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EX-21 - Wonder Auto Technology, Incv176312_ex21.htm
EX-31.2 - Wonder Auto Technology, Incv176312_ex31-2.htm
EX-23.1 - Wonder Auto Technology, Incv176312_ex23-1.htm
EX-32.1 - Wonder Auto Technology, Incv176312_ex32-1.htm
EX-32.2 - Wonder Auto Technology, Incv176312_ex32-2.htm
EX-31.1 - Wonder Auto Technology, Incv176312_ex31-1.htm

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, 2009

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 No. 001-33648

WONDER AUTO TECHNOLOGY, INC.

 (Exact name of registrant as specified in its charter)

Nevada
 
88-0495105
(State or other jurisdiction of incorporation or
organization)
 
(I.R.S. Employer Identification No.)

No. 16 Yulu Street
Taihe District, Jinzhou City
Liaoning Province 121013
People’s Republic of China

(Address of principal executive offices)

(86) 416-2661186

 (Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $0.0001 per share
 
NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Exchange Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ¨ No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ¨ 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 ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o No ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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.
¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large Accelerated Filer  o
 
Accelerated Filer x
Non-Accelerated Filer  o (Do not check if a smaller reporting company)
 
Smaller reporting company  o
 
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes o No x
 
As of June 30, 2009 (the last business day of the registrant’s most recently completed second fiscal quarter), the aggregate market value of the shares of the registrant’s common stock held by non-affiliates (based upon the closing sale price of such shares as reported on the NASDAQ Global Market) was approximately $273 million. Shares of the registrant’s common stock held by each executive officer and director and by each person who owns 10% or more of the outstanding common stock have been excluded from the calculation in that such persons may be deemed to be affiliates of the registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
 
There were a total of 33,859,994 shares of the registrant’s common stock outstanding as of March 4, 2010.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Definitive Proxy Statement for its 2010 Annual Meeting of Stockholder to be filed with the Commission within 120 days after the close of the registrant’s fiscal year are incorporated by reference into Part III of this Annual Report on Form 10-K.

 
 

 

 
WONDER AUTO TECHNOLOGY, INC.
 
Annual Report on FORM 10-K
 For the Fiscal Year Ended December 31, 2009 


TABLE OF CONTENTS

PART I
 
     
Item 1.
Business.
1
Item 1A.
Risk Factors.
10
Item 1B.
Unresolved Staff Comments.
26
Item 2.
Properties.
26
Item 3.
Legal Proceedings.
27
Item 4.
Reserved.
27
     
PART II
 
     
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
28
Item 6.
Selected Financial Data.
30
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
31
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.
46
Item 8.
Financial Statements and Supplementary Data.
47
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
48
Item 9A.
Controls and Procedures.
48
Item 9B.
Other Information.
50
     
PART III
 
     
Item 10.
Directors, Executive Officers and Corporate Governance.
50
Item 11.
Executive Compensation.
50
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
50
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
51
Item 14.
Principal Accounting Fees and Services.
51
     
PART IV
 
     
Item 15.
Exhibits, Financial Statement Schedules.
51

 
 

 

Special Note Regarding Forward Looking Statements

In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as “believe,” “expect,” “anticipate,” “project,” “target,” “plan,” “optimistic,” “intend,” “aim,” “will” or similar expressions which are intended to identify forward-looking statements. Such statements include, among others, those concerning market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; uncertainties related to conducting business in China, as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, as well as assumptions, which, if they were to ever materialize or prove incorrect, could cause the results of the Company to differ materially from those expressed or implied by such forward-looking statements. Such risks and uncertainties, among others, include:

 
·
The effects of the global economic crisis; 
 
 
·
The effects of contraction in automotive sales and production;
 
 
·
Escalating pricing pressures from our customers;
 
 
·
Our ability to accurately project market demand for our products;
 
 
·
Our ability to require additional capital;
 
 
·
Risks associated with future investments or acquisitions;
 
 
·
Interruption in our production processes;
 
 
·
Our ability to attract new customers; 
 
 
·
Our ability to employ and retain qualified employees;
 
 
·
Competition and competitive factors in the markets in which we compete;
 
 
·
General economic and business conditions in China and in the local economies in which we regularly conduct business, which can affect demand for the Company’s products and services;
 
 
·
Changes in laws, rules and regulations governing the business community in China in general and the automobile industry in particular; and
 
 
·
The risks identified in Item 1A. “Risk Factors” included herein.
 
All statements other than statements of historical fact are statements that could be deemed forward-looking statements.  We assume no obligation and do not intend to update these forward-looking statements, except as required by law.

Use of Terms

Except as otherwise indicated by the context, references in this report to:

 
·
“Company,” “WATG,” “we,” “us” and “our” are references to the combined business of Wonder Auto Technology, Inc., a Nevada corporation, and its subsidiaries on a consolidated basis; 
 
 
·
“Friend Birch” are references to Friend Birch Limited, a Hong Kong company and a direct, wholly owned subsidiary of the Company;
 
 
·
“Fuxin Huirui” are references to Fuxin Huirui Mechanical Co., Ltd., a corporation incorporated in the People’s Republic of China and an indirect, wholly owned subsidiary of the Company;
 
 
·
“Jinan Worldwide” are references to Jinan Worldwide Auto Accessories Co., Ltd., a corporation incorporated in the People’s Republic of China and an indirect, wholly owned subsidiary of the Company;
 
 
·
“Jinzhou Dongwoo” are references to Jinzhou Dongwoo Precision Co., Ltd., a corporation incorporated in the People’s Republic of China and an indirect, 50% owned subsidiary of the Company;
 
 
1

 
 
 
·
“Jinzhou Equipment” are references to Jinzhou Wonder Auto Electrical Equipment Co., Ltd., a corporation incorporated in the People’s Republic of China and an indirect, wholly owned subsidiary of the Company;
 
 
·
“Jinzhou Halla” are references to Jinzhou Halla Electrical Equipment Co., Ltd., a corporation incorporated in the People’s Republic of China and an indirect, wholly owned subsidiary of the Company;
 
 
·
“Jinzhou Hanhua” are references to Jinzhou Hanhua Electrical System Co., Ltd., a corporation incorporated in the People’s Republic of China and an indirect, 50% owned subsidiary of the Company;
 
 
·
“Jinzhou Jiade” are references to Jinzhou Jiade Machinery Co., Ltd., a corporation incorporated in the People’s Republic of China and an indirect, wholly owned subsidiary of the Company;
 
 
·
“Jinzhou Karham” are references to Jinzhou Karham Electrical Equipment Co., Ltd., a corporation incorporated in the People’s Republic of China and an indirect, 65% owned subsidiary of the Company;
 
 
·
“Jinzhou Lida” are references to Jinzhou Lida Auto Parts Co., Ltd., a corporation incorporated in the People’s Republic of China and an indirect, 50% owned subsidiary of the Company;
 
 
·
“Jinzhou Motor” are references to Jinzhou Wonder Motor Co., Ltd., a corporation incorporated in the People’s Republic of China and an indirect, wholly owned subsidiary of the Company;
 
 
·
“Jinzhou Wanyou” are references to Jinzhou Wanyou Mechanical Parts Co., Ltd., a corporation incorporated in the People’s Republic of China and an indirect, wholly owned subsidiary of the Company;
 
 
·
“Wonder Auto” are references to Wonder Auto Limited, a British Virgin Islands company and a direct, wholly owned subsidiary of the Company;
 
 
·
“SEC” are references to the United States Securities and Exchange Commission;
 
 
·
“Securities Act” are references to Securities Act of 1933, as amended, and “Exchange Act” are to the Securities Exchange Act of 1934, as amended.
 
 
·
“China” and “PRC” are references to People’s Republic of China;
 
 
·
“RMB” are references to Renminbi, the legal currency of China; and
 
 
·
“U.S. dollar,” “$” and “US$” are references to the legal currency of the United States.

 
2

 

PART I

ITEM 1.
BUSINESS.

Overview
 
We are a leading manufacturer of automotive electric parts, suspension products and engine components in China. Our core products include alternators, starters, engine valves and tappets, and rods and shafts for use in shock absorber systems. We have been producing alternators and starters in China since 1997. According to the China Association of Automobile Manufacturers, or CAAM, in 2008 we ranked second and third in sales revenue in the Chinese market for automobile alternators and starters, respectively. Our subsidiary Jinan Worldwide, which we acquired in October 2008, has been producing engine valves and tappets for over 50 years, and we believe we are now one of the largest manufacturers of engine valves and tappets in China in terms of sales volume as a result of the acquisition.

Our products are used in a wide range of passenger and commercial automobiles, and we are especially focused on the fast-growing small-to-medium engine passenger vehicle market. We sell our products primarily within China to well-known domestic and international automobile original equipment manufacturers, or OEMs, engine manufacturers and automotive parts suppliers. We are increasingly exporting our products to international markets. Our customers include SAIC GM Wuling Automobile Co., Ltd., Beijing Hyundai Motor Company, Shenyang Aerospace Mitsubishi Motors Engine Co., Ltd., Harbin Dongan Automotive Engine Co., Ltd., Shanghai Volkswagen Co., Ltd., BYD Company Limited, Tianjin Toyota Co., Ltd., Chery Automobile Co., Ltd., Dongfeng Yueda Kia Motors Co., Ltd., Geely Automobile Co., Ltd., Tianjin FAW Xiali Automobile Co., Ltd., and a major North American automobile OEM. Most of our customers subject us to a rigorous product qualification process to ensure that our products meet their quality standards. We believe that the complex and stringent requirements of each customer’s qualification process acts as a barrier to entry for many new market entrants.

Our strategically-located manufacturing facilities in Jinzhou and Jinan, China house our high-quality manufacturing, testing and research and development capabilities. We currently have four alternator assembly lines, four starter assembly lines, twenty engine valves production lines, five tappets production lines and three rods and shafts production lines. Our current annual production capacity is approximately 2.6 million units of alternators, 2.4 million units of starters, 27 million units of engine valves and tappets, and 20 million units of rods and shafts, assuming two work shifts per day with eight hours each.

We actively pursue acquisition prospects and other strategic opportunities and have completed the following transactions since the beginning of fiscal year 2009:

 
·
On September 22, 2009, we acquired 100% of the equity interest in Friend Birch Limited, a Hong Kong company, thereby indirectly acquiring its wholly owned Chinese subsidiaries, Jinzhou Jiade Machinery Co., Ltd. and Jinzhou Lida Auto Parts Co., Ltd., which are engaged in designing, manufacturing and selling gas spring shafts and other thin mechanical shafts products, automotive springs and gas spring.  As part of the transaction, we also acquired all proprietary technology of Friend Birch Limited’s rods and shafts technology center in Brazil.

 
·
On November 4, 2009, we entered into a joint venture agreement with Korea Teawon Dianzhuang Corporation, a Korean company, pursuant to which we agreed to establish a joint venture company named Jinzhou Wonder Teawon Co., Ltd. (“Jinzhou Teawon”), which will primarily engage in the manufacture of solenoid switches for automotive starters, alternator collector rings, starter communicators and other automobile parts.  Under the joint venture agreement, we will acquire 75% of Jinzhou Teawon.

 
·
On January 18, 2010, through two separate transactions, we acquired an aggregate of 38.36% of equity interest in Applaud Group Limited which is a British Virgin Islands corporation and has no assets other than its ownership of 52.2% of equity interest in Jinheng Automotive Safety Technology Holdings Limited (“Jinheng Holding”).  As a result of the acquisition of an aggregate of 38.36% of Applaud, we will become the largest shareholder of Applaud and, thereby, owner of 20.02% of Jinheng Holdings. Jinheng Holdings is a high-tech automotive parts supplier that is primarily engaged in developing, manufacturing and selling components of automotive passive safety restraint systems (airbag and seatbelt), automotive engine electronic injection management systems, and components of diesel engines. Jinheng Holdings is listed on the Main Board of Hong Kong Stock Exchange. Our CEO and chairman, Qingjie Zhao, is an executive director of Jinheng Holdings.

 
1

 
 
History and Corporate Structure
 
We were incorporated on June 8, 2000 in the State of Nevada as “MGCC Investment Strategies Inc.”  Until our reverse acquisition of Wonder Auto on June 22, 2006, our business strategy and ownership changed several times. On June 22, 2006, we acquired all of the capital stock of Wonder Auto in exchange for shares of our capital stock. This share exchange transaction resulted in a change of the ownership control of the Company. On August 25, 2006, we amended our Articles of Incorporation and changed our name into “Wonder Auto Technology, Inc.” As a result of the Wonder Auto acquisition, our business became the business of our indirect, wholly-owned Chinese subsidiaries: (1) Jinzhou Halla, (2) Jinzhou Dongwoo, (3) Jinzhou Wanyou, (4) Jinzhou Hanhua, (5) Jinzhou Karham, (6) Jinzhou Motor, (7) Jinzhou Equipment, (8) Fuxin Huirui, (9) Jinan Worldwide; (10) Jinzhou Jiade and (11) Jinzhou Lida.
 
We conduct our operations in China through our PRC subsidiaries. The following chart reflects our organizational structure as of the date of this annual report.


Segment Information
 
Our business operations can be categorized into four segments based on the type of products which we manufacture and sell, specifically, (i) alternators, (ii) starters, (iii) rods and shafts and (iv) engine valves and tappets.

 
2

 
 
Our alternator product line offerings are available in seven series based on different sizes and output rates and come in over 230 models. Our starter product line offerings primarily consist of planetary type starters which are small and lightweight and come in ten series with approximately 150 models based on their size and power output. We manufacture and sell both alternators and starters using largely the same facilities, personnel and other resources in Jinzhou Halla.  Approximately 35.2% and 32.7% of our 2009 sales revenue were derived from the sale of our alternator and starter products.

Our subsidiary Jinzhou Wanyou manufacturers our rod and shaft product line, which is targeted primarily to international market outside China and accounts for approximately 10.1% of our sales revenue in 2009. Our product offerings were expanded to include engine valves and tappets as a result of our acquisition of Jinan Worldwide in 2008.  Sales of our engine valves and tappets accounted for 22.0% of our sales revenue in 2009.

For financial information relating to our business segments, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 24 to the consolidated financial statements appearing elsewhere in this annual report. For a discussion of the risks attendant to our foreign operations and of any dependence on one or more of the Company’s segments upon such foreign operations, please see Item 1A, “Risk Factors.”

Our Products and Markets
 
Our current products include automotive electrical parts, specifically, alternators and starters; rods and shafts; and engine valves and tappets.
 
The following table set forth sales information about our product mix in each of the last three years.
 
(All amounts, other than percentage, in thousands of U.S. dollars)

   
Year Ended December 31,
 
   
2009
   
2008
   
2007
 
Product
 
Revenue
   
Percent of
Revenue
   
Revenue
   
Percent of
Revenue
   
Revenue
   
Percent of
Revenue
 
Alternators
  $ 74,250       35.2 %   $ 63,256       44.8 %   $ 59,790       58.6 %
Starters
    68,946       32.7 %     52,138       36.9 %     35,014       34.3 %
Rods and Shafts
    21,247       10.1 %     18,106       12.8 %     7,280       7.1 %
Engine Valves and Tappets
    46,581       22.0 %     7,690       5.5 %     -       - %
Total
  $ 211,024       100 %   $ 141,190       100 %   $ 102,084       100 %
 
Alternators

Our alternators are manufactured by Jinzhou Halla. An alternator is part of a car engine’s electrical system which is connected to the engine belt of a vehicle and converts mechanical energy into electricity to recharge the battery.  The battery, in turn, provides power to all electrical devices in the vehicle, such as the radio, power steering, headlights and windshield wipers. We have developed, manufactured and sold seven series of alternators, which are represented by different sizes and output rates, in over 230 models. Our alternators’ current electrical current flows range in size and output from 35A to 120A. Larger alternators, as determined by their diameters, have more electrical field coils and can produce stronger currents. Our alternators have dual integrated fans and built-in integrated circuit regulators. Our alternators are designed to produce high outputs while remaining small and lightweight. The size and weight parameters result in the improved cooling performance of integrated fans and higher output from the integrated circuit regulators.

Starters

Our starters are manufactured by Jinzhou Halla. A starter is part of a car engine’s starting system, along with the starter solenoid. At ignition, the starter solenoid is activated and provides power for the starter. The starter then spins the engine a few revolutions to begin the internal combustion process. The starters produced by our Company are known as planetary type starters. These starters are small and lightweight due to their high speed motors combined with speed reduction systems. We produce ten series of starters in terms of diameters (ø) from ø67 to ø100, which produce between 0.85kW to 5.5kW of power.

 
3

 

Rods and Shafts

Our rods and shafts are manufactured by Jinzhou Wanyou. Our rod and shaft products are mainly used in shock absorber which is a key part in a vehicle’s suspension system. A shock absorber rod is the stem in the shock absorber providing full support of a vehicle’s suspension system. Jinzhou Wanyou currently produces 15 series of rods and shafts in terms of diameters from ø8 to ø28 with over 2,000 models.

Engine Valves and Tappets

Our engine valves and tappets are manufactured by Jinan Worldwide. Engine valves and tappets are used in internal combustion engines to control and facilitate the engine’s air intake and exhaust functions. Our engine valves and tappets are critical to optimizing the engine’s power output and fuel consumption.  At present, Jinan Worldwide produces 5 series of engine valves and tappets in term of applications with over 200 models.
 
We strive to produce high quality products and have established a quality control system to ensure that we achieve this goal. We have obtained the ISO9002, QS9000, and TS 16949 certificates for our quality management system.

Our Industry
 
Overview of Chinese Automobile Industry
 
China experienced significant economic growth in 2009 and has overtaken the U.S. as the world’s largest automobile market despite challenging global economic conditions that have had a significant negative impact on the global automobile industry. According to CAAM, China’s automobile production and sales volumes were 13.8 million and 13.6 million units in 2009, representing a 48.3% and 46.2% growth rate over 2008, respectively. Sales of passenger cars in China, including sedans, multipurpose vehicles and sport-utility vehicles, were 10.3 million units in 2009, up 7.3% year-over-year. The automobile vehicle population exceeded 186 million units in 2009 according to the Chinese State Minister of Public Security. The passenger vehicles population increased by 9.6 million units, up to 42.4 million units, representing a 29.3% growth rate over 2008.

