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Executives

Dan Joseph - Integrated Corporate Relations

Ben Chen - Director, Investor Relations

Xiao Ping Zhang - Chairman of the Board of Directors, Chief Executive Officer

Analysts

Peter Cyress - Group Capital

Tony Pollack - Jackson Group

Sorl Auto Parts, Inc. (SORL) Q3 2008 Earnings Call November 12, 2008 8:30 AM ET

Operator

Good day, everyone and welcome to the Sorl Auto Parts Incorporated third quarter 2008 earnings release conference call. Today’s call is being recorded. At this time I would like to turn our conference over to Mr. Dan Joseph of Integrated Corporate Relations. Please go ahead, sir.

Dan Joseph

Thank you and thank you, everyone for joining today’s Sorl Auto Parts 2008 third quarter earnings conference call. On our call today is Mr. Xiao Ping Zhang, Chairman and Chief Executive Officer; Mr. [Bao Xing Tao], Senior Vice President; Mr. [Min Chun Lin], Accounting Manager for Sorl; and Mr. [Ben Chen], Director of Investor Relations.

Before we begin I am going to provide a disclaimer about forward-looking statements. In addition to historical information, this conference call contains forward-looking statements regarding Sorl Auto Parts. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements, other than statements that are historical in nature. These forward-looking statements are based on management’s current expectations and are subject to risks and uncertainties that may result in expectations not being realized and may cause actual outcomes to differ materially from expectations reflected in these forward-looking statements. Potential risks and uncertainties include the nature of operating in China generally, the fact that the company’s new to the U.S. public market and its regulatory regime, product and service demand acceptance, changes in technology or economic conditions, the impact of compensation and pricing, the impact of government relations and other risks described in the statements and reports filed by the company from time to time with the SEC. All such forward-looking statements whether written or oral and whether made by or on behalf of the company are expressly qualified by these cautionary statements. Because forward-looking statements are subject to risks and uncertainties, we caution you not to place undue reliance on these statements.

Now we will begin the main portion of the call and I would like to turn it over to Ben Chen. Ben.

Ben Chen

Thanks. We would like to begin by having our CEO, Mr. Zhang, make a few remarks. Mr. Zhang will speak in Chinese and I will translate.

Xiao Ping Zhang (Translation)

We are satisfied with our overall performance in the third quarter of 2008. Despite the deteriorating global economic environment, our third quarter revenue continued grew by a solid 11% year-over-year and we maintained a relatively high gross margin of 26.9% for the first three quarters of 2008.

As we look to the future we have to recognize that the current condition of the global economy may present us with certain challenges. The credit crisis that started in the U.S. has spread throughout the global economy and now appears to be having an impact on the real economy. The U.S. seems likely to experience negative economic growth over the next few quarters and vehicle sales in the U.S. have fallen off dramatically. There are signs that similar trends will be felt throughout the global economy. This includes China which recently reported that growth has slowed as compared to the 2007 level.

We also believe that this slowdown has begun to impact the vehicle market in China. Given changes in the economic environment since the onset of the financial crisis, moving forward we will give priority to four key objectives -- penetrating new high potential markets, controlling risk, strengthening our relationships with our best customers, and maximizing our efficiency. We are emphasizing on our market strategy to continuously develop the high potential market of bus and agricultural vehicles to enhance the productivity of the patented product and to expand our system sales. Also in the interest of strengthening our customer relationships, we will put more resources into service our better customers, including having more solid technical persons on site regularly, while at the same time paring relationships with customers that present unacceptable credit risk. We will also develop new customers cautiously, particularly as relates to credit risk in order to minimize the direct impact that the credit crisis might have on us.

Finally, we will continue our efforts relative to manufacturing efficiency in order to sustain and build upon the gross margin improvement we have been making.

By focusing on these objectives, we are confident we can continue to improve our business and build up on our track record of growth and profitability in the long run.

Ben Chen

I would like to being by providing an update as to our overall business and I will then discuss our financial results for the quarter. As you know, Sorl is China’s leading manufacturer of [inaudible] and systems and one of the 100 largest vehicle part suppliers in China. Our products are generally used on commercial vehicles that weigh more than 3 tons; examples would include trucks and buses. Our products are sold primarily to three market segments -- Chinese [inaudible] equipment manufacturers, the Chinese after-market, and the export market.

