when it would otherwise plan to request
      an
      advance under the SEDA. In that event, if the Company is unable to obtain
      additional external funding, it could fail to achieve the corporate objectives
      that it had hoped to use the cash to achieve.




The
      securities authorized for issuance under equity compensation plans at December
      31, 2006 are as follows:




Plan
                category
            
            Number
                of securities to be issued upon exercise of outstanding
                options
            
            Weighted
                average exercise price of outstanding options
            
            Number
                of securities remaining available for future issuanceEquity
                compensation plans approved by security holders
            
            
            2,200,000
            
            $
            6.42
            
            
            2,132,500




84





The
      stock
      option plan was approved in the 2004 Annual Meeting of Stockholders, and the
      maximum common shares for issuance under this plan are 2,200,000 with a period
      of 10 years.




17.
       Additional paid-in capital




The
      activities in the Company’s additional paid-in capital account during the year
      ended December 31, 2006 and 2005 are summarized as follows:




Additional
                paid-in capital
            
            NoteBalance,
                December 31, 2004
            
            $
            18,003,168Deemed
                distribution to shareholders
            
            
            74,704
            
            
            Difference
                between fair value and construction cost for the office building
                sold to a
                company controlled by the Chairman.Issuance
                of 22,500 stock options to independent directors
            
            
            68,850Balance,
                December 31, 2005
            
            $
            18,146,722Issuance
                of 1,216,675 common stock for cash in accordance with the standby
                equity
                distribution agreement with Cornell Capital Partners, LP
            
            
            10,899,872
            
            
            Difference
                between exercise value and par valueExercise
                of 22,500 stock options by independent directors
            
            
            101,248
            
            
            Difference
                between exercise value and par valueIssuance
                of 22,500 stock options to independent directors
            
            
            131,625Issuance
                of common stock in accordance with the standby equity distribution
                agreement with Cornell Capital Partners, LP
            
            
            449,996
            
            
            Difference
                between exercise value and par valueIssuance
                of common stock warrants in accordance with the standby equity
                distribution agreement with Cornell Capital Partners, LP
            
            
            832,639Payment
                of commissions and placement agent fee by issuance of common stock
                in
                accordance with the standby equity distribution agreement with Cornell
                Capital Partners, LP
            
            
            (449,996
            )Payment
                  of commissions and placement agent fee by issuance of common stock
                  warrants in accordance with the standby equity distribution agreement
                  with
                  Cornell Capital Partners, LP
            
            
            (832,639
            )Cash
                paid for retaining fee,commissions
                and placement agent fee in connection with offering
            
            
            (627,504
            )Payment
                of commissions and placement agent fee by issuance of common stock
                in
                accordance with the standby equity distribution agreement with Cornell
                Capital Partners, LP
            
            
            (4
            )Balance,
                December 31, 2006
            
            $
            28,651,959





85




On
      March
      20, 2006, the Company issued 37,863 shares of common stock to Cornell Capital
      Partners, LP and a placement agent in non-capital raising transactions,
      collectively at an exercise price of $11.885 per share as a commitment fee
      and a
      placement agent fee of $450,000 in connection with the establishment of a
      $15,000,000 equity line of credit under a Standby Equity Distribution Agreement
      with Cornell Capital Partners, LP. The exercise value of $450,000 by issuing
      37,863 shares of common stock was regarded as financing expense and has been
      debited to share capital with the excess of exercise value over par value,
      $449,996 being credited to additional paid-in capital.




In
      July
      2004, the Company adopted a stock incentive plan. The maximum number of common
      shares for issuance under this plan is 2,200,000 with a period of 10 years.
      The
      stock incentive plan provides for the issuance, to the Company’s officers,
      directors, management and employees, of options to purchase shares of the
      Company’s common stock. On July 21, 2004, the Company issued options to purchase
      7,500 shares of common stock to each of its three independent directors. Such
      stock options vested
      immediately upon grant and are exercisable at $4.50 per share over a period
      of
      two years. The exercise price represents a 11.11% premium from the fair market
      value as based upon the grant date of the stock options. On June 28, 2005,
      the
      Company issued additional options to purchase 7,500 shares of common stock
      to
      each of its three independent directors. Such stock options vested immediately
      upon grant and are exercisable at $6.83 per share over a period of five years.
      The exercise price represents the fair market value based on the grant date
      of
      the stock options. On July 6, 2006, the Company issued options to purchase
      7,500 shares of common stock to three of its independent directors. Such stock
      options vested immediately upon grant and are exercisable at $7.94 per share
      over a period of five years.