Most of our products are manufactured for use in passenger automobiles with small to medium engines, with displacements of 2.0 liters or below. Automobiles with these engine displacements produce lower emissions, tend to be more fuel efficient, more environmentally friendly and less expensive. Sales of small- to medium-engine passenger cars with displacements of 2.0 liters or below in China were approximately 9.45 million units in 2009, representing 91.5% of the total sales of passenger car market in China.

We believe growth in China’s automobile industry will primarily be driven by the following factors:

China’s Macroeconomic Growth.    China’s economy has experienced significant growth since the early 1980s. According to the National Bureau of Statistics of China, the gross domestic product, or GDP, in China was RMB 33.54 trillion in 2009, representing an 8.7% growth as compared to 2008. According to a report published by the Organization for Economic Co-operation and Development (OECD) in November 2009, China’s GDP growth in 2010 is expected to reach approximately 10%, as compared to an expected approximate 3.4% increase in global GDP. We believe that a continued increase in China’s GDP will generate greater Chinese consumer purchasing power for durable goods such as automobiles.

Low Per Capita Rate of Vehicle Ownership.    According to the CAAM, in 2009, the passenger vehicle ownership rate in China was approximately 25 passenger vehicles per 1,000 inhabitants, and even lower in remote areas in China. According to Japan Automobile Manufacturers Association statistics, the average passenger vehicle ownership rate in the United States was more than 450 passenger vehicles per 1,000 inhabitants and the world average passenger vehicle ownership rate was over 100 passenger vehicles per 1,000 inhabitants in 2007. We believe that sales of automobiles in China will experience continued growth, given the significantly lower penetration rate of automobiles in China and rising income levels in China.

 
4

 

Increasing Urbanization and Rising Income Levels.    Overall population growth and a trend towards urbanization have led to significant growth in China’s urban population since 1978. According to the National Bureau of Statistics of China, the urbanization rate in China grew at a CAGR of 2.8% in the period from 2004 to 2008, while annual disposable income per capita of urban residents grew at a CAGR of 13.8% in the same period. We expect a growing and increasingly affluent urban population will result in greater need for more efficient and individualized means of transportation, resulting in rising car ownership.

Growth of Highway Infrastructure.    According to the National Bureau of Statistics of China, the total length of highways in China increased from 1.2 million kilometers in 1996 to 3.7 million kilometers in 2008, representing a CAGR of 10.0%. The growth in the total length of expressways in China has been even faster, with the total length having increased from 3,400 kilometers in 1996 to 65,000 kilometers in 2009, representing a CAGR of 25.5%. We believe the continued growth of China’s highways and related transportation infrastructure is likely to make automobile transportation easier and more efficient resulting in a growing demand for automobiles.

Favorable Government Policies.    The Chinese government has adopted a number of measures and initiatives intended to stimulate the growth and development of China’s automobile industry. The following are selected government initiatives that we believe are likely to have a favorable impact on China’s automobile industry:

 
·
On September 1, 2008, a measure was adopted by the PRC tax authority to reduce the consumption tax rates assessed on low-emission vehicles, which is a primary market for our products.

 
·
In November 2008, China’s State Council announced a RMB 4 trillion (approximately $585.7 billion) economic stimulus package which increases PRC government investment and spending on infrastructure projects, particularly roads, railways and airports.

 
·
On January 1, 2009, the Chinese State Tax Bureau implemented a new fuel tax which replaces six other fees imposed on vehicle owners and provides favorable tax treatment to low-emission vehicles.

 
·
On January 14, 2009, the Chinese government announced a stimulus package of RMB 10 billion (approximately $1.5 billion) to specifically bolster China’s automobile industry, including investment in the development of alternative energy vehicles and parts.

 
·
On January 20, 2009, the Chinese State Tax Bureau reduced the sales tax imposed on sales of small engine vehicles with displacements of 1.6 liters or below by 50%.

 
·
The Chinese Ministry of Financing approved and granted RMB 5 billion (approximately $732.1 million) for the “Cars to the Countryside” program, which is a government subsidy program that became effective on March 1, 2009. Under this program, individuals in rural areas who purchase minibuses with engine sizes of 1.3 liters or below between March 1, 2009 and December 31, 2009 will be entitled to a 10% subsidy of the full price of a vehicle.

 
·
On December 9, 2009, the Chinese State Council announced that the purchase tax for automobiles with displacement of 1.6 liters or less will be 7.5% until December 31, 2010.

 
·
On January 18, 2010, the Chinese State Tax Bureau and the State Finance Ministry jointly announced a new stimulus package to encourage people to abandon the use of old vehicles for new vehicles, which will combine subsidies for old vehicles with a purchase tax deduction for new vehicles.

We expect the above government measures and initiatives will accelerate the demand for automobiles, particularly low-displacement automobiles, in China.

Overview of Chinese Automobile Parts Industry
 
While the Chinese automobile parts industry experienced rapid growth over the past several years, starting in 2009, the Chinese automotive parts industry grew at a considerably slower pace than in past years as the global economic crisis took effect.  The number of automobiles in China reached 186 million at the end of 2009, up 9.83% from 2008. According to Sinomind Consulting, a China based automobile market research and management consulting company, China’s sales of automobile parts reached $136.5 billion in 2008, up 23.9% from $110.2 billion in 2007. According to the United States Department of Commerce, China became the second largest exporter of automobile parts into the United States in 2007, overtaking Germany and following Japan.

 
5

 
 
We believe that growth in China’s auto parts industry will continue due to several important factors.  First, the continued growth of Chinese automobile industry will lay a solid foundation for the growth in the OEM automobile parts industry.  Second, increased levels of car ownership by Chinese residents will lead to the growth of the replacement parts market.  Finally, as Chinese and international automotive manufacturers implement cost savings plans, we expect them to source components directly from low cost manufacturing regions, such as China.
 
Our Intellectual Property
 
Our goal is to utilize our intellectual property to provide us with a competitive advantage. We currently own 64 patents issued in China relating to our products. Additionally, Jinzhou Halla has registered the trademark for the logo “” ,and Jinan Worldwide has registered the trademark for the logo “”, “”, “”, “”, “”, “”, and “” with the Trademark office of the State Administration for Industry and Commerce of China.

We cannot give any assurance that the protection afforded our intellectual property will be adequate. It may be possible for third parties to obtain and use, without our consent, intellectual property that we own or are licensed to use. Unauthorized use of our intellectual property by third parties, and the expenses incurred in protecting our intellectual property rights, may adversely affect our business. See Item 1A, “Risk Factors – Risks Related to our Business – Failure to adequately protect our intellectual property rights may undermine our competitive position, and litigation to protect our intellectual property rights may be costly.” We may also be subject to litigation involving claims of patent infringement or violation of other intellectual property rights of third parties. See Item 1A, “Risk Factors – Risks Related to our Business – We may be exposed to infringement or misappropriation claims by third parties, which, if determined adversely against us, could disrupt our business and subject us to significant liability to third parties.”

Sales and Marketing
 
We market our products directly to our customers though our sales department which, as of December 31, 2009, consisted of approximately 141 employees. Each member of our sales department receives one month of training in both the business and technical aspects that they will need to perform their job functions. In addition, we periodically provide continuing educational training for our sales personnel. Members of our sales department generate sales leads by contacting auto manufacturers directly and by attending industry trade shows and exhibitions. Since we have established our status as one of the leading suppliers of alternators, starters, rods and shafts, and engine valves and tappets, our customers may also contact us for new projects. Although most of our business is developed by direct personal contact and referrals from our customers, we also advertise our products in industry trade journals and other industry media.
 
In order to attract international customers, we also attend international trade shows, such as the automobile shows in Frankfurt and Las Vegas, to raise our brand recognition and promote our products to the international market.  We started selling our products directly to foreign customers in 2003. Our overseas sales accounted for approximately 10.7% of our total sales revenue in 2009.
 
In addition to our sales and marketing department which performs customer service functions, we also employ outside representatives whose primary function is to understand our customers’ needs and promote services that best meet their requirements. These representatives also help our customers resolve installation problems and provide general customer service. As of December 31, 2009, we had twelve representatives stationed at different major customers, including one Mexican representative.

Raw Materials
 
The raw materials we use to produce our starters and alternators fall into four general categories: metal parts, semiconductors, chemicals, and packaging materials. The main raw materials we use to produce our rods, shafts, engine valves and tappets are iron and steel. The prices of these raw materials are determined based upon prevailing market conditions, supply and demand. Supply and demand for these raw materials is generally affected by the cyclical nature of the automobile industry and the auto parts industry. Supply and demand is also affected by macroeconomic conditions, including consumer disposable income and spending patterns.

 
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We purchase the majority of our raw materials and components from suppliers located in China, including Jiangsu Senyuan Special Steel Co., Ltd., Yingkou Die-Casting Products Co., Ltd., Tianjin Jingda Rea Special Enamelled Wire Co., Ltd., Zhejiang Huanfang Auto Electrical Appliance Co. Ltd., Zhejiang Yuhuan Solenoid Co., Ltd., and Jinzhou Hirvon Auto Electronics Co., Ltd.  In situations where we procure raw materials from our subsidiaries, we purchase such materials at cost with no additional mark-up and account for such transactions through intercompany cost allocations.
 
A portion of our raw materials and components are made to our technical specifications, and the remainder of our raw materials and components are non-customized. We consider the raw materials and components that are made to our technical specifications to be proprietary to us, and we have entered into agreements with some of our suppliers which prohibit them from supplying to other third parties these raw materials and components. We believe that in most instances, raw materials and components made to our technical specifications can be obtained from multiple supply sources. We generally have not experienced any difficulties in obtaining our requirements for raw materials.
 
Even though multiple supply sources are available to us, our practice has been to utilize limited vendors for certain types of raw materials and components needed in our business based on our past relationship with particular vendors and their abilities to deliver to us high quality raw materials and components on favorable terms. Over the past years, we have been making efforts to diversify our supply channels in order to increase our bargaining power with suppliers. In 2009, our top five suppliers accounted for approximately 32% of our total cost of sales, decreased from approximately 59% in 2008.
 
We utilize local suppliers in close proximity to us, typically within 300 kilometers of our manufacturing facilities, in order to closely supervise their activities, monitor quality, provide technical training and collaborate on technical improvements. If geographically proximate suppliers continue to be able to provide high quality raw materials and components to us, we intend to continue to source our raw materials and components from them to take advantage of lower shipping costs and favorable quality control capabilities.
 
Our suppliers must meet our quality standards and delivery requirements consistently to remain on our approved supplier list. If a supplier furnishes suboptimal materials and components to us or is repeatedly late in deliveries, we remove them from our approved supplier list.
 
We typically purchase the raw materials that we use to produce our products from our suppliers on credit.  Credit terms usually permit payment up to 90 days following the delivery of the raw materials. When we purchase raw materials from Chinese suppliers, we are able to pay in RMB. When we purchase raw materials from foreign suppliers, we usually pay in U.S. dollars. Our account payables above six months accounted for 1.75%, 1.85% and 3.7% of our total account payables in 2007, 2008 and 2009, respectively.
 
In 2009, our three biggest suppliers were Jiangsu Senyuan Special Steel Co., Ltd., Yingkou Die-Casting Products Co., Ltd. and Tianjin Jingda Rea Special Enameled Wire Co. Ltd., which accounted for approximately 7.1%, 6.7% and 6.6% of our total purchases, respectively. No suppliers accounted for more than 10% of our total cost of sales in 2009.
 
Our Major Customers
 
Large automobile manufacturers and automotive engine suppliers are our primary and most desirable customers.  Our major customers include, among others, Beijing Hyundai Mobis Auto Parts, Harbin Dongan Automotive Engine Co., Ltd., Shenyang Aerospace Mitsubishi Motors Engine Co., Ltd., Weichai Engine Logistic Co., Ltd., Mianyang Xinchen Engine Co., Ltd., Shanghai GM Wuling Automotive Co., Ltd., Guangxi Yuchai Machinery Holdings Company, Jiangsu Mobis Auto Parts Company, Magneti Marelli Suspension System (Brazil). As we continue to increase sales in the domestic market, we also intend to grow our overseas sales. We focus on maintaining long-term relationships with our customers. We have enjoyed recurring orders from most of our customers for periods of four to ten years. Our typical sales contract has a one-year term and is usually renewable.
 
We continued our efforts in diversifying our client base without lowering our total sales revenue. In 2009, our top three customers accounted for approximately 29.9% of our total sales revenue as compared to approximately 34.9% in 2008.  In 2009, our two biggest customers Beijing Hyundai Mobis Auto Parts Co., Ltd., and Harbin Dongan Automotive Engine Co., Ltd. accounted for approximately13.9% and 10.8% of our total sales revenue, respectively. No other customers accounted for more than 10% of our sales revenue in 2009. We plan to further diversify our customer base in 2010 to enhance profitability.

 
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Research and Development
 
We believe that the development of new products and production methods is important to our success. We currently operate four research and development centers, each performing different research and development activities. Three of our research and development centers are located at our principal business headquarters in Jinzhou, China, focusing on the enhancement of current products, and the development and testing of new alternator, starter and electric motor products. The other research and development center is located in Jinan, China, focusing on the development and testing of new engine valve and tappet products. As of December 31, 2009, our research and development personnel consisted of approximately 163 employees.
 
We are often invited by our customers to jointly develop new components tailored to our customers’ specific requirements. In 2009, we had 35 joint development programs used in various models of sedans. Our OEM customers that we conduct joint development projects with include FAW sedans, Chery Automobile, South Korea Doosan and Shanghai GM Wuling. During the past several years, upon the successful completion of most joint development project, we were engaged as the supplier for the jointly developed products.
 
We believe that our development period is shorter than many other industry participants due to our dedicated research and development resources and our close proximity to our customers. Many of our major competitors are foreign joint ventures who generally conduct their primary research and development activities in their home countries. We believe that our China-based research and development operations provide us with an advantage over these competitors since we are within geographic proximity to our customers and our research and development personnel are able to communicate directly with our customers in Chinese and quickly respond to their product requirements.

For the fiscal years ended December 31, 2007, 2008 and 2009, our research and development expenses for new products development, representing salaries of personnel and other costs incurred for research and development of potential new products, were $534,503, $1.2 million and $3.0 million, representing approximately 0.5%, 0.9% and 1.4% of our total sales revenue in 2007, 2008 and 2009, respectively.  The amount incurred for purchase of equipments for research and development were approximately $2.4 million, $2.2 million and $704,616, representing approximately 3.0%, 1.5% and 0.3% of our total sales revenue in 2007, 2008 and 2009, respectively.
 
Backlog
 
Our backlog of orders was approximately $58 million as of December 31, 2009 compared to approximately $12.3 million at December 31, 2008. We anticipate that substantially all of the backlog at the end of 2009 will be delivered during 2010. In the opinion of management, the amount of backlog is not indicative of trends in our business.

Regulation
 
Because our operating subsidiaries are located in the PRC, we are regulated by the national and local laws of the PRC.

There is no private ownership of land in China. Upon payment of a land grant fee, land use rights can be obtained from the government for a period up to 70 years in the case of industrial land and are typically renewable. We have received the necessary land use rights certificate for the 453,900 square feet of land located at No. 16 Yulu Street, Jinzhou High Technology Industrial Park, Jinzhou, China and the 179,500 square feet of land located at West Bo Hai Street, Open Economic Zone, Jinzhou, China. We were granted land use rights from the Chinese government for 1,842,000 square feet of land located at New Century Avenue, Changqing District, Jinan High Technology Industrial Park, Shangdong, China. The land use rights have a 50-year term and will expire on January 27, 2055. This site houses our office building, a research and development center, as well as our production facilities.

We are also subject to China’s foreign currency regulations. The PRC government has controlled Renminbi reserves primarily through direct regulation of the conversion of Renminbi into other foreign currencies. Although foreign currencies, which are required for “current account” transactions, can be bought freely at authorized PRC banks, the proper procedural requirements prescribed by PRC law must be met. At the same time, PRC companies are also required to sell their foreign exchange earnings to authorized PRC banks, and the purchase of foreign currencies for capital account transactions still requires prior approval of the PRC government.

 
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We do not face any significant government regulations in connection with the production of our products. We do not require any special government permits to produce our products other than those permits that are required for all corporations in China.

Our Competition
 
The automobile parts market in China is very competitive. We compete based upon the price and quality of our products, product availability and customer service. There are approximately 10 major competitors in this market trying to sell the same products that we sell to the same group of target customers. Our primary competitors are located in China and include Shanghai Valeo Automotive Electrical Systems Co. Ltd., Hubei Shendian Auto Motor Co., Ltd. and Zhongqi Changdian Co., Ltd.
 
With China’s entry into the WTO and China’s agreement to lift its protections to infant industries, we believe that competition will increase in the China auto parts industry segment. Our primary international competitors include VALEO (France), BOSCH (German), RAMY (U.S.), Mitsubishi Motor (Japan) and Denso (Japan).  Some of our competitors have greater financial resources, larger staff, and more established market recognition in both domestic Chinese and international markets than we have.
    
Environmental Compliance
 
Our manufacturing facilities are subject to various pollution control regulations with respect to noise and air pollution and the disposal of waste and hazardous materials. We are also subject to periodic inspections by local environmental protection authorities. We believe we are in material compliance with the relevant PRC environmental laws and regulations. We are not currently subject to any pending actions alleging any violations of applicable PRC environmental laws. 

Our Employees
 
As of December 31, 2009, we employed 3,766 full-time employees. The following table sets forth the number of our full-time employees by function.

Function 
 
Number of Employees 
Manufacturing and engineering
 
3,180
General and administration
 
282
Marketing and sales
 
141
Research and development
 
163
 
As required by applicable Chinese law, we have entered into employment contracts with all of our officers, managers and employees. We believe that we maintain a satisfactory working relationship with our employees, and we have not experienced any significant labor disputes or any difficulty in recruiting staff for our operations.
 