Since 2004, we have grown with a compounded annual growth of 35% on the top line and 31% on the bottom line, and have developed a very broad customer base, including more than 80 OEMs in China and export sales to more than 80 countries covering North America, Europe, Asia, Africa, and the Middle East. Our competitive advantage includes offering customers a [inaudible] quality ratio which allowed us to compete both at home and abroad; our modern manufacturing facility, which is comprised largely of computerized equipment and [inaudible] applied advanced quality control and manufacturing practices; the most expansive after-market distribution network in China, including 28 authorized distributors and more than 800 sub-distributors that cover most of China; [inaudible] product developments group, which has allowed us to continuously improve the functionality of our products. An example would be the effort we are putting to the development of electronic components, which we believe represents a substantial opportunity for us in the future.

Revenue increased 11% year over year in the third quarter, from $29.7 million to $33 million. That gave us a 27% year-over-year increase for the first nine months of the year, up to $105.8 million as compared to 83.3 in 2007. The contrast between the quarterly growth and the nine-month growth would seem to be [inaudible] [the trend] we have noted last quarter, [inaudible] that because of the introduction of new [imaging standard] in China and the impact of the 2008 Olympic Games in Beijing. Chinese OEM customers skewed their production towards the first half of 2008 with the result that their past orders increased more in the first half of the year than in the third quarter. While we would certainly prefer growth about 11%, we do consider the 27% for the nine-month period to be positive.

I should also add that revenue from China’s domestic OEM market, China’s domestic after market and international market for the third quarter of 2008 were $10.4 million, $8.4 million, and $14.1 million respectively.

Gross profit for the third quarter of 2008 was $8.4 million, a 26.8% increase as compared to $6.6 million for the same period in 2007. Gross profit margin reached 25.5% as compared to 22.3% in the same quarter last year, an increase of 320 basis points. For the nine months ended September 30, 2008, gross profit grew by 52.3% to $28.5 million, and the gross margin increased 450 basis points to 26.9% as compared to the same period in 2007. Furthermore, over those four quarters, our gross margin had been 26.6%. Prior to that, our gross margin had averaged roughly 22.5% and on a quarterly basis had [inaudible] 23.5%. This improvement had come despite the increase of certain manufacturing costs, including labor and materials. We achieved this saving partly as a result of manufacturing efficiency improvements and also because we received higher margins when we sell brake systems as opposed to selling components.

We plan to continue to work on improving efficiency and also to expand our system sales with the goal of protecting and possible further enhancing the margin improvements we have made thus far.

Operating expenses increased 38.9% from $4 million in the third quarter of 2007 to $5.5 million in the same quarter in 2008. As a percentage of revenue, operating expenses increased from 13.3% in the third quarter of 2007 to 16.7% in the same quarter in 2008.

For the nine months ended September 30, 2008, operating expenses as a percentage of revenue were 14.7% as compared to 11.3% during the prior year period.

In addition to the general growth of the business, several factors contributed to the increase in operating expenses. Most significantly was a 160% increase in reach and development expenses, from $0.94 million during the first nine months of 2007 to $2.46 million during the first nine months of 2008, a reflection of increased investments in new product development, such as electronic components.

Other factors including increases in packaging costs, increased wage and benefit rates for our employees, and an increase in bad debt allowance due to concerns about the possible impact of the global credit crisis on collections from export accounts.

Operating income increased 8.9% from $2.7 million in the third quarter of 2007 to $2.9 million in the third quarter of 2008. As a percentage of revenue, operating income was 8.8% in the third quarter of 2008 as compared to 9% in the prior year period. For the nine months ended September 30, 2008, operating income increased 39.8% to $12.9 million, as compared to the same period in 2007. Also for the nine months ended September 30, 2008, operating income as a percentage of revenue was 12.2% as compared to 11.1% during the prior year period.

Net income increased to 10.9% from $2.1 million in the third quarter of 2007 or $0.12 per share to $2.3 million in the third quarter of 2008, or $0.13 per share. Net margin of 7.1% in the third quarter of 2008 was the same as in the first quarter of 2008. For the nine months ended September 30, 2008, net income grew by 7.3% to $10.6 million, or $0.85 per diluted share as compared to $8.3 million, or $0.45 per diluted share during the prior year period.