The
      fair
      value of the options at the grant date was $131,625, $68,850 and $55,125 for
      the
      years 2006, 2005 and 2004, respectively, which was calculated based on
      Black-Scholes option pricing model. The fair value was recorded as compensation
      expenses for the years ended December 31, 2006, 2005 and 2004. These amounts
      have been debited to operating expenses and credited to additional paid-in
      capital.




The
      weighted-average fair value of options granted during the periods 2006,
      2005 and 2004 was $5.85, $3.06 and $2.45, respectively. The fair value of each
      option granted was estimated on the date of grant using the Black-Scholes option
      valuation model and assumptions noted in the table:




2006
            
            2005
            
            2004Expected
                volatility
            
            
            93.19
            %
            
            46.00
            %
            
            121.60
            %Risk-free
                rate
            
            
            4.75
            %
            
            3.60
            %
            
            4.00
            %Expected
                term (years)
            
            
            5
            
            
            5
            
            
            2Dividend
                yield
            
            
            0.00
            %
            
            0.00
            %
            
            0.00
            %




On
      March
      20, 2006, the Company raised a gross amount of $5,000,000 in a private placement
      (PIPE) to Cornell Capital Partners, LP, “Investor” by issuing 625,000 shares of
      common stock. As part of the financing cost, the Company issued a warrant to
      purchase 86,806 shares of common stock, exercisable for three years at an
      exercise price of $14.40 per share, and a warrant to purchase 69,444 shares
      of
      common stock, exercisable for three years at an exercise price of $18.00 per
      share, to Cornell Capital Partners, LP. The fair value of above-mentioned
      warrants at the grant date is $832,639, which was measured based on
      Black-Scholes option pricing model. This amount was recorded as financing
      expenses and debited to additional paid-in capital. Additionally, the same
      amount was credited to additional paid-in capital, resulting in zero effect
      on
      additional paid-in capital and the Consolidated Financial
      Statements.




The
      weighted average fair value of warrants issued during the 2006 year-end was
      $5.33. The fair value of the warrants granted was estimated on the date of
      grant
      using the option valuation model and assumptions noted in the
      table:





Expected
                volatility
            
            Risk-free
                rate
            
            Expected
                term (years)
            
            Dividend
                yield82.20%
            
            4.66%
            
            3
            
            0%




86





A
      summary
      of option activities under the plans to December 31, 2006 was as
      follows:





**Shares**
            
            **Weighted-Average
                Exercise Price**
            
            **Weighted-Average
                Contractual Term (years)**Outstanding
                - January 1, 2005
            
            
            22,500
            
            $
            4.50
            
            
            2Granted
            
            
            22,500
            
            
            6.83
            
            
            5Exercised
            
            
            —
            
            
            —
            
            
            —Cancelled
            
            
            —
            
            
            —
            
            
            —Outstanding
                - December 31, 2005
            
            
            45,000
            
            
            5.67
            
            
            3.5Granted
            
            
            22,500
            
            
            7.94
            
            
            5Exercised
            
            
            (22,500
            )
            
            4.5
            
            
            —Cancelled
            
            
            —
            
            
            —
            
            
            —Outstanding
                - December 31, 2006
            
            
            45,000
            
            
            7.39
            
            
            5





The
      following is a summary of warrants granted for the year ended December 31,
      2006:





**Shares**
            
            **Weighted-Average
                Exercise Price**
            
            **Weighted-Average
                Contractual Term (years)**Outstanding
                - December 31, 2005
            
            
            —
            
            $
            —
            
            
            —Granted
            
            
            156,250
            
            $
            16.00
            
            
            3Exercised
            
            
            —
            
            
            —
            
            
            —Cancelled
            
            
            —
            
            
            —
            
            
            —Outstanding
                - December 31, 2006
            
            
            156,250
            
            $
            16.00
            
            
            3




The
      following is a summary of the range of exercise prices for stock options that
      are outstanding and exercisable at December 31, 2006:





Range
                of Exercise Prices
            
            Outstanding
                Stock Options
            
            Weighted
                Average Remaining Life
            
            Weighted
                Average Exercise Price
            
            Number
                of Stock Options Exercisable
            
            Weighted
                Average Exercise Price$4.50
                - $10.00
            
            45,000
            
            4.01
            
            $
                7.39
            
            45,000
            
            $7.39





The
      following is a summary of the range of exercise prices for warrants that are
      outstanding and exercisable at December
      31, 2006:





Range
                of Exercise Prices
            
            Issued
                Warrants
            
            Weighted
                Average Remaining Life
            
            Weighted
                Average Exercise Price
            
            Number
                of Warrants Exercisable
            
            Weighted
                Average Exercise Price$10.01 - $20.00
            
            156,250
            
            2.22
            
            $16.00
            
            156,250
            
            $16.00





87




18.
       Retained earnings - Appropriated




The
      activities in the Company’s retained earnings - appropriated account during the
      year ended December 31, 2006 and 2005 are summarized as follows:




Balance,
                December 31, 2004
            
            $
            4,396,339Retained
                earnings-appropriated
            
            
            526,923Balance,
                December 31, 2005
            
            
            4,923,262Retained
                earnings-appropriated
            
            
            1,286,647Balance,
                December 31, 2006
            
            $
            6,209,909




Pursuant
      to the relevant laws and regulations of Sino-foreign joint venture enterprises,
      the profits of the Company’s Sino-foreign subsidiaries, which are based on their
      PRC statutory financial statements, are available for distribution in the form
      of cash dividends after these subsidiaries have paid all relevant PRC tax
      liabilities, provided for losses in previous years, and made appropriations
      to
      statutory surplus at 10%.




When
      the
      statutory surplus reserve reaches 50% of the registered capital of a company,
      additional reserve is no longer required. However, the reserve cannot be
      distributed to joint venture partners. Based on the business licenses of the
      Sino-foreign joint ventures, the registered capital of Henglong, Jiulong,
      Shenyang , Zhejiang, USAI, Jielong, and Wuhu are $10,000,000, $4,283,170
      (RMB35,000,000), $8,132,530 (RMB67,500,000), $7,000,000, $10,000,000, $6,000,000
      and $3,750,387 (RMB30,000,000) respectively.




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




19.
      Other
      Income




During
      2006 and 2005, the Company recorded other income, government subsidies, of
      $94,257 and $150,809, respectively.




During
      2004, the Company recorded other income of $856,939, consisting of Government
      subsidies of $175,959 and $680,980 arising from the write off of accounts
      payable.




Government
      subsidies represent refunds by the Chinese Government of interest paid to banks
      by companies entitled to such subsidies. This applies only to interest on loans
      related to production facilities expansion. Commencing in 2003 and 2004, the
      Company had used this type of special loan to improve its production lines
      by
      increasing capability and enhancing quality. The expansion was completed and
      began to operate at the end of 2004 and 2005. During 2005 and 2006, the Chinese
      Government sent experts to review and assess the Company’s usage of its improved
      production facilities on site to confirm that the Company’s improvements had
      achieved its goals and thereby qualify for the subsidy  .




88




The
      amounts of income written off against accounts payable related to the Company’s
      trial products obtained from a number of suppliers 2 or 3 years ago for product
      .These accounts payable would no longer be payable and since these recoveries
      happened very infrequently and did not relate to the normal operations of the
      Company in 2004, they were recorded in other income rather than income from
      operations.




20.
       Income Taxes for Continuing Operations




The
      Company’s subsidiaries registered in the PRC are subject to state and local
      income taxes within the PRC at the applicable tax rate on the taxable income
      as
      reported in their PRC statutory financial statements in accordance with the
      relevant income tax laws applicable to foreign invested enterprise. The
      Company’s PRC subsidiaries are generally subject to enterprise income tax at a
      statutory rate of 33%, which comprises 30% national income tax and 3% local
      income tax.