Our employees in China participate in a state pension scheme organized by Chinese municipal and provincial governments. We are required to contribute to the scheme at the rates of 30.6% to 45.0% of the employees’ salaries and wages.  The compensation expenses related to this scheme was approximately $3.2 million, $1.2 million and $681,944 for the fiscal years 2009, 2008 and 2007, respectively.
 
In addition, we are required by Chinese law to cover employees in China with various types of social insurance.  We have purchased social insurance for all of our employees.
 
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Available Information
 
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, including exhibits, and amendments to those reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Exchange Act, are available free of charge on our website at www.watg.cn as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. Copies of these reports may also be obtained free of charge by sending written requests to Investor Relation, Wonder Auto Technology, Inc., No. 16 Yulu Street, Taihe District, Jinzhou City, Liaoning, People’s Republic of China, 121013. The information posted on our web site is not incorporated into this Annual Report.

ITEM 1A.
RISK FACTORS.

RISKS RELATED TO OUR BUSINESS

The global economic crisis could further impair the automotive industry thereby limiting demand for our products and affecting the overall availability and cost of external financing for our operations.

The continuation or intensification of the recent global economic crisis and turmoil in the global financial markets may adversely impact our business, the businesses of our customers and our potential sources of capital financing. Our automotive parts are primarily sold to automakers, engine manufacturers and auto parts suppliers. The recent global economic crisis harmed most industries and has been particularly detrimental to the automotive industry. Since virtually all of our sales are made to auto industry participants, our sales and business operations are dependent on the financial health of the automotive industry and could suffer if our customers experience, or continue to experience, a downturn in their business. In addition, the lack of availability of credit could lead to a further weakening of the Chinese and global economies and make capital financing of our operations more expensive for us or impossible altogether. Presently, it is unclear whether and to what extent the economic stimulus measures and other actions taken or contemplated by the Chinese government and other governments throughout the world will mitigate the effects of the crisis on the automotive industry and other industries that affect our business. These conditions have not presently impaired our ability to access credit markets and finance our operations. However, the impact of the current crisis on our ability to obtain capital financing in the future, and the cost and terms of the financing, is unclear. Furthermore, deteriorating economic conditions including business layoffs, downsizing, industry slowdowns and other similar factors that affect our customers could have further negative consequences for the automotive industry and result in lower sales, price reductions in our products and declining profit margins. The economic situation also could harm our current or future lenders or customers, causing them to fail to meet their obligations to us. No assurances can be given that the effects of the current crisis will not damage on our business, financial condition and results of operations.

A contraction in automotive sales and production could have a material adverse affect on our results of operations and liquidity and on the viability of our supply base.

Automotive sales and production are highly cyclical and depend, among other things, on general economic conditions and consumer spending and preferences (which can be affected by a number of issues including fuel costs and the availability of consumer financing). As the volume of automotive production fluctuates, the demand for our products also fluctuates. The global automotive sales and production deteriorated substantially in the second half of 2008 and are not expected to rebound significantly in the near term. While the China automotive sales and production maintained modest growth momentum in 2008 and continued to grow in 2009, the growth rate was down from previous years. A contraction in automotive sales and production could harm our results of operations and liquidity. In addition, our suppliers would also be subject to many of the same consequences which could pressure their results of operations and liquidity. Depending on an individual supplier’s financial condition and access to capital, its viability could be challenged which could impact its ability to perform as we expect and consequently our ability to meet our own commitments.

Escalating pricing pressures from our customers may adversely affect our business.

Pricing pressure in the automotive supply industry has been substantial and is likely to continue. Many vehicle manufacturers seek price reductions in both the initial bidding process and during the term of the contract. Price reductions have impacted our sales and profit margins and are expected to do so in the future. If we are not able to offset continued price reductions through improved operating efficiencies and reduced expenditures, those price reductions may have a material adverse effect on our results of operations.

 
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If we fail to accurately project market demand for our products, our business expansion plan could be jeopardized and our financial condition and results of operations will suffer.

If actual customer orders are less than our projected market demand, we will likely suffer overcapacity problems and may have to leave capacity idle, which may reduce our overall profitability and hurt our financial condition and results of operations. Even though our business increasingly has included more international sales, we derive most of our sales revenue from sales of our products in China. The continued development of our business depends, in large part, on continued growth in the automotive industry, especially in China. Although China’s automotive industry has grown rapidly in the past, it may not continue to grow at the same growth rate in the future or at all. However, the developments in our industry are, to a large extent, outside of our control and any reduced demand for automotive parts products and services, any other downturn or other adverse changes in China’s automotive industry could severely harm our business.

Our business is capital intensive and our growth strategy may require additional capital which may not be available on favorable terms or at all.

We believe that our current cash and cash flow from operations are sufficient to meet our present and reasonably anticipated cash needs. We may, however, require additional cash resources due to changed business conditions, implementation of our strategy to expand our manufacturing capacity or other investments or acquisitions we may decide to pursue. If our own financial resources are insufficient to satisfy our capital requirements, we may seek to sell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity securities could result in dilution to our stockholders. The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financial covenants that would restrict our operations. Given the current global economic crisis, financing may not be available in amounts or on terms acceptable to us, if at all. Any failure by us to raise additional funds on terms favorable to us, or at all, could limit our ability to expand our business operations and could harm our overall business prospects.

Due to our rapid growth in recent years, our past results may not be indicative of our future performance so evaluating our business and prospects may be difficult.

Our business has grown and evolved rapidly in recent years as demonstrated by our growth in annual sales revenue from approximately $48.1 million in 2005 to $211.0 million in 2009. We may not be able to achieve similar growth in future periods, and our historical operating results may not provide a meaningful basis for evaluating our business, financial performance and prospects. Moreover, our ability to achieve satisfactory manufacturing results at higher volumes is unproven. Therefore, you should not rely on our past results or our historical rate of growth as an indication of our future performance.
 
We face risks associated with future investments or acquisitions.

An important element of our growth strategy is to invest in or acquire businesses that will enable us, among other things, to expand the products we offer to our existing target customer base, lower our costs for raw materials and components and capitalize on opportunities to expand into new markets. We recently acquired controlling interests in several complementary businesses, including Friend Birch Limited and its subsidiaries which we expect to contribute to our future growth. In the future, we may be unable to identify other suitable investment or acquisition candidates or may be unable to make these investments or acquisitions on commercially reasonable terms, if at all.

If we complete an investment or acquisition, we may not realize the anticipated benefits from the transaction. Integrating an acquired business is distracting and time consuming, as well as a potentially expensive process. We are currently in the process of integrating our operations with the operations of recently acquired companies. The successful integration of these companies and any other acquired businesses require us to:

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

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

 
·
coordinate research and development efforts;

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

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

Acquisitions involve a number of risks and present financial, managerial and operational challenges, including:
 
 
·
Our ability to successfully commercialize our strategic investments;

 
·
increased expenses, including travel, legal, administrative and compensation expenses resulting from newly hired employees;

 
·
increased costs to integrate personnel, customer base and business practices of the acquired company with our own;

 
·
adverse effects on our reported operating results due to possible write-down of goodwill associated with acquisitions;

 
·
potential disputes with sellers of acquired businesses, technologies, services, products and potential liabilities;

 
·
potential liabilities as a result of assumption of liabilities of acquired companies; and

 
·
dilution to our earnings per share if we issue common stock in any acquisition.

Moreover, geographic distance between business operations, the compatibility of the technologies and operations being integrated and the disparate corporate cultures being combined also present significant challenges. Acquired businesses are likely to have different standards, controls, contracts, procedures and policies, making it more difficult to implement and harmonize company-wide financial, accounting, billing, information and other systems. Our focus on integrating operations may also distract attention from our day-to-day business and may disrupt key research and development, marketing or sales efforts. Performance problems with an acquired business, technology, product or service could also have a material adverse impact on our reputation as a whole. Any acquired business, technology, product or service could significantly under-perform relative to our expectations. In addition, although we have conducted due diligence with respect to our recently acquired companies, there may still be unidentified issues and hidden liabilities, which could have a material adverse effect on our business, liquidity, financial condition and results of operations. For instance, in connection with our acquisition of Jinan Worldwide, a previously state-owned enterprise, the local Chinese government may, among other things, require us fulfill obligations of the prior owner of Jinan Worldwide to contribute additional capital of approximately RMB 330 million into Jinan Worldwide by May 2010 and achieve certain performance targets with respect to Jinan Worldwide. If we cannot overcome these challenges, we may not realize actual benefits from past and future acquisitions, which will impair our overall business results.

Our acquisition strategy also depends on our ability to obtain necessary government approvals. See “–Risks Related to Doing Business in China – We may be unable to complete a business combination transaction efficiently or on favorable terms due to complicated merger and acquisition regulations which became effective on September 8, 2006.”

We may not be able to realize the potential financial or strategic benefits of strategic investment in Jinheng Holding, which could hurt our ability to grow our business and harm our financial condition.

As part of our growth strategy, we will continue to explore and make strategic investments in business that is complementary or additive to our core business and product offerings.  For instance, on January 18, 2010, through two separate transactions, we made a strategic investment in which we acquired an aggregate of 38.36% of equity interest in Applaud Group Limited, and, thereby, owner of 20.02% of Jinheng Holding, which manufactures airbag safety devices for automobiles.  We expect to utilize our strategic investment in Jinheng Holding to further strengthen and broaden our research and development expertise, expand customer base and improve value-added services. However, the success of the strategic investment depends on various factors over which we may have limited or no control. Mergers and acquisitions and strategic investments are inherently subject to significant risks. For instance, the commercial aspects and goals of our strategic investment may not materialize as desired or yield the commercial benefits sought.  Moreover, regardless of whether the commercial aspects and goals of the strategic investment prove to be positive, an strategic investment in another company comes with the typical investment risks, such as the partial or total loss of investment in the worst case.  Our inability to pinpoint and make favorable strategic investments, from both a commercial and investment perspective and our inability to effectively manage the associated risks could materially and adversely affect our business, financial condition and results of operations. In the case of Jinheng Holding, our strategic investment may decline in value and/or may not meet our desired objectives. If we do not successfully manage the risks associated with this and other acquisitions and strategic investments, our business, financial condition and results of operations could be materially and adversely affected.

 
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If we fail to comply with covenants in our loan agreements, our lenders may allege a breach of a covenant and seek to accelerate the loan or exercise other remedies, which could strain our cash flow and harm our business, liquidity and financial condition.

In connection with loans made to us by several commercial lenders, we have entered into loan agreements which impose upon us certain financial and operating covenants. The financial covenants require us to satisfy certain financial metrics and maintain financial ratios deemed appropriate by our lenders. The operating covenants often require us to take certain actions, such as keeping current on our debt payments, delivering reports to our lenders and so forth, or refraining from taking actions without the lender’s consent or at all, such as incurring additional debt, making capital expenditures, paying dividends or distributions or acquiring other business or assets. Even though we strive to comply with our covenants, we have failed in the past, and may fail in the future, to do so and our lenders may notify us of such non-compliance and seek to accelerate a loan or exercise other remedies. For instance, under our loan agreement with DEG - Deutsche Investitions - und Entwicklungsgesellschaft mbH, or DEG, dated November 24, 2006, we agreed not to make certain acquisitions without prior consent of DEG. For some of our recent acquisitions, we did not obtain prior approval from DEG, but instead have subsequently informed DEG about the acquisitions. We have not received from DEG any written notice of non-compliance or breach as we believe our subsequent notices have remedied any problems. However, we cannot assure you that DEG will not, in the future, send a notice of breach to us and require acceleration of the loan, in which case we currently believe we have adequate cash to meet the payment obligation. If, in the future, we fail to comply with our loan agreement covenants, and we receive a notice of non-compliance or default, we will attempt to cure any non-compliance and/or negotiate appropriate waivers with our lenders. If we cannot cure any non-compliance or obtain a waiver, our lenders may declare us to be in default, which would give them the right to accelerate our outstanding indebtedness. If any larger amount of our indebtedness is accelerated as a result of a default, we may be forced to repay our loans earlier than expected, which would have a material adverse effect on our business, liquidity and financial condition.

Any interruption in our production processes could impair our financial performance and negatively affect our brand.

We manufacture or assemble our products primarily at our facilities in Jinzhou and Jinan, China. Our manufacturing operations are complicated and integrated, involving the coordination of raw material and component sourcing from third parties, internal production processes and external distribution processes. While these operations are modified on a regular basis in an effort to improve manufacturing and distribution efficiency and flexibility, we may experience difficulties in coordinating the various aspects of our manufacturing processes, thereby causing downtime and delays. We have also been steadily increasing our production capacity and have limited experience operating at these higher production volume levels. In addition, we may encounter interruption in our manufacturing processes due to a catastrophic loss or events beyond our control, such as fires, explosions, labor disturbances or violent weather conditions. Any interruptions in our production or capabilities at our facilities could result in our inability to produce our products, which would reduce our sales revenue and earnings for the affected period. If there is a stoppage in production at any of our facilities, even if only temporary, or delays in delivery times to our customers, our business and reputation could be severely affected. Any significant delays in deliveries to our customers could lead to increased returns or cancellations and cause us to lose future sales. We currently do not have business interruption insurance to offset these potential losses, delays and risks so a material interruption of our business operations could severely damage our business.

Part of our strategy involves the development of new products, and if we fail to timely develop new products or we incorrectly gauge the potential market for new products, our financial results will be adversely affected.

We plan to utilize our in-house research and development capabilities to develop new products that could become new sources of sales revenue for us in the future and help us to diversify our revenue base. For example, we acquired the research and development center owned by Friend Birch Limited which is focused on developing new technology for rods and shafts. Our future research and development efforts will continue to be focused on expanding our product offering beyond our current products into other similar products and components for different applications, such as hub motors for electric bicycles and electric vehicles. If we fail to timely develop new products or if we miscalculate market demand for new products that we develop, we may not be able to grow our sales revenue at expected growth rates and may incur expenses relating to the development of new products that are not offset by sufficient sales revenue generated by these new products.

 
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Exporting our products outside of China is an important component of our overall growth strategy, which could subject us to various economic, political, regulatory, legal and foreign exchange risks.

We currently sell most of our products in China. Our overseas sales accounted for 9.6%, 16.2% and 10.7% of our total sales revenue in 2007, 2008 and 2009, respectively. We plan to selectively enter international markets in which an opportunity to sell our products has been identified. The marketing, distribution and sale of our products overseas expose us to a number of risks, including:

 
·
fluctuations in currency exchange rates;

 
·
difficulty in designing products that are compatible with product standards in foreign countries;

 
·
greater difficulty in accounts receivable collection;

 
·
increased marketing and sales costs;

 
·
difficulty and costs of compliance with foreign regulatory requirements and different commercial and legal requirements;

 
·
an inability to obtain, maintain or enforce intellectual property rights in foreign countries;

 
·
changes to import and export regulations, including quotas, tariffs and other trade barriers, delays or difficulties in obtaining export and import licenses, repatriation controls on foreign earnings and currency conversion restrictions; and

 
·
difficulty in engaging and retaining distributors and agents who are knowledgeable about, and can function effectively in, overseas markets.

If we cannot effectively manage these risks, our ability to conduct or expand our business abroad would be impaired, which may in turn hamper our business, financial condition and prospects.
 
If we cannot keep pace with market changes and produce automotive parts with new technologies in a timely and cost-efficient manner to meet our customers’ requirements and preferences, the growth and success of our business will be hindered.

The automotive parts market in China is characterized by increasing demand for new and advanced technologies, evolving industry standards, intense competition and wide fluctuations in product supply and demand. If we cannot keep pace with market changes and produce automotive parts incorporating new technologies in a timely and cost-efficient manner to meet our customers’ requirements and preferences, the growth and success of our business will suffer.

From time to time, new products, product enhancements or technologies may replace or shorten the life cycles of our products or cause our customers to defer purchases of our existing products. Shorter product life cycles may require us to invest more in developing and designing new products and to introduce new products more rapidly, which may increase our costs of product development and decrease our profitability. In addition, we may not be able to make such additional investments and any additional investments we make in new product development and introductions may not be successful.

Even if we develop and introduce new products, their market acceptance is not assured and depends on:

 
·
the perceived advantages of our new products over existing competing products;

 
·
our ability to attract vehicle manufacturers who are currently using our competitors’ products;

 
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·
product cost relative to performance; and

 
·
the level of customer service available to support new products.

Therefore, commercial acceptance by customers of our products may not occur at our expected rate or level, and we may not be able to successfully adapt existing products to effectively and economically meet customer demand, thus impairing the return from our investments. We may also be required under applicable accounting standards to recognize a charge for the impairment of assets to the extent our existing products become uncompetitive or obsolete or if any new products fail to achieve commercial acceptance. Any such charge may jeopardize our ability to operate profitably.

Failure to adequately protect our intellectual property rights may undermine our competitive position, and litigation to protect our intellectual property rights may be costly.

We strive to strengthen and differentiate our product portfolio by developing new and innovative products and product improvements. As a result, we believe that the protection of our intellectual property will become increasingly important to our business. Implementation and enforcement of intellectual property-related laws in China has historically been lacking due primarily to ambiguities in PRC intellectual property law. Accordingly, protection of intellectual property and proprietary rights in China may not be as effective as in the United States or other countries. Currently, we hold 64 PRC patents that relate to various product configurations and product components. We will continue to rely on a combination of patents, trade secrets, trademarks and copyrights to provide protection in this regard, but this protection may be inadequate. For example, our pending or future patent applications may not be approved or, if allowed, they may not be of sufficient strength or scope. As a result, third parties may use the technologies and proprietary processes that we have developed and compete with us, which could negatively affect any competitive advantage we enjoy, dilute our brand and harm our operating results.
In addition, policing the unauthorized use of our proprietary technology can be difficult and expensive. Litigation may be necessary to enforce our intellectual property rights and given the relative unpredictability of China’s legal system and potential difficulties enforcing a court judgment in China, there is no guarantee litigation would result in an outcome favorable to us. Furthermore, any such litigation may be costly and may divert management attention away from our core business. An adverse determination in any lawsuit involving our intellectual property is likely to jeopardize our business prospects and reputation. We have no insurance coverage against litigation costs so we would be forced to bear all litigation costs if we cannot recover them from other parties. All of the foregoing factors could harm our business and financial condition.