For both the first nine months of both 2007 and 2008, net margin was 10% as a result of the increase in gross margin offset by the increase in operating expenses. Looking to the future, we believe the fundamental condition driving our growth, including the rapid growth of the Chinese economy and the vehicle market, our [inaudible] quality to cost ratio and our expansive distribution network will enable us to continue our growth in the years ahead. However, due to the current economic environment, at this time it is difficult for us to estimate slightly market demands over the next year or so.

For the fourth quarter of 2008, in addition to the possible impact of economic conditions, it is also likely that the OEM order imbalance from the first half of the year will continue to impact orders. As for 2009, while we believe the foundation does not change, at this time we think it is still too early to understand the full impact that the credit crisis will have on global economic activities and vehicle demand. As such, we will at this time refrain from making specific comments as to the outlook for 2009.

This concludes the financial review. Thank you for listening and we will now take questions that you might have. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from Peter [Cyress], [Group Capital].

Peter Cyress - Group Capital

I just want to understand -- there’s no guidance for the fourth quarter and no guidance for next year. Is that correct?

Ben Chen

Yes.

Peter Cyress - Group Capital

Why? Does that mean you have no idea of how business is going to be in the fourth quarter or next year? Let’s start with the fourth quarter. We are already halfway into the fourth quarter. You must have some idea of what business is like right now, right?

Ben Chen

Let me translate to Mr. Zhang first.

Xiao Ping Zhang (Translation)

Although for the fourth quarter already [inaudible] for like around one month, but the change was really dramatically and actually the debt crisis which originated from the U.S. had already spread throughout global. And like GM or other big auto parts manufacture companies, they are already reduced their production capacity and also reduced their labor force. And for our Chinese companies, they also reduced their output capacity. So for us, it is really one of the most difficult seasons for us and so far it is really difficult for us to make any forecast or guidance for the fourth quarter.

Peter Cyress - Group Capital

I understand that it is difficult but I mean, do you think you will be profitable in the fourth quarter?

Xiao Ping Zhang (Translation)

Yeah, sure, we will be profitable. We are going to reduce our sales, our revenues, but we also want to maintain our profit capability.

Peter Cyress - Group Capital

Okay, so even though there’s no guidance for the fourth quarter, you are willing to say that your earnings -- you earn what, $0.58 in the nine months -- you are willing to say that your earnings for the year will be higher than the $0.58 that we currently have for the nine months -- that’s correct?

Xiao Ping Zhang (Translation)

Yes, and in another way, we can say that our EPS for 2008 will be less than $0.70 but more than $0.60.

Peter Cyress - Group Capital

Okay, fine, so it’s going to be less than the $0.70 guidance but more than $0.60, so we know what 2008 is. Now let me ask you about 2009 -- I know there is no way to judge 2009. What do you -- we’re sitting here in New York, we’re not in China. What do you -- you know, they are talking about [inaudible] stimulus packages, building more roads, things that should be good for your business as they reach construction and stuff like that. What do you see as the sort of risk and opportunities in 2009?

Ben Chen

You mean are our [risks] that we are facing in 2009, right?

Peter Cyress - Group Capital

I mean, it’s -- if I look at your stock today, I have to make some guess as to what 2009 is and you are not giving me any guidance, so if you are going to lose money in 2009 then I don’t want to buy the stock. If you are going to make $0.70 in 2009, I do want to buy the stock, so I want to try to understand what the opportunities or risks are going forward.

Xiao Ping Zhang (Translation)

We are confident that we will maintain the profitability in 2009 and we already do some strategic change according to our 2009 and especially to some new penetrated market or some high potential markets in China, like the bus and agricultural vehicle segment.

Peter Cyress - Group Capital

So if I were to ask you -- I’m not asking for a projection. I’m just saying what would be the worst -- can you give me a wide range of what you think 2009 could be? What’s the worst case, what’s the best case?

Ben Chen

You will find that our [Premier of our government] already announced some statements for 2009 on the 10th of November and will enlarge our internal demand, so for us we will be [inaudible] to maintain a profit but so far, we really cannot provide guidance for 2009.

Peter Cyress - Group Capital

So no -- not even a broad range?