On
      January 1, 1996, one of the subsidiary of the Company, Jiulong, was granted
      an
      enterprise income tax holiday of a 100% enterprise income tax exemption for
      two
      years commencing from 1996, and a 50% enterprise national income tax
      deduction and a 100% local income tax deduction for the next nine years
      thereafter (from 1998 to 2006) for income tax purposes.




On
      January 1, 1999, one of the subsidiary of the Company, Henglong, was granted
      an
      enterprise income tax holiday of a 100% enterprise income tax exemption for
      two
      years commencing from 1999, and a 50% enterprise national income tax deduction
      and a 100% local income tax deduction for the next nine years thereafter (from
      2001 to 2009) for income tax purposes.




On
      January 1, 2003, one of the subsidiary of the Company, Shenyang, was granted
      an
      enterprise income tax holiday of a 100% enterprise income tax exemption for
      two
      years commencing from 2003, and a 75% enterprise national income tax deduction
      and a 100% local income tax deduction for the next three years thereafter (from
      2005 to 2007) for income tax purposes.




On
      January 1, 2004, one of the subsidiary of the Company, Zhejiang, was granted
      an
      enterprise income tax holiday of a 100% enterprise income tax exemption for
      two
      years commencing from 2004, and a 50% enterprise national income tax deduction
      and a 50% local income tax deduction for the next three years thereafter (from
      2006 to 2008) for income tax purposes.




USAI,
      Wuhu and Jielong are at their start up stage and accordingly, there is no
      assessable profit for the year ended December 31, 2006 subject to PRC enterprise
      income tax.




No
      provision for HongKong tax is made as Jilong and Great Genesis
      are both investment holding companies, and have no assessable income in HongKong
      for the years ended on December 31, 2006, 2005 and 2004.




No
      provision for US tax is made as the Company has no assessable income in US
      for
      the years ended on December 31, 2006, 2005 and 2004.





The
      account of income tax as of the December 31, 2006, 2005 and 2004 is summarized
      as follows:





2006
            
            2005
            
            2004Tax
                rate
            
            7.5%-16.5%
            
            7.5%-15%
            
            15%Taxation
                payable
            
            2,597,189
            
            1,371,863
            
            1,520,000Income
                tax refund
            
            (928,108)
            
            -
            
            (901,600)Income
                tax
            
            1,669,081
            
            1,371,863
            
            618,400




21.
       Discontinued Operations




Effective
      August 31, 2004, in order to concentrate on its main products, namely steering
      and automotive parts, the Company disposed of its 51% interest in Jingzhou
      by
      entering into an equity exchange agreement, the “Exchange Agreement”, with Hubei
      Wanlong Investment Co., Ltd., “HBWL”, which is controlled by Mr. Hanlin Chen,
      the Chairman of the Company. Pursuant to the Exchange Agreement, the 51% equity
      interest in Jingzhou owned by the Company was exchanged for 2.5% of HBWL’s
      equity interests in Henglong based on their respective fair market values as
      determined by an independent appraisal firm. Accordingly, effective August
      31,
      2004, the Company did not own Jingzhou’s equity.




89




The
      disposal of Jingzhou was accounted for as discontinued operations according
      as
      SFAS No. 144. The operating results and related costs and expenses of Jingzhou
      have been shown as discontinued operations in the consolidated statements of
      operations. Financial statements of prior periods are also changed to reflect
      the discontinued operations of Jingzhou. There are no taxes accrued for the
      discontinued operating loss.




The
      consolidated statement of operations for 2004 included net loss from
      discontinued operations of $(21,591).




The
      consolidated statement of cash flows for 2004 included decreased net cash flows
      from discontinued operations of $52,014, consisting of net cash flows used
      in
      operating activities from discontinued operations of $1,354,506, net cash
      provided by investing activities from discontinued operations of $121,769,
      and
      net cash provided by financing activities from discontinued operations of
      $1,180,723.