We may be exposed to infringement or misappropriation claims by third parties, which, if determined adversely against us, could disrupt our business and subject us to significant liability to third parties.

Our success largely depends on our ability to use and develop our technology, know-how and product designs without infringing upon the intellectual property rights of third parties. We may be subject to litigation involving claims of patent infringement or violation of other intellectual property rights of third parties. The holders of patents and other intellectual property rights potentially relevant to our product offerings may be unknown to us or may otherwise make it difficult for us to acquire a license on commercially acceptable terms.

We have not registered and do not own the logo . Wonder Auto Group Limited, a Hong Kong company controlled by Mr. Qingjie Zhao, our chairman, chief executive officer and president and is now dormant, has registered the “ ” trademark in Hong Kong. Jinzhou Wonder Auto Suspension System Co., Ltd. has registered the trademarks “ ” and “ ” in China. We have not been able to register the logo in China because it is similar to the trademarks registered by Jinzhou Wonder Auto Suspension System Co., Ltd. An independent third party entity has registered the “Jinzhou Halla” trademark in China. We currently do not sell any products or services using the marks similar to the trademarks registered by Jinzhou Wonder Auto Suspension System Co., Ltd. or “Jinzhou Halla” trademarks. We have entered into an agreement with Jinzhou Wonder Auto Suspension System Co., Ltd. Under this agreement, Jinzhou Wonder Auto Suspension System Co., Ltd. has agreed not to bring any legal action against us for using the mark “ ” in China. However, we cannot assure you that no action will be brought against us based on our use of “ ”.

 
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There may also be technologies licensed to and relied on by us that are subject to infringement or other corresponding allegations or claims by others which could damage our ability to rely on such technologies. In addition, although we endeavor to ensure that companies that work with us possess appropriate intellectual property rights or licenses, we cannot fully avoid the risks of intellectual property rights infringement created by suppliers of components used in our products or by companies with which we work in cooperative research and development activities.

Our current or potential competitors, many of which have substantial resources and have made substantial investments in competing technologies, may have obtained or may obtain patents that will prevent, limit or interfere with our ability to make, use or sell our products in China or other countries. The defense of intellectual property claims, including patent infringement suits, and related legal and administrative proceedings can be both costly and time consuming, and may significantly divert the efforts and resources of our technical and management personnel. Furthermore, an adverse determination in any such litigation or proceeding to which we may become a party could cause us to:

 
·
pay damage awards;

 
·
seek licenses from third parties;

 
·
pay additional ongoing royalties, which could decrease our profit margins;

 
·
redesign our products; or

 
·
be restricted by injunctions.
 
These factors could effectively prevent us from pursuing some or all of our business objectives and result in our customers or potential customers deferring, canceling or limiting their purchase or use of our products, which could have a material adverse effect on our financial condition and results of operations.

We rely on certain technologies licensed to us from third parties and the loss of these licenses or failure to renew such licenses on a timely basis could interrupt our production and have a material adverse impact on our business.

We rely on certain technologies licensed to us from third parties for manufacturing our products. Through our licensing arrangements, we are able to integrate third party technologies into our products. We can also produce and sell products that are more suitable for specific types of vehicles utilizing these licensed technologies. If certain licenses are terminated, or not timely renewed, the production of our products using the licensed technologies would be disrupted and our business and financial condition could be damaged. If any of our licensors is alleged to have infringed on any other party’s proprietary right, we may be prevented from using the technology in question, thus disrupting our production.

We may be subject to contractual obligations that limit our ability to sell our automotive parts in certain markets.

When we enter into commercial arrangements, we strive to negotiate the most favorable contractual provisions for our company with respect to both pricing and other terms. In some commercial arrangements, we have negotiated exclusivity, preferred vendor and non-competition arrangements that are favorable to our company. In other instances, counterparties to some of our commercial arrangements have imposed such provisions upon us. For instance, in one of our commercial arrangements, we are restricted from selling certain products using intellectual property licensed from the other party to some foreign companies, joint ventures with foreign companies and companies in countries where the licensor has business. While we believe that our commercial arrangements, when considered in their entirety, are favorable to our business, certain commercial arrangements may restrict our ability to freely sell our products on terms favorable to us or at all, which could have a negative impact on our sales revenue and our ability to grow and expand our business.

If we fail to maintain or improve our market position or respond successfully to changes in the competitive landscape, our business and results of operations will suffer.

Our competition includes a number of global and PRC-based manufacturers and distributors that produce and sell products similar to ours. We compete primarily on the basis of quality, technological innovation and price. Our main competitors include Shanghai Valeo Automotive Electrical Systems Co., Ltd., a joint venture of Shanghai Auto Industrial Group and Valeo Group, Hubei Shendian Auto Motor Co., Ltd., a joint venture of Hubei Shendian Auto Electrical Equipment Co., Ltd., Zhongqi Changdian Co., Ltd. and Remy International, Inc., Bosch Group, Mitsubishi Motors Corporation and Denso Corporation. Many of our competitors have longer operating histories, greater name recognition, larger global market share, access to larger customer bases and significantly greater economies of scale, as well as greater financial, sales and marketing, manufacturing, distribution, technical and other resources than we do. As a result of these competitive pressures and expected increases in competition, we may price our products lower than our competitors in order to maintain market share. Any lower pricing may negatively affect our profit margins. If we fail to maintain or improve our market position and respond successfully to changes in the competitive landscape, our business and results of operations may suffer.

 
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A large percentage of our sales revenue is derived from sales to a limited number of customers, and our business will suffer if sales to these customers decline.

A significant portion of our sales revenue historically has been derived from a limited number of customers. Our top five customers accounted for approximately 35.6% of our sales in 2008 and 37.8% in 2009. Any significant reduction in demand for vehicles manufactured by any of these major customers and any decrease in their demand for our products could harm our sales and business operations. The loss of one or more of these customers could damage our business, financial condition and results of operations.

If we cannot obtain sufficient raw materials and components at a reasonable cost, our ability to produce and market our products, and thus our business, could suffer.

We purchase raw materials and component parts for our products from various suppliers located primarily in Asia, most of which are located in China and a few of which are located in South Korea. The raw materials we use to produce our starters and alternators fall into four general categories: metal parts, semiconductors, chemicals, and packaging materials. The main raw materials we use to produce our rods, shafts, engine valves and tappets are iron and steel rods. The majority of our raw materials and components are purchased from suppliers in China, including Jiangsu Senyuan Special Steel Co., Ltd., Yingkou Die-Casting Products Co., Ltd., Tianjin Jingda Rea Special Enameled Wire Co. Ltd., Zhejiang Huanfang Auto Electrical Appliance Co. Ltd., and Zhejiang Yuhuan Solenoid Co., Ltd. Purchases from our top five raw materials and component parts suppliers accounted for approximately 32% of our total purchases in 2009. We may experience a shortage in the supply of certain raw materials and components in the future, and if any such shortage occurs, our manufacturing capabilities and operating results of operations could be negatively affected. If any supplier is unwilling or unable to provide us with high-quality raw materials and components in required quantities and at acceptable costs, we may not be able to find alternative sources on satisfactory terms in a timely manner, or at all. In addition, some of our suppliers may fail to meet qualifications and standards required by our customers now or in the future, which could impact our ability to source raw materials and components. Our inability to find or develop alternative supply sources could result in delays or reductions in manufacturing and product shipments. Moreover, these suppliers may delay shipments or supply us with inferior quality raw materials and components that may adversely impact the performance of our products. The prices of raw materials and components needed for our products could also increase, and we may not be able to pass these price increases on to our customers. If any of these events occur, our competitive position, reputation and business could suffer.

If our customers and/or the ultimate consumers of the vehicles that use our products successfully assert product liability claims against us due to defects in our products, our operating results may suffer and our reputation may be harmed.

Our products are used primarily in low emission passenger vehicles. Significant property damage, personal injuries and even death can result from malfunctioning vehicles. If our products are not properly designed, built or installed or if people are injured because of our products, we could be subject to claims for damages based on theories of product liability and other legal theories. The costs and resources to defend such claims could be substantial and, if such claims are successful, we could be responsible for paying some or all of the damages. We have maintained product liability insurance only for products manufactured by Jinzhou Wanyou, which are sold in the United States and Canada. Negative publicity from such claims may also damage our reputation, regardless of whether such claims are successful. Any of these consequences resulting from defects in our products would hurt our operating results and, in turn, the value of our common stock.

Our products may become subject to recall in the event of defects or other performance related issues.

Like many other participants in the automotive industry, we are at risk for product recall costs which are costs incurred when, either voluntarily or involuntarily, a product is recalled through a formal campaign to solicit the return of specific products due to a known or suspected performance defect. Costs typically include the cost of the product, part or component being replaced, the cost of the recall borne by our customers and labor to remove and replace the defective part or component. Our products have not been the subject of an open recall. If a recall decision is made, we will need to estimate the cost of the recall and record a charge to earnings in that period. In making this estimate, judgment is required as to the quantity or volume to be recalled, the total cost of the recall campaign, the ultimate negotiated sharing of the cost between us and the customer and, in some cases, the extent to which the supplier of the part or component will share in the recall cost. As a result, these estimates are subject to change. Excessive recall costs or our failure to adequately estimate these costs may negatively affect our operating results.

 
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We depend heavily on key personnel, and loss of key employees and senior management could harm our business.

Our future business and results of operations depend in significant part upon the continued contributions of our key technical and senior management personnel, including Qingjie Zhao, our chairman, chief executive officer and president, Meirong Yuan, our director, chief financial officer and treasurer, Yuncong Ma, our chief operating officer, Seuk Jun Kim, our vice president of new product development, Yuguo Zhao, our vice president of sales and marketing and Yongdong Liu, our vice president of production. They also depend in significant part upon our ability to attract and retain additional qualified management, technical, marketing and sales and support personnel for our operations. If we lose a key employee, if a key employee fails to perform in his or her current position or if we are not able to attract and retain skilled employees as needed, our business could suffer. Turnover in our senior management could significantly deplete institutional knowledge held by our existing senior management team and impair our operations.

In addition, if any of these key personnel joins a competitor or forms a competing company, we may lose some of our customers. We have entered into confidentiality and non-competition agreements with all of these key personnel. However, if any disputes arise between these key personnel and us, it is not clear, in light of uncertainties associated with the PRC legal system, what the court decisions will be and the extent to which these court decisions could be enforced in China, where all of these key personnel reside and hold some of their assets. See “– Risks Related to Doing Business in China – Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.”

Certain of our existing stockholders have substantial influence over our company, and their interests may not be aligned with the interests of our other stockholders.

Mr. Qingjie Zhao, our chairman, chief executive officer and president, beneficially owns approximately 19.4% of our common stock. As a result, he has significant influence over our business, including decisions regarding mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. This concentration of ownership may also have the effect of discouraging, delaying or preventing a future change of control, which could deprive our stockholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our shares.

Mr. Qingjie Zhao’s association with other businesses could impede his ability to devote ample time to our business and could pose conflicts of interest.

Mr. Qingjie Zhao, our chairman, chief executive officer and president, owns 10.4% of China Wonder Limited, a company listed on the Alternative Investment Market of the London Stock Exchange, which is principally engaged in the manufacture and sale of specialty packaging machinery to the PRC pharmaceutical market. He also serves as an executive director of Jinheng Holdings, a company listed on the Hong Kong Stock Exchange of which we have a 20.02% indirect ownership. In addition, Mr. Zhao serves as the chairman of Jinzhou Wonder Alternative Energy Automobile Technology Co., Ltd., which is principally engaged in the research and manufacture of electrical vehicles, Jinzhou Qingjie Electrical Power Technology Co., Ltd., which has no current operations but will engage in the battery business, and Jinzhou Wonder Packing Machinery Co., Ltd., which is principally engaged in pharmaceutical packaging. Mr. Zhao devotes most of his business time to our affairs and the remainder of his business time to the affairs of other companies. Mr. Zhao’s decision-making responsibilities for these companies are similar in the areas of public relations, management of human resources, risk management and strategic planning. Also, we may enter into agreement with these parties to sell or buy goods and services to or from them. As a result, conflicts of interest may arise from time to time. We will attempt to resolve any such conflicts of interest in our favor. Additionally, even though Mr. Zhao is accountable to us and our stockholders as a fiduciary, which requires that he exercise good faith and due care in handling our affairs, his existing responsibilities to other entities may limit the amount of time he can spend on our affairs.

 
18

 

Problems with product quality or product performance could result in a decrease in customers and revenue, unexpected expenses and loss of market share.

Our operating results depend, in part, on our ability to deliver quality products on a timely and cost-effective basis. As our products become more advanced, it may become more difficult to maintain our quality standards. If we experience deterioration in the performance or quality of any of our products, it could result in delays in shipments, cancellations of orders or customer returns and complaints, loss of goodwill and harm to our brand and reputation. Furthermore, our products are used together with components and in motor vehicles that have been developed and maintained by third parties, and when a problem occurs, it may be difficult to identify the source of the problem. In addition, some automobile parts and components may not be fully compatible with our products and may not meet our or our customers’ quality, safety, security or other standards. The use by customers of our products with incompatible or otherwise substandard components is largely outside of our control and could result in malfunctions or defects in our products and result in harm to our brand. These problems may lead to a decrease in customers and revenue, harm to our brand, unexpected expenses, loss of market share, the incurrence of significant warranty and repair costs, diversion of the attention of our engineering personnel from our product development efforts, customer relation problems or loss of customers, any one of which could materially adversely affect our business.

Environmental claims or failure to comply with any present or future environmental regulations may require us to spend additional funds and may harm our results of operations.

We are subject to environmental, health and safety laws and regulations that affect our operations, facilities and products in each of the jurisdictions in which we operate. Some of our newly incorporated Chinese subsidies have not obtained pollutant discharge permits required by Chinese laws. Other than the foregoing, we believe that we are in material compliance with all material environmental, health and safety laws and regulations related to our products, operations and business activities. Although we have not suffered material environmental claims in the past, the failure to comply with any present or future regulations could result in the assessment of damages or imposition of fines against us, suspension of production, cessation of our operations or even criminal sanctions. New regulations could also require us to acquire costly equipment or to incur other significant expenses. Our failure to control the use of, or adequately restrict the discharge of, hazardous substances could subject us to potentially significant monetary damages and fines or suspension of our business operations, which could cause damage to our business.

We have limited insurance coverage and do not carry any business interruption insurance, third-party liability insurance for our manufacturing facilities or insurance that covers the risk of loss of our products in shipment.

Operation of our facilities involves many risks, including equipment failures, natural disasters, industrial accidents, power outages, labor disturbances and other business interruptions. Furthermore, if any of our products are faulty, then we may become subject to product liability claims or we may have to engage in a product recall. We do not carry any business interruption insurance, product recall or third-party liability insurance for our manufacturing facilities or with respect to our products to cover claims pertaining to personal injury or property or environmental damage arising from defaults with our products, product recalls, accidents on our property or damage relating to our operations. We have obtained product liability insurance only for products manufactured by Jinzhou Wanyou which are sold to customers in the United States and Canada. Therefore, our existing insurance coverage may not be sufficient to cover all risks associated with our business. As a result, we may be required to pay for financial and other losses, damages and liabilities, including those caused by natural disasters and other events beyond our control, out of our own funds, which could have a material adverse effect on our business, financial condition and results of operations.

Furthermore, under the shipping terms of some of our customer contracts, we bear the risk of loss in shipment of our products. We do not insure this risk. While we believe that the shipping companies that we use carry adequate insurance or are sufficiently solvent to cover any loss in shipment, there can be no assurance that we will be adequately reimbursed upon the loss of a significant shipment of our products.

 
19

 

We may be exposed to potential risks relating to our internal controls over financial reporting and our ability to have the operating effectiveness of our internal controls attested to by our independent auditors.

As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the SEC adopted rules requiring public companies to include a report of management on the Company’s internal controls over financial reporting in their annual reports and the independent registered public accounting firm auditing a company’s financial statements to attest to and report on the operating effectiveness of such company’s internal controls. Although our independent auditor has provided a positive attestation for the year ended December 31, 2009, we can provide no assurance that we will comply with all of the requirements imposed thereby and we will receive a positive attestation from our independent auditors in the future. In the event we identify significant deficiencies or material weaknesses in our internal controls that we cannot remediate in a timely manner or we are unable to receive a positive attestation from our independent auditors with respect to our internal controls, investors and others may lose confidence in the reliability of our financial statements.

Our holding company structure may hinder the payment of dividends.

Wonder Auto Technology, Inc. has no direct business operations, other than its ownership of our subsidiaries. While we have no current intention of paying dividends, should we decide in the future to do so, as a holding company, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries and other holdings and investments. In addition, our operating subsidiaries, from time to time, may be subject to restrictions on their ability to make distributions to us due to restrictive covenants in loan agreements, restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions as discussed below. If future dividends are paid in Renminbi, fluctuations in the exchange rate for the conversion of Renminbi into U.S. dollars may reduce the amount received by U.S. stockholders upon conversion of the dividend payment into U.S. dollars.

PRC regulations currently permit the payment of dividends only out of accumulated profits as determined in accordance with PRC accounting standards and regulations. Our subsidiaries in China are also required to set aside a portion of their after tax profits according to PRC accounting standards and regulations to fund certain reserve funds. Currently, our subsidiaries in China are the only sources of sales revenue or investment holdings for the payment of dividends. If they do not accumulate sufficient profits under PRC accounting standards and regulations to first fund certain reserve funds as required by PRC accounting standards, we will be unable to pay any dividends.