Ben Chen

Yes, not even a broad range, yes, so far.

Peter Cyress - Group Capital

Okay. Thank you.

Operator

(Operator Instructions) We’ll now hear from Tony [Pollack], [Jackson Group].

Tony Pollack - Jackson Group

Could you go over the substantial increase in inventory and accounts receivables as compared to the sales volume, which was a lot less percentage wise?

Ben Chen

You mean our accounts receivable to the revenues, the rate is [inaudible]?

Tony Pollack - Jackson Group

Right, and also the inventory.

Xiao Ping Zhang (Translation)

For the account receivable part, actually the accounts receivable should be at the same rate of our revenues but maybe you will find that our accounts receivable is decreasing because our third quarter, the revenue of the third quarter is decreasing. And for the inventory, it is -- the company established a [inaudible] distribution warehouse close to the major OEM customers and maintaining some stock in that warehouse to ensure timely deliveries at the request of major OEM customers. That’s the reason for the increase of our inventory. Thank you.

Tony Pollack - Jackson Group

Could you also give us a feeling that if the stock gets down to a certain price that the company would be interested in buying back their own stock? I mean, we’re selling at a significant discount to book value. Our current ratio is three or four to one. Is there a point where the company would buy back stock?

Ben Chen

Sorry, could you repeat that again?

Tony Pollack - Jackson Group

Is there a point where the company would buy back stock? You know, with what’s happening in the markets and the decimation of many stock prices and your substantial discount to book value and your substantial current ratio, is there a price where you would buy back your own stock?

Ben Chen

You mean you want us to give you some guidance and at which price that we suggest you to buy?

Tony Pollack - Jackson Group

No, I would like to know is there a price where the company itself would buy back their own stock. The company stock is selling at a huge discount to book value. Your current ratio is three or four to one. Many, many companies in this day and age that are profitable that are selling huge discounts to book value buy back their own stock. You have a substantial cash flow every year. You said you are going to be profitable in the fourth quarter.

Ben Chen

Yes, I get it.

Xiao Ping Zhang (Translation)

Actually, we really pay close attention to the capital market recently and especially since the start of the debt/credit crisis. And we find that according to our opinion, that the capital market, the [state] of the capital market is mainly caused by the financial crisis, which caused our investors to lose their confidence on the capital market. And actually to us, we really pay close attention to that and we want to make [inaudible] at the right time and at the right price. And actually, we really have some cash and you can find that from our cash flow and we will do that at the right time and we are considering that right now.

Tony Pollack - Jackson Group

Thank you.

Operator

(Operator Instructions) There are no further questions. Mr. Chen, I will turn it back to you for closing or additional remarks, sir.

Ben Chen

No more investors?

Operator

(Operator Instructions)

Ben Chen

Maybe we can wait just for a couple of minutes.

Operator

(Operator Instructions) We have a follow-up from Peter Cyress, Group Capital.

Peter Cyress - Group Capital

Okay. I’m not trying to give you guys a hard time but I want to come back to this thing, which is if -- I don’t want to wait for another six months to have any idea of what business is going to be like next year, so why the -- I would like to understand a little more about what you guys see in the market for next year that makes it impossible for you to even give a range of earnings.

Xiao Ping Zhang (Translation)

Actually, we will take a constructive and optimistic point of view to the guidance for 2009 and actually you are going to find that our Chinese Government already held a couple of meetings and a conference and also announced internationally that we are going to expand our internal demand. Actually, we already make some strategic plans before the financial crisis, things last year, like the bus market and the agricultural vehicle market and we will be confident for these two segment markets we’ll achieve a better performance in 2009. And for Sorl, actually we have a certain kind of competitive advantage and that’s one of the reasons why we will be optimizing to our future, and also why we take 2009 as cautiously that the financial crisis already impacts the real economy and especially the American market is dramatically increased recently and maybe we are experiencing a stagnant in the coming future, and that’s the reasons why we cannot provide any guidance so far but we will try to make some guidance, until the market is [even clear].

Operator

There are no further questions at this time. Mr. Chen, do you have any closing remarks, sir?

Ben Chen

Sure. Thank you.

Operator

That concludes today’s conference. We do appreciate your participation. Everyone have a great day.

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