22.
       Significant Concentrations




The
      Company grants credit to its customers, generally on an open account basis.
      The
      Company’s customers are all located in the PRC.




In
      2006,
      the Company’s ten largest customers accounted for 72.5% of the Company’s
      consolidated sales, with four customers accounting for in excess of 10% of
      consolidated sales, i.e. 16.4%, 13.3%, 11.1% and 10.3% of consolidated sales,
      or
      an aggregate of 51.1% of consolidated sales.




In
      2005,
      the Company’s ten largest customers accounted for 69.9% of the Company’s
      consolidated sales, with three customers accounting for in excess of 10% of
      consolidated sales, i.e. 14.0%, 11.6% and 11.5% of consolidated sales, or an
      aggregate of 37.1% of consolidated sales.




In
      2004,
      the Company’s ten largest customers accounted for 73.1% of the Company’s
      consolidated sales, with three customers accounting for in excess of 10% of
      consolidated sales, i.e. 19.2%, 16.2% and 10.9% of consolidated sales, or an
      aggregate of 46.3% of consolidated sales.




At
      December 31, 2006 and 2005, approximately 35.5% and 37.0% of accounts receivable
      were from trade transactions with the aforementioned
      customers.




23.
       Related Party Transactions




The
      Company’s related party transactions include product sales, material purchases
      and purchases of equipment and technology. These transactions were consummated
      under similar terms as those with the Company's customers and suppliers. On
      some
      occasions, the Company’s related party transactions also include purchase/sale
      of capital stock of the joint ventures and sale of property, plant and
      equipment.




Related
      sales and purchases: During the years ended December 31, 2006, 2005 and 2004,
      the joint-ventures entered into related party transactions with companies with
      common directors as shown below:




Merchandise
      Sold to Related Parties





December
                31,2006
            
            2005
            
            2004Xiamen
                Joylon
            
            $
            2,813,113
            
            $
            1,970,984
            
            $
            1,367,087Shanghai
                Fenglong
            
            
            465,331
            
            
            319,145
            
            
            315,538Total
            
            $
            3,278,444
            
            $
            2,290,129
            
            $
            1,682,625





90





Materials
      Purchased from Related Parties





December
                31,2006
            
            2005
            
            2004Xiamen
                Joylon
            
            $
            2,909
            
            $
            —
            
            $
            —Shanghai
                Fenglong
            
            
            270,597
            
            
            139,008
            
            
            256,212Jiangling
                Tongchuang
            
            
            2,333,399
            
            
            1,526,573
            
            
            1,446,967Jingzhou
                Tongyi
            
            
            148,644
            
            
            —
            
            
            —Jingzhou
                Tongying
            
            
            94,734
            
            
            2,104
            
            
            —Total
            
            $
            2,850,283
            
            $
            1,667,685
            
            $
            1,703,179




Technology
      Purchased from Related Parties





December
                31,2006
            
            2005
            
            2004Changchun
                Hualong
            
            $
            193,719
            
            $
            125,926
            
            $
            175,904





Equipment
      Purchased from Related Parties





December
                31,2006
            
            2005
            
            2004Hubei
                Wiselink
            
            $
            858,115
            
            $
            51,191
            
            $
            —




Related
      receivables, advance payments and account payable: As at December 31, 2006
      and
      2005, accounts receivables, advance payments and account payable between the
      Company and related party are as shown below:




Due
      from
      Related Parties





December
                31,2006
            
            2005Xiamen
                Joylon
            
            $
            1,521,413
            
            $
            1,554,134Shanghai
                Fenglong
            
            
            249,520
            
            
            274,941Total
            
            $
            1,770,933
            
            $
            1,829,075





91





Due
      to
      Related Parties





December
                31,2006
            
            2005Xiamen
                Joylon
            
            $
            3,021
            
            $
            —Shanghai
                Tianxiang
            
            
            534,216
            
            
            237,888Shanghai
                Fenglong
            
            
            79,417
            
            
            50,208Jiangling
                Tongchuang
            
            
            18,284
            
            
            92,489Hubei
                Wiselink
            
            
            3,111
            
            
            2,648Jingzhou
                Tongyi
            
            
            2,356
            
            
            345Total
            
            $
            640,405
            
            $
            383,578





Advanced
      Equipment Payment to Related Parties





December
                31,2006
            
            2005Hubei
                Wiselink
            
            $
            488,873
            
            $
            599,729





Advanced
      Expenses and Others to Related Parties





December
                31,2006
            
            2005Shanghai
                Fenglong
            
            **$**
            —
            
            **$**
            31,733Changchun
                Hualong
            
            
            128,205
            
            
            61,111Jiangling
                Tongchuang
            
            
            —
            
            
            173,220Jingzhou
                Tongyi
            
            
            111,620
            
            
            45,972Jingzhou
                Tongying
            
            
            247,508
            
            
            —Total
            
            $
            487,333
            
            $
            312,036




O ther
      Transactions with Related Parties:




Effective
      August 31, 2004, in order to concentrate on its main products, namely steering
      and automotive parts, the Company disposed of its 51% interest in Jingzhou
      by
      entering into the Exchange Agreement with HBWL, which is controlled by Mr.
      Hanlin Chen, the Chairman of the Company. Pursuant to the Exchange Agreement,
      the 51% equity interest in Jingzhou owned by the Company was exchanged for
      2.5%
      of HBWL’s equity interests in Henglong based on their respective fair market
      values as determined by an independent appraisal firm. The difference between
      the fair value and the book value resulting from the disposition of the joint
      venture interest in Jingzhou was debited to additional paid-in capital. With
      respect to consideration paid by the Company in excess of the Chairman’s basis
      in his investment, such excess has been charged to additional paid-in capital
      as
      a distribution to the Chairman, resulting in the acquired 2.5% equity interests
      in Henglong being recorded by the Company at the Chairman’s original cost basis.
      The Company paid approximately $90,000 to Hubei Wanlong in conjunction with
      this
      transaction.




92




Henglong,
      one of the Company’s Joint-ventures, has constructed seven buildings dedicated
      to research and administration for its operations in Wuhan. Due to the unified
      building guidance and planning on floor and building areas by the government
      of
      Wuhan, the actual building areas were greater than the areas the Company
      needed. In 2005, the Company decided to dispose of two of its seven buildings,
      with construction costs of $2,468,574, to WuHan Geological University
      Information S&T Development Co., Ltd. "WuHan Information", a Chinese company
      controlled by Mr. Hanlin Chen, the Chairman of the Company, at fair market
      value of $2,636,444, which was determined by an independent appraisal firm. As
      of
      December 31, 2006, WuHan Information has paid receivables of $2,636,444 and
      interest revenue of $95,000 to the Company according to the contract
      agreement.




24 .
      Commitments and Contingencies




Legal
      Proceedings - The Company is not currently a party to any threatened or pending
      legal proceedings, other than incidental litigation arising in the ordinary
      course of business. In the opinion of management, the ultimate disposition
      of
      these matters will not have a material adverse effect on the Company's
      consolidated financial position, results of operations or cash flows.




The
      following table summarizes the Company‘s major contractual payment obligations
      and commitments as of December 31, 2006:





Payment
                Obligations by Period2007
            
            2008
            
            2009
            
            2010
            
            Thereafter
            
            TotalObligations
                for service agreements
            
            $
            110,000
            
            $
            110,000
            
            $
            110,000
            
            $
            110,000
            
            $
            110,000
            
            $
            550,000Obligations
                for purchasing agreements
            
            
            4,371,999
            
            
            1,124,685
            
            
            —
            
            
            —
            
            
            —
            
            
            5,496,684Total
            
            $
            4,481,999
            
            $
            1,234,685
            
            $
            110,000
            
            $
            110,000
            
            $
            110,000
            
            $
            6,046,684




25. Off-Balance
      Sheet Arrangements




At
      December 31, 2006 and 2005, the Company did not have any transactions,
      obligations or relationships that could be considered off-balance sheet
      arrangements.