China passed a new Enterprise Income Tax Law, or the New EIT Law, and its implementing rules, both of which became effective on January 1, 2008, which provide that dividends sourced from China payable to “non-resident enterprises” shall be subject to Chinese enterprise income tax at a rate of 10%. Such dividend tax rate may be reduced by applicable tax treaties or arrangements.

Under the New EIT Law and its implementation rules, dividend payments between qualified Chinese resident enterprises are exempted from enterprise income tax. However, due to the short history of the New EIT Law, it remains unclear as to the detailed qualification requirements for such exemption and whether dividend payments from our Chinese subsidiaries to us will be exempted from enterprise income tax if we are considered as a Chinese resident enterprise for tax purposes.

RISKS RELATED TO DOING BUSINESS IN CHINA

Adverse changes in political and economic policies of the PRC government could impede the overall economic growth of China, which could reduce the demand for our products and damage our business.

We conduct substantially all of our operations and generate most of our revenue in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The PRC economy differs from the economies of most developed countries in many respects, including:

 
the higher level of government involvement;
 
the early stage of development of the market-oriented sector of the economy;
 
the rapid growth rate;
 
the higher level of control over foreign exchange; and
 
the allocation of resources.
   
As the PRC economy has been transitioning from a planned economy to a more market-oriented economy, the PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. While these measures may benefit the overall PRC economy, they may also have a negative effect on us.
  
 
20

 
Although the PRC government has in recent years implemented measures emphasizing the utilization of market forces for economic reform, the PRC government continues to exercise significant control over economic growth in China through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and imposing policies that impact particular industries or companies in different ways.

Any adverse change in the economic conditions or government policies in China could have a material adverse effect on the overall economic growth and the level of automotive investments and expenditures in China, which in turn could lead to a reduction in demand for our products and consequently have a material adverse effect on our business and prospects.

Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.

We conduct substantially all of our business through our operating subsidiaries in China. Our operating subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference, but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. In addition, all of our executive officers and all but one of our directors are residents of China and not of the United States, and substantially all the assets of these persons are located outside the United States. As a result, it could be difficult for investors to effect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese officers, directors and subsidiaries.

The PRC government exerts substantial influence over the manner in which we must conduct our business activities.

The PRC government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its policies, laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.

Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.

Restrictions on currency exchange may limit our ability to receive and use our sales revenue effectively.

Most of our sales revenue and expenses are denominated in Renminbi. Under PRC law, the Renminbi is currently convertible under the “current account,” which includes dividends and trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans. Currently, our PRC operating subsidiaries may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, without the approval of the State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. However, the relevant PRC government authorities may limit or eliminate our ability to purchase foreign currencies in the future. Since a significant amount of our future revenue will be denominated in Renminbi, any existing and future restrictions on currency exchange may limit our ability to utilize revenue generated in Renminbi to fund our business activities outside China that are denominated in foreign currencies.

Foreign exchange transactions by PRC operating subsidiaries under the capital account continue to be subject to significant foreign exchange controls and require the approval of or need to register with PRC government authorities, including SAFE. In particular, if our PRC operating subsidiaries borrow foreign currency through loans from us or foreign lenders, these loans must be registered with SAFE, and if we finance the subsidiaries by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the Ministry of Commerce, or their respective local counterparts. These limitations could affect our PRC operating subsidiaries’ ability to obtain foreign exchange through debt or equity financing.

 
21

 

Fluctuations in exchange rates could adversely affect our business and the value of our securities.

The value of our common stock will be indirectly affected by the foreign exchange rate between U.S. dollars and the Renminbi and between those currencies and other currencies in which our sales may be denominated. Because substantially all of our earnings and cash assets are denominated in Renminbi and our financial results are reported in U.S. dollars, fluctuations in the exchange rate between the U.S. dollar and the Renminbi will affect our balance sheet and our earnings per share in U.S. dollars. In addition, appreciation or depreciation in the value of the Renminbi relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars and earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.

Since July 2005, the Renminbi has no longer been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the Renminbi may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future the PRC authorities may lift restrictions on fluctuations in the Renminbi exchange rate and lessen intervention in the foreign exchange market.

Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert Renminbi into foreign currencies.

Currently, some of our raw materials, components and major equipment are imported. In the event that the U.S. dollars appreciate against Renminbi, our costs will increase. If we cannot pass the resulting cost increases on to our customers, our profitability and operating results will suffer. In addition, since our sales to international customers are growing rapidly, we are increasingly subject to the risk of foreign currency depreciation.
 
Failure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident stockholders to personal liability, limit our ability to acquire PRC companies or to inject capital into our PRC subsidiaries, limit our PRC subsidiaries' ability to distribute profits to us or otherwise materially adversely affect us.

In October 2005, SAFE issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China, generally referred to as Circular 75, which required PRC residents to register with the competent local SAFE branch before establishing or acquiring control over an offshore special purpose company, or SPV, for the purpose of engaging in an equity financing outside of China on the strength of domestic PRC assets originally held by those residents. Internal implementing guidelines issued by SAFE, which became public in June 2007 (known as Notice 106), expanded the reach of Circular 75 by (1) purporting to cover the establishment or acquisition of control by PRC residents of offshore entities which merely acquire “control” over domestic companies or assets, even in the absence of legal ownership; (2) adding requirements relating to the source of the PRC resident's funds used to establish or acquire the offshore entity; (3) covering the use of existing offshore entities for offshore financings; (4) purporting to cover situations in which an offshore SPV establishes a new subsidiary in China or acquires an unrelated company or unrelated assets in China; and (5) making the domestic affiliate of the SPV responsible for the accuracy of certain documents which must be filed in connection with any such registration, notably, the business plan which describes the overseas financing and the use of proceeds. Amendments to registrations made under Circular 75 are required in connection with any increase or decrease of capital, transfer of shares, mergers and acquisitions, equity investment or creation of any security interest in any assets located in China to guarantee offshore obligations, and Notice 106 makes the offshore SPV jointly responsible for these filings. In the case of an SPV which was established, and which acquired a related domestic company or assets, before the implementation date of Circular 75, a retroactive SAFE registration was required to have been completed before March 31, 2006; this date was subsequently extended indefinitely by Notice 106, which also required that the registrant establish that all foreign exchange transactions undertaken by the SPV and its affiliates were in compliance with applicable laws and regulations. Failure to comply with the requirements of Circular 75, as applied by SAFE in accordance with Notice 106, may result in fines and other penalties under PRC laws for evasion of applicable foreign exchange restrictions. Any such failure could also result in the SPV's affiliates being impeded or prevented from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the SPV, or from engaging in other transfers of funds into or out of China.

 
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We recently acquired Yearcity Limited and its subsidiary Jinan Worldwide, as well as Fuxin Huirui and have not registered these companies with the relevant branch of SAFE, as currently required. We plan to make the proper registration in the next few months.  We have asked our stockholders who are PRC residents as defined in Circular 75 to register with the relevant branch of SAFE, as currently required, in connection with their equity interests in us and our acquisitions of equity interests in our PRC subsidiaries. However, we cannot provide any assurances that they can obtain the above SAFE registrations required by Circular 75 and Notice 106. Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies. For example, our present and prospective PRC subsidiaries’ ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with Circular 75 and Notice 106 by our PRC resident beneficial holders.

In addition, such PRC residents may not always be able to complete the necessary registration procedures required by Circular 75 and Notice 106. We also have little control over either our present or prospective direct or indirect stockholders or the outcome of such registration procedures. A failure by our PRC resident beneficial holders or future PRC resident stockholders to comply with Circular 75 and Notice 106, if SAFE requires it, could subject these PRC resident beneficial holders to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiaries' ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.

We may be unable to complete a business combination transaction efficiently or on favorable terms due to complicated merger and acquisition regulations which became effective on September 8, 2006.

On August 8, 2006, six Chinese regulatory agencies promulgated the Regulation on Mergers and Acquisitions of Domestic Companies by Foreign Investors, which became effective on September 8, 2006, or the M&A Regulations. This regulation, among other things, governs the approval process by which a Chinese company may participate in an acquisition of assets or equity interests. Depending on the structure of the transaction, the regulation will require the Chinese parties to make a series of applications and supplemental applications to the government agencies. In some instances, the application process may require the presentation of economic data concerning a transaction, including appraisals of the target business and evaluations of the acquirer, which are designed to allow the government to assess the transaction. Government approvals will have expiration dates by which a transaction must be completed and reported to the government agencies. Compliance with the regulations is likely to be more time consuming and expensive than in the past and the government can now exert more control over the combination of two businesses. Accordingly, due to this regulation, our ability to engage in business combination transactions has become significantly more complicated, time consuming and expensive, and we may not be able to negotiate a transaction that is acceptable to our stockholders or sufficiently protect their interests in a transaction.
The regulation allows Chinese government agencies to assess the economic terms of a business combination transaction. Parties to a business combination transaction may have to submit to the Ministry of Commerce and other relevant government agencies an appraisal report, an evaluation report and the acquisition agreement, all of which form part of the application for approval, depending on the structure of the transaction. The regulations also prohibit a transaction at an acquisition price obviously lower than the appraised value of the PRC business or assets and in certain transaction structures, require that consideration must be paid within defined periods, generally not in excess of a year. The regulation also limits our ability to negotiate various terms of the acquisition, including aspects of the initial consideration, contingent consideration, holdback provisions, indemnification provisions and provisions relating to the assumption and allocation of assets and liabilities. Transaction structures involving trusts, nominees and similar entities are prohibited. Therefore, such regulation may impede our ability to negotiate and complete a business combination transaction on financial terms that satisfy our investors and protect our stockholders’ economic interests.

In addition to the above risks, in many instances, we will seek to structure transactions in a manner that avoids the need to make applications or a series of applications with Chinese regulatory authorities under these M&A regulations. If we fail to effectively structure an acquisition in a manner that avoids the need for such applications or if the Chinese government interprets the requirements of the M&A regulations in a manner different from our understanding of such regulations, then acquisitions that we have effected may be unwound or subject to rescission. Also, if the Chinese government determines that our structure of any of our acquisitions does not comply with these regulations, then we may also be subject to fines and penalties.

 
23

 

Failure to comply with Chinese regulations regarding the registration requirements for employee stock ownership plans or share option plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.

In December 2006, the People’s Bank of China promulgated the Administrative Measures for Individual Foreign Exchange, which set forth the respective requirements for foreign exchange transactions by Chinese individuals under either the current account or the capital account. In January 2007, SAFE issued the Implementation Rules of the Administrative Measures for Individual Foreign Exchange, which, among other things, specified approval requirements for certain capital account transactions such as a Chinese citizen’s participation in the employee stock ownership plans or stock option plans of an overseas publicly-listed company. On March 28, 2007, SAFE promulgated the Processing Guidance on Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plans or Stock Option Plans of Overseas-Listed Companies. Under this rule, PRC citizens who are granted stock options by an overseas publicly-listed company are required, through a qualified PRC domestic agent or PRC subsidiary of such overseas publicly-listed company, to register with SAFE and complete certain other procedures. We and our Chinese employees who receive stock option grants will be subject to this rule. Our board of directors has adopted the Wonder Auto Technology, Inc. 2008 Equity Incentive Plan. If we or the Chinese optionees fail to comply with these regulations, we or these optionees may be subject to fines and other legal or administrative sanctions.

PRC regulation of loans and direct investment by offshore holding companies to PRC entities may delay or prevent us from making loans or additional capital contributions to our PRC operating subsidiaries.

As an offshore holding company of our PRC operating subsidiaries, we may make loans to our PRC subsidiaries. Any loans to our PRC subsidiaries are subject to approval by relevant governmental authorities in China and other requirements under relevant PRC regulations.

We may also decide to finance our PRC subsidiaries by means of capital contributions. According to the relevant PRC regulations on foreign-invested enterprises in China, depending on the amount of total investment and the type of business in which a foreign-invested enterprise is engaged, capital contributions to foreign-invested enterprises in China are subject to approval by the Ministry of Commerce or its local branches. We may not obtain these government approvals on a timely basis, if at all, with respect to future capital contributions by us to our PRC subsidiaries. If we fail to receive such approvals, our ability to capitalize our PRC operations may be negatively affected, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

Under the New EIT Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.

On March 16, 2007, the National People’s Congress of China passed the New EIT Law, and on November 28, 2007, the State Council of China passed the New EIT Law Implementing Rules which took effect on January 1, 2008. Under the New EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes.  The implementing rules of the New EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.

On April 22, 2009, the State Administration of Taxation issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of de facto Management Bodies, or the Notice, further interpreting the application of the New EIT Law and its implementation non-Chinese enterprise or group controlled offshore entities.  Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “non-domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) its substantial assets and properties, accounting books, corporate chops, board and shareholder minutes are kept in China; and (iv) at least half of its directors with voting rights or senior management often resident in China.  A resident enterprise would be subject to an enterprise income tax rate of 25% on its worldwide income and must pay a withholding tax at a rate of 10% when paying dividends to its non-PRC shareholders.  However, it remains unclear as to whether the Notice is applicable to an offshore enterprise incorporated by a Chinese natural person.  Nor are detailed measures on imposition of tax from non-domestically incorporated resident enterprises are available. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.
 
24

 

We may be deemed to be a resident enterprise by Chinese tax authorities.  If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on financing proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the New EIT Law and its implementing rules dividends paid to us from our PRC subsidiaries would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes.  Finally, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC shareholders and with respect to gains derived by our non-PRC shareholders from transferring our shares.  We are actively monitoring the possibility of “resident enterprise” treatment for the 2010 tax year and are evaluating appropriate organizational changes to avoid this treatment, to the extent possible.

If we were treated as a “resident enterprise” by PRC tax authorities, we would be subject to taxation in both the U.S. and China, and our PRC tax may not be creditable against our U.S. tax.

RISKS RELATED TO THE MARKET FOR OUR STOCK GENERALLY

The price of our common stock may fluctuate significantly, which could negatively affect us and holders of our common stock.

The trading price of our common stock may fluctuate significantly in response to a number of factors, many of which are beyond our control. For instance, if our financial results are below the expectations of securities analysts and investors, the market price of our common stock could decrease, perhaps significantly. Other factors that may affect the market price of our common stock include announcements relating to significant corporate transactions; fluctuations in our quarterly and annual financial results; operating and stock price performance of companies that investors deem comparable to us; and changes in government regulation or proposals relating to us. In addition, since the middle of 2008, the U.S. securities markets have experienced significant price and volume fluctuations. These fluctuations often have been unrelated to the operating performance of companies in these markets. Market fluctuations and broad market, economic and industry factors may negatively affect the price of our common stock, regardless of our operating performance. You may not be able to sell your shares of our common stock at or above your purchase price, or at all. Any volatility of or a significant decrease in the market price of our common stock could also negatively affect our ability to make acquisitions using common stock. Further, if we were to be the object of securities class action litigation as a result of volatility in our common stock price or for other reasons, it could result in substantial costs and diversion of our management’s attention and resources, which could negatively affect our financial results.

The market price of our stock may be affected by low volume.

Our common stock has a relatively low average daily volume. Reported average daily trading volume in our common stock for the three month period ended March 1, 2010, was approximately 0.7 million shares. Without a significantly larger average trading volume, our common stock will be less liquid than the common stock of companies with higher trading volume, as a result, the trading prices for our common stock may be more volatile.

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

We have never declared or paid any cash dividends on shares of our common stock. We intend to retain any future earnings to fund the operation and expansion of our business and, therefore, we do not anticipate paying cash dividends on shares of our common stock in the foreseeable future.

 
25

 

Certain provisions of our Articles of Incorporation may make it more difficult for a third party to effect a change-of-control.

Our Articles of Incorporation authorizes the board of directors to issue up to 10,000,000 shares of preferred stock. The preferred stock may be issued in one or more series, the terms of which may be determined at the time of issuance by the board of directors without further action by the stockholders. These terms may include preferences as to dividends and liquidation, conversion rights, redemption rights and sinking fund provisions. The issuance of any preferred stock could diminish the rights of holders of our common stock, and therefore could reduce the value of such common stock. In addition, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell assets to, a third party. The ability of the board of directors to issue preferred stock could make it more difficult, delay, discourage, prevent or make it more costly to acquire or effect a change-in-control, which in turn could prevent our stockholders from recognizing a gain in the event that a favorable offer is extended and could materially and negatively affect the market price of our common stock.

ITEM 1B.
UNRESOLVED STAFF COMMENTS.

None.

ITEM 2.
PROPERTIES.

All land in China is owned by the State. Individuals and companies are permitted to acquire rights to use land or land use rights for specific purposes. In the case of land used for industrial purposes, the land use rights are granted for a period of up to 70 years. This period may be renewed at the expiration of the initial and any subsequent terms. Granted land use rights are transferable and may be used as security for borrowings and other obligations.
 
We were granted land use rights from the Chinese government for following properties: (1) 453,900 square feet of land located at No. 16 Yulu Street, Jinzhou High Technology Industrial Park, Jinzhou, China. The land use rights have a 30-year term and will expire on August 15, 2026. Our headquarters are located at this site. This site houses our office building, a research and development center, as well as our production facilities; (2) 179,500 square feet of land located at West Bo Hai Street, Open Economic Zone, Jinzhou, China. This site houses our production facilities and (3) 1,842,000 square feet of land located at New Century Avenue, Changqing District, Jinan High Technology Industrial Park, Shandong, China. The land use rights have a 50-year term and will expire on January 27, 2055. This site houses our office building, a research and development center, as well as our production facilities.
 
In addition to the land use rights, we also have ownership of eleven other properties.  Two properties are located at No. 16 Yulu Street, two properties are located at Fuzhou Street, Taihe District of Jinzhou and the remaining seven are residential properties located at Huianli Guta District of Jinzhou. We have placed mortgages on the land and the four properties located at No. 16 Yulu Street and Fuzhou Street to secure certain bank loan from China Bank Jinzhou Branch for an amount up to RMB 50 million (approximately $6.25 million).
 
We also own 2,100 square feet of office space at Focus Square, No. 6 Futong St., Wangjing, Chaoyang District, Beijing where our Beijing Representative Office is located.
 
We currently have four alternator assembly lines, four starter assembly lines, twenty engine valves production lines, five tappets production lines and three rods and shafts production lines. Our current annual production capacity is approximately 2.6 million units of alternators, 2.4 million units of starters, 27 million units of engine valves and tappets, and 20 million units of rods and shafts, assuming two work shifts per day with eight hours each.

We currently work in two work shifts of eight hours, each to maximize the capabilities of our assembly lines. For 2007, 2008 and 2009, the utilization rates of our alternator production lines were approximately 108%, 78% and 89%, respectively, while those of our starter production lines were approximately 86%, 75% and 90%, respectively.  The utilization rates of our engine valve and tappet production lines for 2008 and 2009 were approximately 75% and 88%, respectively, while those of our rod and shaft production lines were approximately 110% and 95%, respectively.
 
We believe that all our properties have been adequately maintained, are generally in good condition, and are suitable and adequate for our business.

 
26

 

ITEM 3.
LEGAL PROCEEDINGS.

From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business.  However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.  We are currently not aware of any such legal proceedings or claims that we believe will have a material adverse affect on our business, financial condition or operating results.

ITEM 4.
RESERVED.

ITEM X. 
Executive Officers
 
Our executive officers as of March 4, 2010 are as follows:

NAME
 
AGE
 
POSITION
Qingjie Zhao
 
53
 
Chairman, Chief Executive Officer and President
Meirong Yuan
 
39
 
Chief Financial Officer and Treasurer
Yuncong Ma
 
64
 
Chief Operating Officer
Seuk Jun Kim
 
54
 
Vice President of New Product Development
Yuguo Zhao
 
54
 
Vice President of Sales and Marketing
Yongdong Liu
 
41
 
Vice President of Production

Qingjie Zhao.  Mr. Zhao has been our Chief Executive Officer and President since June 22, 2006 and Chairman of our board since July 2006. Mr. Zhao joined our subsidiary, Jinzhou Halla, as its Chairman in October 1997. Mr. Zhao is also currently an executive director and 10.4% owner of China Wonder Limited, a company listed on the Alternative Investment Market of the London Stock Exchange, which is principally engaged in the manufacture and sale of specialty packaging machinery to the PRC pharmaceutical market, and an executive director of Jinzhou Jinheng Automotive Safety System Co., Ltd., which is principally engaged in the manufacture and sale of automotive airbag safety systems in China. Our company, China Wonder Limited and Jinzhou Jinheng Automotive Safety System Co., Ltd. do not directly compete with each other.  Mr. Zhao devotes most of his business time to our affairs and the remainder of business time to the affairs of other companies. Mr. Zhao’s decision making responsibilities for these three companies are similar in the areas of public relations, management of human resources, risk management and strategic planning. Mr. Zhao graduated from the Liaoning Industry Academy in 1982. He thereafter became a faculty member at the Liaoning University of Technology from 1982 to 1989. After leaving his post at the Liaoning University of Technology, Mr. Zhao joined Jinzhou Shock Absorber Co., which is principally engaged in the manufacture and sale of suspension systems for automobiles, in January 1989 as an engineer and the head of the research department. He became its Chief Executive Officer in 1991 and remained in that position until 1997.

Meirong Yuan.  Mr. Yuan became our Chief Financial Officer and Treasurer on June 22, 2006 and our director on March 2007. He has been the Vice President of Jinzhou Wonder Industrial Co., Ltd. Since June 2005. Mr. Yuan also served as a director of Jinzhou Halla since January 2002. From July 2003 to June 2005, Mr. Yuan served as the Vice President of Shenzhen Luante Asphalt Advanced Technology Co. Ltd. and was in charge of accounting and finance. Between October 2000 and October 2001, Mr. Yuan studied at ISMA Center in England. Mr. Yuan is a CPA in China and has a Ph.D. in management from South California University for Professional Study.

Yuncong Ma.  Mr. Ma became our Chief Operating Officer on June 22, 2006. He has been the General Manager of our subsidiary Jinzhou Halla since 1997 and is responsible for Jinzhou Halla’s overall operations. He has over 30 years of production experience and over 16 years of management experience in the automotive industry. Mr. Ma graduated from the Harbin Institute of Technology in 1970 specializing in machine crafting. After graduation, Mr. Ma worked for Jinzhou Huaguang Electron Tube Factory from 1970 to 1989. During that time, he worked in various posts in its production, technology and corporate structuring departments and was promoted to the post of Production Manager in 1984. Mr. Ma joined Jinzhou Shock Absorber Co., Ltd. in 1989 as its Chief Engineer and Vice Factory Manager.

 
27

 

Seuk Jun Kim.  Mr. Kim became our Vice President of New Product Development in February 2007. From June 2006 to February 2007, Mr. Kim served as our Vice President for Research and Development. Mr. Kim joined Jinzhou Halla in October 1997 and has served as its Vice President of Research and Development since January 2005. Mr. Kim is responsible for Jinzhou Halla’s research and development and quality control functions. In 1981, Mr. Kim graduated from Pohang University of Science and Technology in Korea with a bachelor’s degree in automotive electrical engineering. Prior to formally joining Jinzhou Halla in 1997, Mr. Kim worked at the Korea Qingzhou Electrical Machinery Factory where he was in charge of technical support.

Yuguo Zhao.  Mr. Zhao became our Vice President of Sales and Marketing on June 22, 2006, and he has been the head of sales and marketing since June 1996 when he joined Jinzhou Halla. He became the Assistant General Manager in January 2005. Mr. Zhao is responsible for our sales and after-sales operations. In 1979, Mr. Zhao graduated from the Jinzhou Agriculture Academy, formerly known as Jinzhou Agriculture Automotive School. Between 1980 and 1996, he worked for Jinzhou Electrical as its Production Department Manager, Chief of Production and Chief of Operations, among other posts.

Yongdong Liu.  Mr. Liu became our Vice President of Production on June 22, 2006, and he has been the Head of Production of Jinzhou Halla since May 2001 and an Assistant General Manager of Jinzhou Halla since January 2005. Mr. Liu oversees our production, purchasing, human resources and administration functions. Mr. Liu graduated from the Suzhou Institute of Silk Textile Technology with a degree in weaving mechanical design in 1992. Between 1992 and 1996, Mr. Liu worked in Jinzhou Electrical and was responsible for its production technologies. He joined us in June 1996 as a division head in the production department.
 
PART II
 
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information

Our common stock is quoted on the Nasdaq Global Market under the symbol “WATG.” 
 
The following table sets forth, for the periods indicated, the high and low closing prices of our common stock.  These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.

   
Closing Bid Prices(1)
 
   
High
   
Low
 
Year Ended December 31, 2009
           
1st Quarter
  $ 4.28     $ 2.08  
2nd Quarter
    11.10       3.65  
3rd Quarter
    12.28       8.40  
4th Quarter
    15.50       10.62  
                 
Year Ended December 31, 2008
               
1st Quarter
  $ 12.63     $ 6.47  
2nd Quarter
    9.27       7.03  
3rd Quarter
    9.42       6.41  
4th Quarter
    5.93       2.58  

(1) The above table sets forth the range of high and low closing prices per share of our common stock as reported by www.quotemedia.com for the periods indicated.

Approximate Number of Holders of Our Common Stock

As of March 1, 2010, there were approximately 138 holders of record of our common stock.  This number excludes the shares of our common stock owned by stockholders holding stock under nominee security position listings.

 
28

 

Dividend Policy

Other than the dividends declared or paid by our subsidiary Wonder Auto before the reverse acquisition transaction and the forward stock split in 2006, we have never declared dividends or paid cash dividends. Our board of directors will make any future decisions regarding dividends. We currently intend to retain and use any future earnings for the development and expansion of our business and do not anticipate paying any cash dividends in the near future.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table includes the information as of December 31, 2009 for each category of our equity compensation plan:

Plan
 
Number of Securities to be 
Issued Upon Exercise of 
Outstanding Options, 
Warrants and Rights (2)
   
Weighted-Average
Exercise Price of Outstanding 
Options, Warrants and 
Rights
   
Number of Securities 
Remaining Available for 
Future Issuance
Under the Plan
 
Equity compensation plans approved by security holders (1)
    1,674,400     $ 11.48       1,825,600  
Equity compensation plans not approved by security holders
                 
Total
    1,674,400     $ 11.48       1,825,600  
 (1) On April 30, 2008, our Board of Directors authorized the establishment of the Wonder Auto Technology, Inc. Equity Incentive Plan, or Plan, whereby we are authorized to issue a maximum 3.5 million shares of our common stock to certain employees, consultants and directors.    

(2) On November 24, 2009, the Company’s compensation committee granted options to purchase a total of 1,674,400 shares of our common stock to certain officers, directors and employees with an exercise price of $11.48. One third of the option will vest and become exercisable on each of the filing dates of the Company's Annual Reports on Form 10-K for fiscal years 2009, 2010 and 2011, respectively, upon the achievement of certain income thresholds which are set to be US$23.0 million for fiscal year 2009, US$34.5 million for fiscal year 2010 and US$42.3 million for fiscal year 2011. 

Recent Sales of Unregistered Securities

We have not sold any equity securities during the fiscal year ended December 31, 2009 that were not previously disclosed in a quarterly report on Form 10-Q or a current report on Form 8-K that was filed during the 2009 fiscal year.

Report of Offering of Securities and Use of Proceeds Therefrom
 
On November 16, 2009, we completed an underwritten public offering of our common stock pursuant to a shelf Registration Statement on Form S-3 (Registration No. 333-161358), filed with the SEC on August 14, 2009 (declared effective August 21, 2009), including a base prospectus included therein and a final prospectus supplement filed with the SEC on November 12, 2009. Our net proceeds, after deduction of the underwriting discount of $3.7 million and offering expenses of $1.8 million, were approximately $69.0 million. None of the expense payments were made to the underwriters, to any of our directors, officers or affiliates or to any persons owning 10% or more of any class of our equity securities.
 
We used some of the net proceeds from the offering for general corporate purposes, including $6.5 million for the expansion of capacity at our existing facilities, $14.9 million for investment in Jinheng Holding, and $11.7 million for the acquisition of Friend Birch. The remaining net proceeds from the offering have been invested in cash and cash equivalents. The use of the proceeds from the offering does not represent a material change in the use of proceeds described in the prospectus supplement described above.

Purchases of Equity Securities

No repurchases of our common stock were made during the fourth quarter of 2009.

 
29

 

ITEM 6.
SELECTED FINANCIAL DATA.

The following selected historical financial information should be read in conjunction with our consolidated financial statements and related notes and the information contained in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

The selected consolidated statement of operations data and statement of cash flows data for the years ended December 31, 2009, 2008 and 2007 and the selected balance sheet data as of December 31, 2009 and 2008 are derived from our audited consolidated financial statements included elsewhere in this report. The selected consolidated financial data for the years ended December 31, 2006 and 2005 and the selected balance sheet data as of December 31, 2007, 2006 and 2005 are derived from our audited consolidated financial statements not included in this report.

(All amounts, except for share and per share amounts, in thousands of U.S. dollars)

   
Fiscal Year Ended December 31,
 
   
2009
   
2008
   
2007
   
2006
   
2005
 
Statement of Operations Data:
                             
Sales revenue
  $ 211,024     $ 141,190     $ 102,084     $ 72,150     $ 48,063  
Cost of sales
    159,660       104,750       76,460       57,342       35,963  
Gross profit
    51,364       36,439       25,624       14,808       12,100  
Operating expenses:
                                       
Administrative expenses
    11,674       6,827       3,565       1,918       1,155  
Share-based compensation
    1,172       706       -       -       -  
Research and development expenses
    3,027       1,648       1,136       948       824  
Selling expenses
    7,768       4,093       3,291       2,138       2,148  
Unusual charge - make good provision
            -       18,266       7,508       -  
Income/(loss) from operations
    27,724       23,165       (634 )     2,297       7,972  
Income taxes
    3,224       2,175       1,389       1,270       897  
Net income (loss) attributable to WATG
    22,859       18,909       (3,750 )     716       6,401  
Earnings (losses) per share - basic and diluted
    0.82       0.70       (0.16 )     0.03       0.37  
                                         
Balance Sheet Data:
                                       
Working capital
  $ 97,785     $ 26,359     $ 56,143     $ 18,933     $ 10,185  
Current assets
    236,788       156,728       99,260       56,127       38,467  
Total assets
    362,252       263,030       142,397       78,000       52,090  
Current liabilities
    139,003       130,369       43,117       37,194       28,282  
Total liabilities
    163,778       150,028       60,740       37,194       33,236  
Stockholders’ equity
    192,650       102,060       78,442       38,227       18,853  
                                         
Statement of Cash Flows Data:
                                       
Net cash provided by (used in):
                                       
Operating Activities
  $ 18,157     $ 9,106     $ 12,170     $ 1,389     $ 11,439  
Investing Activities
    (38,518 )     (37,266 )     (24,566 )     (6,219 )     (2,099 )
Financing Activities
    94,537       9,226       29,232       8,308       (6,952 )

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

The following management’s discussion and analysis should be read in conjunction with our financial statements and the notes thereto and the other financial information appearing elsewhere in this report. In addition to historical information, the following discussion contains certain forward-looking information. See “Special Note Regarding Forward Looking Statements” above for certain information concerning those forward looking statements. Our financial statements are prepared in U.S. dollars and in accordance with U.S. GAAP.

Overview

We are a leading manufacturer of automotive electric parts, suspension products and engine components in China. Our products include alternators, starters, engine valves and tappets, and rods and shafts for use in shock absorber systems.

Our products are used in a wide range of passenger and commercial automobiles, and we are especially focused on the fast-growing small- to medium-engine passenger vehicle market. We sell our products primarily within China to well-known domestic and international automobile OEMs, engine manufacturers and automotive parts suppliers. We are increasingly exporting our products to international markets. Our customers include SAIC GM Wuling Automobile Co., Ltd., Beijing Hyundai Motor Company, Shenyang Aerospace Mitsubishi Motors Engine Co., Ltd., Harbin Dongan Automotive Engine Co., Ltd., Shanghai Volkswagen Co., Ltd., BYD Company Limited, Tianjin Toyota Co., Ltd., Chery Automobile Co., Ltd., Dongfeng Yueda Kia Motors Co., Ltd., Geely Automobile Co., Ltd., Tianjin FAW Xiali Automobile Co., Ltd., and a major North American automobile OEM. Most of our customers subject us to a rigorous product qualification process to ensure that our products meet their quality standards. We believe that the complex and stringent requirements of each customer’s qualification process acts as a barrier to entry for many new market entrants.

Our strategically-located manufacturing facilities in Jinzhou and Jinan, China house our high-quality manufacturing, testing and research and development capabilities. We currently have four alternator assembly lines, four starter assembly lines, twenty engine valves production lines, five tappets production lines and three rods and shafts production lines. Our current annual production capacity is approximately 2.6 million units of alternators, 2.4 million units of starters, 27 million units of engine valves and tappets, and 20 million units of rods and shafts, assuming two work shifts per day with eight hours each.

In November 2009, we completed an underwritten public offering whereby we sold 6,900,000 shares of our common stock at a public offering price of $10.75 per share and received net proceeds of approximately $69.0 million. The offering was made under the Company’s Shelf Registration Statement on Form S-3 (Registration No. 333-161358), filed with the Securities and Exchange Commission on August 14, 2009.

Recent Developments

On January 18, 2010, through two separate transactions, we acquired an aggregate of 38.36% of equity interest in Applaud Group Limited which is a British Virgin Islands corporation and has no assets other than its ownership of 52.2% of equity interest in Jinheng Holding.  As a result of the acquisition of an aggregate of 38.36% of Applaud, we will become the largest shareholder of Applaud and, thereby, owner of 20.02% of Jinheng Holdings. Jinheng Holdings is a high-tech automotive parts supplier that is primarily engaged in developing, manufacturing and selling components of automotive passive safety restraint systems (airbag and seatbelt), automotive engine electronic injection management systems, and components of diesel engines. Jinheng Holdings is listed on the Hong Kong Stock Exchange. Our CEO and chairman Qingjie Zhao is an executive director of Jinheng Holdings. We expect to utilize our strategic investment in Jinheng Holding to further strengthen and broaden our research and development expertise, expand customer base and improve value-added services.

Our Strategic Priorities

We have six strategic priorities designed to create long-term sustainable growth for our company and value for our shareholders. These strategic priorities are: vertical integration; sales expansion into select international markets; increasing production capacity; strengthening of our research and development capabilities; developing new products and focusing on supplying parts and components for low-emission vehicles.

 
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Our Core Capabilities

As we operate and grow our business, we seek to enhance and capitalize on what we view as our core capabilities described below:

 
Leading Market Position. According to CAAM, in 2008 we ranked second and third in sales revenue in the Chinese market for automobile alternators and starters, respectively. Our subsidiary Jinan Worldwide, which we acquired in October 2008, has been producing engine valves and tappets for over 50 years, and we believe we are now one of the largest manufacturers of engine valves and tappets in China in terms of sales volume as a result of the acquisition. We believe our brand and our products are well recognized and accepted in the automotive industry in China.
     
 
Established Supplier Network. We purchase the majority of raw materials and components used in our products through a network of low-cost suppliers, primarily located within close proximity to our manufacturing facilities. We have established long-term relationships with many of our suppliers. Our established supplier network enables us to maintain a competitive low cost structure, shorten our product lead-times, closely monitor product quality and enjoy sourcing stability.

 
Proprietary Manufacturing Processes. We have invested substantial time and resources in developing customized assembly lines and equipment to optimize our manufacturing efficiency. Our proprietary manufacturing processes and customized equipment provide flexibility and efficiency, achieve shorter lead-times, improve quality assurance, reduce equipment downtime and material wastage and provide greater cost-competitiveness.