26.
      Subsequent Events




On
      January 17, 2007, the Company raised $1,200,000 in a private placement (PIPE)
      to
      Cornell Capital Partners, LP, “Investor”, by issuing 108,121 shares of common
      stock.




Pursuant
      to the joint venture agreement entered into with Sensor as set out in note
      2
      regarding the formation of USAI, Sensor has failed to contribute its
      sensor-related technologies and thereby failed to fulfill its capital
      contribution commitment as of March 20, 2007, Sensor agreed to withdraw from
      USAI and another technology supplier is being sought. There is no effect on
      the Company's existing production, but it may materially affect USAI's future
      development.




27. Segment
      Reporting




The
      accounting policies of the product sectors are the same as those described
      in
      the summary of significant accounting policies except that the disaggregated
      financial results for the product sectors have been prepared using a management
      approach, which is consistent with the basis and manner in which management
      internally disaggregates financial information for the purposes of
      assisting them in
      making internal operating decisions. Generally, the Company evaluates
      performance based on stand-alone product sector operating income and accounts
      for inter segment sales and transfers as if the sales or transfers were to
      third
      parties, at current market prices.




93




During
      2006, the Company had seven product sectors, four of them were principal profit
      makers, which were reported as separate sectors who engaged in the production
      and sales of power steering for cars (Henglong), power steering for trucks
      (Jiulong) power steering for light duty vehicles (Shenyang), and power pumps
      (Zhejiang). The other three sectors which were established in 2005 and 2006
      respectively, engaged in the  production
      and sales of sensor modular (USAI), power steering for special vehicles (Wuhu),
      and  electronic
      power steering (Jielong).since the revenues, net income and net assets of these
      three sectors are less than 10% of its segment in the consolidated statement,
      the Company incorporated these three sectors into “other sectors”.




During
      2004 and 2005, the Company had five product sectors, (Jingzhou was discontinued
      in August 2004. Four of them were principal profit makers, which were presented
      as separate sectors engaged in the production and sales of power steering for
      cars (Henglong), power steering for trucks (Jiulong), power steering for light
      duty vehicles (Shenyang), and power pumps (Zhejiang). The sensor
      sector (USAI), which was established in 2005, and the textile sector (Jingzhou),
      which was discontinued in August 2004, were reported in “other
      sectors . ”




2006
            
            Power
                steering for cars
            
            Power
                steering for trucks
            
            Power
                steering for light duty vehicles
            
            Power
                pumps
            
            Other
                sectors
            
            Other(a)
            
            TotalRevenueNet
                product sales - external
            
            $
            45,312,457
            
            $
            25,135,726
            
            $
            14,935,722
            
            $
            10,221,478
            
            $
            161,056
            
            $
            -
            
            $
            95,766,439Net
                product sales - internal
            
            
            8,191,505
            
            
            3,584,952
            
            
            884,979
            
            
            352,030
            
            
            0
            
            
            (13,013,466
            )
            
            0Gain
                on other salesand
                other income - external
            
            
            261,420
            
            
            83,941
            
            
            28,623
            
            
            3,273
            
            
            0
            
            
            (3,784
            )
            
            373,473Total
                revenue
            
            $
            53,765,382
            
            $
            28,804,619
            
            $
            15,849,324
            
            $
            10,576,781
            
            $
            161,056
            
            
            ($13,017,250
            )
            $
            96,139,912Depreciation
                and amortization
            
            $
            3,087,440
            
            $
            1,696,590
            
            $
            415,523
            
            $
            631,094
            
            $
            547,700
            
            $
            97,867
            
            $
            6,476,214Net
                income
            
            
            3,329,962
            
            
            1,304,902
            
            
            1,627,718
            
            
            789,239
            
            
            (827,957
            )
            
            (1,412,160
            )
            
            4,811,704Total
                assets
            
            
            74,295,465
            
            
            37,217,985
            
            
            15,279,830
            
            
            14,857,762
            
            
            8,216,363
            
            
            2,241,133
            
            
            152,108,538Capital
                expenditures
            
            $
            2,393,008
            
            $
            860,317
            
            $
            688,242
            
            $
            918,305
            
            $
            2,974,934
            
            
            ($280,970
            )
            $
            7,553,836








2005
            
            Power
                steering for cars
            
            Power
                steering for trucks
            
            Power
                steering for light duty vehicles
            
            Power
                pumps
            
            Other
                sectors
            
            Other(a)
            