 
Strong Long-Term Customer Base. We are a qualified supplier of automotive components to many leading automobile industry players in China and worldwide. Given the high switching costs and rigorous qualification processes of our customers, we believe many of them have come to rely on us as a primary supplier of key components based on our proven ability to meet their growing demand and quality standards.

Principal Factors Affecting Our Financial Performance

Our operating results are primarily affected by the following factors:

 
General economic conditions.  Our financial results will be influenced by general economic conditions, the financial stability of our customers and suppliers, consumer confidence levels, instability and fluctuations in the capital markets and other unforeseen factors. Notwithstanding the global economic downturn, China’s GDP growth in 2009 is expected to reach approximately 10%, substantially higher than the global GDP growth rate which is projected to be approximately 3.4%. Since most of our sales revenue is generated from the Chinese market, we expect to benefit from the continued economic growth in China. Currently, it will also be challenging to maintain our historic growth rate due to general economic conditions which may reduce the demand for our products and overall ability and cost of external financing for our operations.  To meet this challenge, we plan to focus on further integrating our operations and generating greater synergies across our portfolio of technologies, products, and subsidiaries. We also plan to focus on increasing our manufacturing and administrative efficiencies through targeted cost savings initiatives.

 
Government Policies.  The PRC government has adopted a number of measures and initiatives to spur the growth and development of small engine and low-emission vehicles. These measures include reduction of consumption tax rates assessed on low emission vehicles, implementation of a new fuel tax which provides favorable tax treatment to low emission vehicles and a 50% sales tax deduction imposed upon the sales of small engine vehicles with displacements of 1.6L and below.  We anticipate these measures will have a positive impact on sales of our products. We also intend to capitalize on the favorable government policies on alternative energy vehicles by deepening our penetration into that market and by developing products for use in electric vehicles.

 
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Export.  Recent market events, especially the global economic slow-down, the challenging automotive industry conditions and the continued global credit crisis, are adversely impacting global automotive demand which may adversely impact our business, especially our exports. Export sales may also subject us to various economic, political, regulatory, legal and foreign exchange risks. However, we also see great opportunities for expanding our market share in the international market. As international automotive manufacturers implement cost saving plans, we expect them to source components directly from low cost manufacturing regions, such as China. We believe our high quality, low cost products will be attractive to international automakers and engine manufacturers. In addition, our subsidiary Jinzhou Wanyou is specialized in the manufacturing of rods and shafts. With more and more oversea automakers ceasing to manufacture rods and shafts themselves due to cost concerns, we anticipate more sales opportunities for our rods and shafts in the oversea market. We also plan to utilize our existing export sales network and resources to sell engine valves and tappets manufactured by our recently acquired subsidiary Jinan Worldwide. This strategy, if successfully implemented, will further increase our export sales.

Taxation

United States and British Virgin Islands

We are subject to United States tax at a tax rate of 34%. No provision for income taxes in the United States has been made as we have no income taxable in the United States.

Our subsidiaries Wonder Auto and Yearcity Limited were incorporated in the British Virgin Islands and, under the current laws of the BVI, are not subject to income taxes. Friend Birch is incorporated in Hong Kong and subject to a profit tax rate of 16.5% on the assessable profits.

China

Before the implementation of the New EIT Law, foreign-invested enterprises established in the PRC, unless granted preferential tax treatments by the PRC government, were generally subject to an enterprise income tax, or EIT, rate of 33.0%, which included a 30.0% state income tax and a 3.0% local income tax. On March 16, 2007, the National People’s Congress of China passed the New EIT Law, and on November 28, 2007, the State Council of China passed its implementing rules, both of which took effect on January 1, 2008. The New EIT Law and its implementing rules impose a unified EIT of 25.0% on all domestic-invested enterprises and foreign-invested enterprises, unless they qualify under certain limited exceptions. Despite these changes, there will be a transition period for enterprises, whether foreign-invested or domestic, that are currently receiving preferential tax treatments granted by relevant tax authorities.  Enterprises that are subject to an EIT rate lower than 25% may continue to enjoy the lower rate and will transition into the new EIT rate over a five year period beginning on the effective date of the New EIT Law.  Enterprises that are currently entitled to exemptions for a fixed term will continue to enjoy such treatment until the exemption term expires.  Preferential tax treatment will continue to be granted to industries and projects that qualify for such preferential treatments under the New EIT Law.

As approved by the relevant tax authority in the PRC, Jinzhou Halla, Jinzhou Dongwoo, Jinzhou Wanyou, Jinzhou Hanhua, Jinzhou Karham, Fuxin Huirui and Jinan Worldwide were entitled to two years’ exemption from the first profit making calendar year of operations after offset of accumulated taxable losses, followed by a 50% tax reduction for the immediate next three calendar years.  Following is summary of these preferential tax treatments, known as “tax holidays,” and the effective tax rates applicable to these companies:  

 
·
The tax holiday of Jinzhou Halla commenced in fiscal year 2001.  Accordingly, Jinzhou Halla was subject to tax rate of 13.5% for 2003, 2004 and 2005.  Furthermore, Jinzhou Halla, being a foreign-invested enterprise engaged in an advanced technology industry, was approved to enjoy a further three years’ 50% tax reduction for 2006, 2007, and thereafter subject to a tax rate of 15%.

 
·
The tax holiday of Jinzhou Dongwoo commenced in fiscal year 2004.  Accordingly, Jinzhou Dongwoo was subject to tax rate of 13.5% for 2006 and 2007, 12.5% for 2008 and 25% for 2009.  

 
·
Jinzhou Wanyou has elected to commence the tax holiday in fiscal year 2007.  Accordingly, Jinzhou Wanyou was exempted from EIT for 2007 and 2008 and thereafter was and will be entitled to a 50% reduction on EIT rate to 12.5% for 2009, 2010 and 2011.  

 
·
The tax holiday of Jinzhou Hanhua commenced in fiscal year 2005.  Accordingly, Jinzhou Hanhua was subject to tax rate of 13.5% for 2007 and 12.5% for 2008 and 2009. It will be subject to tax rate of 25% for 2010.

 
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·
Jinzhou Karham has elected to commence the tax holiday in fiscal year 2008.  Accordingly, Jinzhou Karham was exempted from EIT for 2008 and 2009 and thereafter will be entitled to a 50% reduction on EIT rate 12.5% for 2010, 2011 and 2012. 

 
·
The tax holiday of Fuxin Huirui commenced in the fiscal year 2008.  Accordingly, Fuxin Huirui was exempted from EIT for 2008 and 2009 and thereafter will be entitled to a 50% reduction on EIT rate 12.5% for 2010, 2011 and 2012.  

 
·
The tax holiday of Jinan Worldwide commenced in the fiscal year of 2006.  Accordingly, Jinan Worldwide was and will be subject to tax rate of 12.5% for 2008, 2009 and 2010.  

 
·
Jinzhou Motor, Jinzhou Equipment, Jinzhou Lida and Jinzhou Jiade are subject to the New EIT Law and the EIT rate of 25%.

In addition to the changes to the current tax structure, under the New EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a resident enterprise and will normally be subject to an EIT of 25% on its global income. The implementing rules define the term “de facto management bodies” as “an establishment that exercises, in substance, overall management and control over the production, business, personnel, accounting, etc., of a Chinese enterprise.” If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our organization’s global income will be subject to PRC income tax of 25%. For detailed discussion of PRC tax issues related to resident enterprise status, see Item 1A, “Risk Factors – Risks Related to Our Business – Under the New EIT Law, we may be classified as a ‘resident enterprise’ of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.”

In addition, the New EIT Law and its implementing rules generally provide that a 10% withholding tax applies to China-sourced income derived by non-resident enterprises for PRC enterprise income tax purposes unless the jurisdiction of incorporation of such enterprises’ shareholder has a tax treaty with China that provides for a different withholding arrangement.

Our future effective income tax rate depends on various factors, such as tax legislation, the geographic composition of our pre-tax income and non-tax deductible expenses incurred. Our management carefully monitors these legal developments and will timely adjust our effective income tax rate when necessary.

Business Segment Information
 
Our business operations can be categorized into four segments based on the type of products we manufacture and sell, specifically (i) alternators, (ii) starters, (iii) rods and shafts, and (iv) engine valves and tappets.

In 2009, our sales revenue from our alternator products was $74.2 million, our sales revenue from our starter products was $68.9 million, our sales revenue from our rod and shaft products was $21.2 million, and our sales revenue from our engine valves and tappets was $46.6 million. Among the four principal products, rods and shafts production enjoyed the fastest growth rate and the highest gross margin, reaching approximately 25-30%.

We manufacture and sell both our alternators and starters using largely the same facilities, personnel and other resources in Jinzhou Halla. Rods and shafts are mainly manufactured by our subsidiary Jinzhou Wanyou. Valves and tappets are manufactured by our newly acquired subsidiary Jinan Worldwide.

Additional information regarding our products can be found at Note 24 in our audited consolidated financial statements contained elsewhere in this annual report.

Results of Operations

The following tables set forth key components of our results of operations for the periods indicated, in dollars and as a percentage of sales revenue.

(all amounts, other than percentages, in thousands of U.S. dollars)

 
34

 
   
Year Ended December 31,
 
   
2009
   
2008
   
2007
 
   
Amount
   
% of
Revenue
   
Amount
   
% of
Revenue
   
Amount
   
% of
Revenue
 
Sales revenue
    211,024       100 %     141,190       100 %     102,084       100 %
Cost of sales
    159,660       75.7 %     104,750       74.2 %     76,460       74.9 %
Gross profit
    51,364       24.3 %     36,439       25.8 %     25,624       25.1 %
Administrative expenses
    11,674       5.5 %     6,827       4.8 %     3,565       3.5 %
Share-based compensation
    1,172       0.6 %     706       0.5 %            
Research and development expenses
    3,027       1.4 %     1,648       1.2 %     1,136       1.1 %
Selling expenses
    7,768       3.7 %     4,093       2.9 %     3,291       3.2 %
Unusual charge-make good provision
                            18,266       17.9 %
Total expenses
    23,640       11.2 %     13,275       9.4 %     26,258       25.7 %
Other income
    1,177       0.6 %     1,360       1.0 %     287       0.3 %
Government grants
    2,755       1.3 %     193       0.1 %     1,497       1.5 %
Net finance costs
    4,578       2.2 %     2,246       1.6 %     2,409       2.4 %
Equity in unconsolidated affiliate
                1,073       0.8 %     34       0.0 %
                                                 
Income (loss) before income taxes and noncontrolling interests
      27,079       12.8 %     23,544       16.7 %     (1,225 )     (1.2 )%
Income taxes
    3,224       1.5 %     2,175       1.5 %     1,389       1.4 %
Noncontrolling interests
    996       0.5 %     2,460       1.7 %     1,137       1.1 %
Net income/(loss) attributable to WATG
    22,859       10.8 %     18,909       13.4 %     (3,750 )     (3.7 )%

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

Sales Revenue. Sales revenue increased $69.8 million, or 49.5%, to $211.0 million in 2009 from $141.2 million in 2008. In 2009, sales revenue from alternators, starters, rods and shafts, engine valves and tappets increased $11.0 million, $16.8 million, $3.1 million and $38.9 million from 2008, respectively. This increase was mainly attributable to our recent acquisition of Jinan Worldwide which contributed $38.9 million in sales revenue in 2009. We acquired 65% interest in Jinan Worldwide in October 2008 and the remaining 35% interest in January 2009. We also benefited from the increased sales of starter and alternator products in 2009 due to the high market demand.
 
The following tables show the different segments and geographic areas comprising our total sales revenue:
 
Sales Revenue by Product Segments
(all amounts, other than percentages, in thousands of U.S. dollars)

   
Year Ended December 31,
   
Percent change
 
Components of Sales Revenue
 
2009
   
2008
   
2009 v. 2008
 
Alternator
    74,250       63,256       17.4 %
Starter
    68,946       52,138       32.2 %
Rod and shaft
    21,247       18,106       17.3 %
Engine valve and tappet
    46,581       7,690       505.7 %
Total sales revenue
    211,024       141,190       49.5 %

 
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Revenue By Geographic Areas
(all amounts in thousands of U.S. dollars)

   
Year Ended December 31,
 
   
2009
   
2008
 
PRC
    188,377       118,251  
South Korea
    5,868       9,066  
Brazil
    6,996       5,903  
Mexico
    1,584       1,769  
United States
    7,135       3,469  
Others
    1,064       2,732  
Total
    211,024       141,190  
 
Cost of Sales.  Our cost of sales increased $54.9 million, or 52.4%, to $159.7 million in 2009 from $104.8 million in 2008. This increase was mainly due to the increase in our raw material and labor costs, which we believe was generally in line with the increase in our sales volume. As a percentage of sales revenue, the cost of sales increased to 75.7% in 2009 from 74.2% in 2008.  The slight percentage increase was mainly because a larger portion of our sales revenue was generated from alternators and starters with mid-to-small displacement as compared to 2008. Our alternators and starters for small-to-mid displacement engine vehicles generally have a lower margin than our alternators and starters for large displacement engine vehicles, and starter products generally have a lower average sales price.
 
Gross Profit. Our gross profit increased $14.9 million,41.0%, to $51.4 million in 2009 from $36.4 million in 2008. Gross profit as a percentage of sales revenue was 24.3% in 2009, as compared to 25.8% in 2008. The decreased gross margin was mainly due to the factor as discussed above.
 
Administrative Expenses.  Our administrative expenses increased $4.8 million, or 71.0%, to $11.7 million in 2009 from $6.8 million in 2008. As a percentage of sales revenue, administrative expenses increased to 5.5% in 2009 from 4.8% in 2008. The increase in the amount and percentage of administrative expenses was primarily due to the consolidation of the operating results of Yearcity and Jinan Worldwide, the professional expenses incurred in connection with our acquisition of Friend Birch and investment in Jinheng Holdings, and other professional expenses.

Share-based compensation. Our non-cash share-based compensation increased $465,640, or 65.9%, to $1.2 million in 2009 from $706,295 in 2008. On November 24, 2009, we granted options to purchase a total of 1,674,400 shares of our common stock to certain officers, directors and employees with an exercise price of $11.48.

Research and development expenses.  Our research and development costs increased $1.4 million, or 83.7%, to $3.0 million in 2009 from $1.6 million in 2008. As a percentage of sales revenue, research and development costs increased to 1.4% for the year ended December 31, 2009 from 1.2% in 2008. Such dollar and percentage increases were primarily attributable to the increased expenses associated with development of new products, including alternative energy vehicle parts.
 
Selling Expenses. Our selling expenses include sales commissions, advertising and promotional materials costs, salaries and fringe benefits of sales personnel, after-sale support services and other sales related costs. Our selling expenses increased $3.7 million, or 89.8%, to $7.8 million in 2009 from $4.1 million in 2008. As a percentage of sales revenue, our selling expenses increased to 3.7% in 2009 from 2.9% in 2008. The increase in the amount and percentage of selling expenses was mainly due to the consolidation of the operating results of Yearcity and Jinan Worldwide which incurred approximately $2.7 million selling expenses in 2009.
  
Total Expenses.  Our total expenses increased $10.4 million, or 78.1%, to $23.6 million in 2009 from $13.3 million in 2008. As a percentage of sales revenue, our total expenses increased to 11.2% in 2009 from 9.4% in 2008. The increases in amount and percentage were mainly due to the facts discussed above.

Other Income. Our other income includes other payables waived, sales of scrap materials, service income, and gain on disposal of property, plant and equipment. Our other income decreased $182,668 to $1.2 million in 2009 from $1.4 million in 2008.

Government Grants. Government grant increased $2.6 million to $2.8million in 2009 from $192,882 in 2008. Government grants are received for purchases of property, plant and equipment, to subsidize the research and development expenses incurred, for compensation expenses already incurred or for good performance of the Company.

 
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Net finance costs. Our financial costs increased $2.3 million to $4.6 million in 2009 from $2.2 million in 2008. Such increase was mainly due to an outstanding loan in the amount of 7.2 million Euro (approximately $10.3 million). Since this loan is denominated in Euro, with the appreciation of RMB against Euro, we had a $70,802 net foreign exchange loss in 2009, as compared to a $975,305 net exchange gain in 2008.

Equity in net income of non-consolidated affiliates. We recognized a net income of $1.1 million from Money Victory Limited in 2008. We used the equity method to recognize profit or loss for the investment in which we exercised significant influence but did not control. We disposed of our investment in Money Victory Limited in November 2008.
 
Income Before Income Taxes and Noncontrolling interests. Our income before income taxes and noncontrolling interests was $27.1 million in 2009, as compared to $23.5 million in 2008.  As a percentage of sales revenue, income before income and noncontrolling interests decreased to 12.8% in 2009 from 16.7% in 2008. Such decrease in income before income tax and noncontrolling interests was mainly due to factors discussed above.
 
Income Taxes. Income taxes increased $1.0 million to $3.2 million in 2009 from $2.2 million in 2008. As a percentage of sales revenue, our income taxes remained at 1.5% in 2009 and 2008. Our effective income tax rate was 11.9% in 2009, which was 9.2% in 2008.

Noncontrolling Interests. Our financial statements reflect an adjustment to our consolidated group net income, and our noncontrolling interest decreased $1.5 million in 2009 to $996,114 from $2.5 million in 2008, reflecting the controlling interests held by third parties in Jinzhou Dongwoo, Jinzhou Hanhua, Jinzhou Karham.

Net Income Attributable to WATG.  Our net income attributable to Wonder Auto increased $3.9 million, or 20.9%, to $22.9 million in 2009 from $18.9 million in 2008, due to the factors discussed above, including increased market demand in China. Excluding the increased $465,640 in non-cash share-based compensation charge, our net income attributable to Wonder Auto increased $4.4 million, or 22.5%, to $24.0 million in 2009 from $19.6 million in 2008.