            TotalRevenueNet
                product sales - external
            
            $
            30,447,713
            
            $
            17,534,928
            
            $
            9,596,922
            
            $
            5,992,737
            
            $
            -
            
            $
            -
            
            $
            63,572,301Net
                product sales - internal
            
            
            4,977,022
            
            
            4,340,931
            
            
            1,837,282
            
            
            283,216
            
            
            0
            
            
            (11,438,450
            )
            
            0Gain
                on other salesand
                other income - external
            
            
            297,759
            
            
            197,150
            
            
            23,779
            
            
            7,182
            
            
            
            
            
            (15,075
            )
            
            510,795Total
                revenue
            
            $
            35,722,494
            
            $
            22,073,009
            
            $
            11,457,983
            
            $
            6,283,135
            
            $
            -
            
            
            (11,453,525
            )
            $
            64,083,096Depreciation
                and amortization
            
            $
            2,413,074
            
            $
            1,405,892
            
            $
            402,653
            
            $
            580,124
            
            $
            6,026
            
            $
            100,474
            
            $
            4,908,243Net
                income
            
            
            1,275,570
            
            
            1,453,572
            
            
            1,128,038
            
            
            285,572
            
            
            
            
            
            (827,274
            )
            
            3,315,478Total
                assets
            
            
            59,611,582
            
            
            37,400,013
            
            
            13,593,450
            
            
            12,065,965
            
            
            3,608,168
            
            
            (6,749,455
            )
            
            119,529,723Capital
                expenditures
            
            $
            8,274,746
            
            $
            2,356,095
            
            $
            217,353
            
            $
            143,491
            
            $
            220,100
            
            $
            -
            
            $
            11,211,785




94




2004
            
            Power
                steering for cars
            
            Power
                steering for trucks
            
            Power
                steering for light duty vehicles
            
            Power
                pumps
            
            Other
                sectors
            
            Other
                (a)
            
            TotalRevenueNet
                product sales - external
            
            $
            18,705,317
            
            $
            26,656,495
            
            $
            8,957,088
            
            $
            3,866,945
            
            $
            -
            
            $
            -
            
            $
            58,185,845Net
                product sales - internal
            
            
            10,323,892
            
            
            275,891
            
            
            3,733,121
            
            
            392,846
            
            
            -
            
            
            (14,725,750
            )
            
            -Gain
                on other salesand
                other income - external
            
            
            866,935
            
            
            710,101
            
            
            67,210
            
            
            20,120
            
            
            -
            
            
            (12,806
            )
            
            1,651,560Total
                revenue
            
            $
            29,896,144
            
            $
            27,642,487
            
            $
            12,757,419
            
            $
            4,279,911
            
            $
            -
            
            
            ($14,738,556
            )
            $
            59,837,405Depreciation
                and amortization
            
            $
            771,053
            
            $
            594,593
            
            $
            240,128
            
            $
            320,302
            
            
            -
            
            $
            79,975
            
            $
            2,006,052Net
                income
            
            
            1,050,385
            
            
            4,637,097
            
            
            1,510,770
            
            
            602,555
            
            
            (21,591
            )
            
            (911,879
            )
            
            6,867,337Total
                assets
            
            
            53,962,794
            
            
            35,543,244
            
            
            13,728,122
            
            
            9,725,379
            
            
            -
            
            
            (7,472,894
            )
            
            105,486,645Capital
                expenditures
            
            $
            13,348,622
            
            $
            4,947,372
            
            $
            603,880
            
            $
            1,620,427
            
            $
            -
            
            $
            4,819
            
            $
            20,525,120





(a) 
      Other includes activity at the corporate level, unrealized income between
      product companies (sectors), and elimination of inter-sector transactions.





The
      following is a list of exhibits filed as part of this Annual
      Report.





95