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

Sales Revenue. Sales revenue increased $39.1 million, or 38.3%, to $141.2 million in 2008 from $102.1 million in 2007. In 2008, sales revenue from alternators and starters, rods and shafts, engine valves and tappets increased $20.6 million, $10.8 million and $7.7 million from 2007, respectively. The increase was mainly attributable to the increased market demand for our mid to small displacement alternator and starter products. We believe that our sales revenue increased in 2008 because of our ability to sell high quality products at competitive prices. Our export sales increased significantly to $22.9 million, accounting for 16.2% of the total sales revenue in 2008, as compared to 9.6% in 2007.  Furthermore, our sales revenue increased partly because of our acquisition of Jinan Worldwide which contributed $7.7 million to our sales revenue in 2008.
 
The following tables show the different segments and geographic areas comprising our total sales revenues:

Sales Revenue by Product Segments
(all amounts, other than percentages, in thousands of U.S. dollars)

   
Year Ended December 31,
   
Percent
 
   
2008
   
2007
   
Change
 
Components of Sales Revenue
                 
Alternator
    63,256       59,790       5.8 %
Starter
    52,138       35,014       48.9 %
Rod and shaft
    18,106       7,280       148.7 %
Engine valve and tappet
    7,690       -       - %
Total sales revenue
    141,190       102,084       38.3 %

 
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Revenue By Geographic Areas
(all amounts in thousands of U.S. dollars)

   
Year Ended December 31,
 
   
2008
   
2007
 
PRC
    118,251       92,329  
South Korea
    9,066       4,650  
Brazil
    5,903       2,633  
Mexico
    1,769       -  
United States
    3,469       1,647  
Others
    2,732       825  
Total
    141,190       102,084  
 
Cost of Sales.  Our cost of sales increased $28.3 million to $104.8 million in 2008 from $76.5 million in 2007. Such amount increase was mainly a result of the substantial growth in sales volume. As a percentage of sales revenue, the cost of sales decreased to 74.2% in 2008 from 74.9% in 2007.  The percentage decrease was primarily attributable to the decrease of per unit cost of products resulting from our ability to realize the benefits of economies of scale. We also benefited from more efficient cost control management and improved technology which allowed us to reduce raw material and component consumption per unit of production.
 
Gross Profit. Our gross profit increased $10.8 million to $36.4 million in 2008 from $25.6 million in 2007. Gross profit as a percentage of sales revenue was 25.8% in 2008, as compared to 25.1% in 2007. The increased gross margin was mainly attributable to the factor as discussed above.
 
Administrative Expenses.  Our administrative expenses increased $3.3 million, or 91.5%, to $6.8 million in 2008 from $3.6 million in 2007. As a percentage of sales revenue, administrative expenses increased to 4.8% in 2008 from 3.5% in 2007.  This dollar and percentage increase of administrative expenses was mainly due to the consolidation of the financial results of Jinzhou Hanhua, Jinzhou Karham, Fuxin Huirui and Jinan Worldwide, and third party professional fees associated with such acquisitions, as well as the audit and assessment costs in complying with the rules and regulations related to our status as a public reporting company in the United States.

Share-based compensation. We incurred a non-cash employee compensation of $706,295 as a result of the stock option grants to senior management and other staff made under our equity incentive plan adopted in April 2008.  Such stock option grants were terminated in December 2008.

Research and development expenses.  Our research and development costs increased $511,891, or 45.1%, to $1.6 million in 2008 from $1.1 million in 2007. As a percentage of sales revenue, research and development costs increased to 1.2% for the year ended December 31, 2008 from 1.1% in 2007. Such dollar and percentage increases were primarily attributable to the increased expenses associated with development of new products.
 
Selling Expenses. Our selling expenses include sales commissions, advertising and promotional materials costs, salaries and fringe benefits of sales personnel, after-sale support services and other sales related costs. Our selling expenses increased to $4.1 million in 2008 from $3.3 million in 2007. The increased selling expenses were mainly attributable to the increased sales commissions and salaries resulting from the growth of our sales revenue, and the higher transportation costs during Beijing Olympic Games. As a percentage of sales revenue, our selling expenses decreased to 2.9% in 2008 from 3.2% in 2007. This percentage decrease was primarily attributable to lower warranty costs resulting from the improved product quality.
 
Unusual Charge – Make Good Provision. In connection with our private placement which closed in June 2006, two of our stockholders Choice Inspire Limited, or CIL, and Empower Century Limited, or ECL, pledged and deposited into escrow 3,300,000 shares of our common stock pursuant to a “make good” escrow agreement with the private placement investors.  Under the “make good” escrow agreement, the pledged shares were deliverable to the investors, on a pro rata basis, if we did not meet certain minimum net income thresholds during the fiscal years 2006 and 2007, but would be released back to CIL and ECL if the net income thresholds were achieved.  On February 8, 2007 and February 2, 2008, stockholders’ of CIL and ECL transferred their rights to receive the 3,300,000 shares in escrow for no consideration to Xiangdong Gao. who ultimately received the escrowed shares. Per ASC 718, Accounting for Stock-Based Compensation, if the net income threshold is met, the shares will be released back to CIL and ECL and treated as an expense equal to the amount of the market value of the shares as of the date when the respective performance goal was met.  We achieved the net income thresholds for both 2006 and 2007, accordingly, we recognized a non-cash expense of $7.5 million and $18.3 million in 2006 and 2007, respectively. As the make good arrangement only applies to 2006 an 2007, no such compensation expense was recognized in 2008.

 
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Total Expenses.  Our total expenses decreased $13.0 million to $13.3 million in 2008 from $26.3 million in 2007. As a percentage of sales revenue, our total expenses decreased to 9.4% in 2008 from 25.7% in 2007. The decreases in amount and percentage were mainly due to the non-cash expenses of $18.3 million related to the make good arrangement recognized in 2007 as discussed above.

Other Income. Our other income includes other payables waived, sales of scrap materials, service income, and gain on disposal of property, plant and equipment. Our other income increased $1.1 million to $1.4 million in 2008 from $287,322 in 2007.

Net finance costs. Our financial costs decreased $162,922 to $2.2 million in 2008 from $2.4 million in 2007. Such decrease was mainly due to an outstanding loan in the amount of 8.3 million Euro (approximately $11.8 million). Since this loan is denominated in Euro, with the appreciation of RMB against Euro, we had a $975,305 net foreign exchange gain in 2008.

Equity in net income of non-consolidated affiliates. We recognized a net income of $1.1 million from Money Victory Limited in 2008, as compared to $34,147 from Jinzhou Wanyou in 2007. We used the equity method to recognize profit or loss for the investment in which we exercised significant influence but did not control.
 
Income (Loss) Before Income Taxes and Noncontrolling interests. Our income before income taxes and minority interests was $23.5 million in 2008, as compared to a loss of $1.2 million in 2007.  Such increase in income before income tax and minority interests was mainly attributable to the non-cash expense of $18.3 million related to the make good arrangement recognized in 2007. No non-cash expense related to the make good arrangement was recognized in 2008.
 
Income TaxesIncome taxes increased $785,940 to $2.2 million in 2008 from $1.4 million in 2007. As a percentage of sales revenue, our income taxes increased to 1.5% in 2008 from 1.4% in 2007.

Noncontrolling Interests. Our financial statements reflect an adjustment to our consolidated group net income, and our noncontrolling interest increased $1.3 million in 2008 to $2.5 million from $1.1 million in 2007, reflecting the noncontrolling interests held by third parties in Jinzhou Dongwoo, Jinzhou Hanhua, Jinzhou Karham and Jinan Worldwide.

Net Income(Loss)/attributable to WATG.  Our net income was $18.9 million in 2008 as compared to a loss of $3.8 million in 2007. The significant increase in net income was mainly attributable to the non-cash expense of $18.3 million related to the make good arrangement recognized in 2007. Other than the $18.3 million non-cash expense, our net income increased $4.4 million in 2008 mainly because of the factors discussed above, including increased market demand and increased export sales.
 
Liquidity and Capital Resources

As of December 31, 2009, we had cash and cash equivalents of $82.4 million and restricted cash of $15.8 million. The following table provides detailed information about our net cash flow for all financial statements periods presented in this report.

Statement of Cash Flow
(All amounts in thousands of U.S. dollars)

   
Year Ended December 31,
 
   
2009
   
2008
   
2007
 
Net cash provided by operating activities
  $ 18,157     $ 9,106     $ 12,170  
Net cash used in investing activities
    (38,518 )     (37,266 )     (24,566 )
Net cash provided by financing activities
    94,537       9,226       29,232  
Effect of foreign currency translation on cash and cash equivalents
    79       991       1,063  
Net cash inflow(outflow)
    74,255       (17,944 )     17,899  
 
Operating Activities
 
We believe our ability to generate cash from operating activities is one of our fundamental financial strengths. We expect to meet all of our financial commitments and operating needs for the foreseeable future.

 
39

 
Net cash provided by operating activities was $18.2 million in 2009, as compared to $9.1 million in 2008. The increase was mainly attributable to increased trade payables, increased inventories and other receivables, partially offset by an increase in bills receivable.

Net cash provided by operating activities was $9.1 million in 2008, as compared to $12.2 million in 2007. The decrease was mainly attributable to the increase of finished product inventories as of December 31, 2008. Due to the global economic crisis, in the fourth quarter of 2008, our sales of alternators and starters were lower than the anticipated sales level which resulted in an increase of inventory for finished goods. In addition, the acquisition of Jinan Worldwide in the fourth quarter of 2008 also contributed to the increase of inventory.
 
Investing Activities

Our main uses of cash for investing activities in 2009 were for the acquisition of property, plant and equipment.

Net cash used in investing activities in 2009 was $38.5 million, as compared to $37.3 million in 2008. Net cash used in investing activities in 2009 was mainly attributable to $13.0 million payment to acquire and to deposit for acquisition of property, plant and equipment and $21.7 million paid to acquire Yearcity and Friend Birch.

Net cash used in investing activities in 2008 was $37.3 million, as compared to $24.6 million in 2007. Net cash used in investing activities in 2008 was mainly attributable to a $5 million investment in Money Victory Limited, and payments totaling $16.6 million for the acquisitions of Jinzhou Hanhua, Jinzhou Karham, Fuxin Huirui and Jinan Worldwide. In addition, we spent approximately $17.3 million in connection with the acquisition of property, mainly for the purchase of land use right for Jinzhou Motor and Jinzhou Equipment and the capacity expansion of Jinzhou Wanyou.
 
Financing Activities
 
Net cash provided by financing activities in 2009 totaled $94.5 million as compared to $9.2 million in 2008. In November 2009, we completed an underwritten public offering whereby we sold 6,900,000 shares of our common stock at a public offering price of $10.75 per share and received a net proceeds of approximately $69.0 million. 

Net cash provided by financing activities in 2008 totaled $9.2 million as compared to $29.2 million provided by financing activities in 2007. The decrease in net cash was mainly attributable to the $22.7 million proceeds we received from private placement transaction closed in December 2007, which more than offset the $9.2 million increase in net proceeds from bank loans in 2008.
 
Our debt to equity ratio was 40.5% as of December 31, 2009. We plan to maintain our debt to equity ratio below 65%, increase long-term loans, decrease short-term loans and increase the ratio of the borrowing in foreign currency to take advantage of the expected appreciation of  RMB against the U.S. dollar.
 
Loan Facilities
 
As of December 31, 2009, we had approximately $97.9 million of bank deposits, our total assets were $362.3 million, and total equity was $198.5 million.

As of December 31, 2009, the amount, maturity date and term of each of our secured borrowings are as follows.

 
40

 
 
Short Term Loans
(All amounts in millions of U.S. dollars)

Bank
 
Amount
 
Maturity Date
 
Term
China Construction Bank
  $ 2.6  
October 29, 2010
 
12 months
China construction Bank
    1.5  
February 24, 2010
 
12 months
China Construction Bank
    5.9  
April 12, 2010
 
12 months
Bank of China
    4.4  
November 26, 2010
 
12 months
Huaxia Bank
    2.9  
June 30, 2010
 
12 months
China CITIC Bank
    8.8  
April 26, 2010
 
12 months
China CITIC Bank
    5.9  
June 28, 2010
 
12 months
Bank of China
    2.9  
August16, 2010
 
12 months
Bank of Jinzhou
    0.4  
March 30, 2010
 
12 months
Bank of Jinzhou
    0.2  
August 31, 2010
 
12 months
Bank of Jinzhou
    0.4  
September 23, 2010
 
12 months
Bank of China
    2.9  
April 28, 2010
 
12months
Bank of China
    1.0  
January 24, 2010
 
3 months
Bank of China
    1.5  
May 19, 2010
 
12 months
China CITIC
    2.9  
October 21, 2010
 
12 months
Bank of Jinzhou
    0.1  
October 28, 2010
 
12 months
Bank of Jinan
    2.9  
May 15, 2010
 
12 months
Huaxia Bank
    2.9  
June 22, 2010
 
12months
SZD Bank
    2.9  
February 28, 2010
 
6 months
Total
  $ 53.0        

Installment Loans
(All amounts in millions of U.S. dollars)

   
Within 1
Year
   
1-2
Years
   
2-3
Years
   
3-4
Years
   
4-5
Years
   
After 5
Years
   
Total
 
Bank of China*
  $ 0.7     $ 4.0     $ 4.0     $ 2.7     $ 2.1     $ -     $ 13.5  
DEG**
    3.2       3.2       3.2       0.7       -       -       10.3  
Changqing*
    -       -       -       -       0.2       0.8       1.0  
Total
  $ 3.9     $ 7.2     $ 7.2     $ 3.4     $ 2.3     $ 0.8     $ 24.8  

*The loans are denominated in RMB, we used the exchange rate of $1 = RMB6.8166
**The loan is denominated in Euro, we used the exchange rate of 1 Euro = RMB9.8

During the year ended December 31, 2009, we repaid bank loans in the total amount of approximately $61.8 million. Approximately $56.9 million bank loans will mature within the next twelve months. We plan to either repay these loans as they mature or refinance them using other existing credit lines.

We believe that we maintain good relationships with the banks providing credits and loans to us, and our current available working capital should be adequate to sustain our operations at our current levels through at least the next twelve months.

As of the date of this report, we believe that our currently available working capital, including the aggregate proceeds of our capital raising activities and the credit facilities referred to above, should be adequate to sustain our operations at our current levels through at least the next twelve months. We may, however, in the future, require additional cash resources due to the changed business conditions, implementation of our strategy to expand our production capacity or other investments or acquisitions we may decide to pursue. If our own financial resources are insufficient to satisfy our capital requirements, we may seek to sell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity securities could result in dilution to our stockholders. The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financial covenants that would restrict our operations. Financing may not be available in amounts or on terms acceptable to us, if at all. Any failure by us to raise additional funds on terms favorable to us, or at all, could limit our ability to expand our business operations and could harm our overall business prospects.

Obligations under Material Contracts

Below is a table setting forth our contractual obligations as of December 31, 2009:

 
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(All amounts in thousands of U.S. dollars)

   
Total
   
Less than
1 year
   
1-3 years
   
3-5 years
   
More than
5 years
 
Long term debt obligations
  $ 24.8     $ 3.9     $ 14.4     $ 5.7     $ 0.8  
Capital commitments
    1.3       1.3                    
Operating lease obligations
    0.2       0.2                    
Purchase obligations
                             
Total
  $ 26.3     $ 5.4     $ 14.4     $ 5.7     $ 0.8  

Off-Balance Sheet Arrangements
 
We do not have any off-balance sheet arrangements.

Seasonality
 
Our operating results and operating cash flows historically have not been subject to seasonal variations. This pattern may change, however, as a result of new market opportunities or new product introductions. 
 
Critical Accounting Policies and Estimates
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires our management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements, including the notes thereto, and related disclosures of commitments and contingencies, if any. We consider our critical accounting policies to be those that require the more significant judgments and estimates in the preparation of financial statements, including the following: 

Principles of consolidation. The consolidated financial statements include the accounts of the Company and its subsidiaries.  All significant inter-company accounts and transactions have been eliminated in consolidation.

Share-based compensation.  The Company adopted the provisions of ASC 718 (previously SFAS 123(R)), which requires the use of the fair value method of accounting for share-based compensation. Under the fair value based method, compensation cost related to employee stock options or similar equity instruments which are equity-classified awards, is measured at the grant date based on the value of the award and is recognized over the requisite service period, which is usually the vesting period. ASC 718 also requires measurement of cost of a liability-classified award based on its current fair value.

Fair value of share options granted is determined using the Black-Scholes model. Under this model, certain assumptions, including the risk-free interest rate, the expected life of the options and the estimated fair value of the Company’s common stock and the expected volatility, are required to determine the fair value of the options. If different assumptions had been used, the fair value of the options would have been different from the amount the Company computed and recorded, which would have resulted in either an increase or decrease in the compensation expense.

Use of estimates. In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods.  These accounts and estimates include, but are not limited to, the valuation of accounts receivable, inventories, deferred income taxes, provision for warranty, goodwill, know-how, share-based compensation and the estimation on useful lives of property, plant and equipment.  Actual results could differ from those estimates.

 
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Allowance for doubtful accounts.  The Company establishes an allowance for doubtful accounts based on management’s assessment of the collectability of trade receivables.  A considerable amount of judgment is required in assessing the amount of the allowance, the Company considers the historical level of credit losses and applies percentages to aged receivable categories.  The Company makes judgments about the creditworthiness of each customer based on ongoing credit evaluations, and monitors current economic trends that might impact the level of credit losses in the future.  If the financial condition of the customers were to deteriorate, resulting in their inability to make payments, a larger allowance may be required.

Based on the above assessment, during the reporting years, the management establishes the general provisioning policy to make allowance equivalent to 100% of gross amount of trade receivables due over 1 year.  Additional specific provision is made against trade receivables aged less than 1 year to the extent which they are considered to be doubtful.

Bad debts are written off when identified.  The Company extends unsecured credit to customers ranging from three to six months in the normal course of business.  The Company does not accrue interest on trade accounts receivable.

Historically, losses from uncollectible accounts have not significantly deviated from the general allowance estimated by the management and no significant additional bad debts have been written off directly to the profit and loss.  This general provisioning policy has not changed in the past since establishment and the management considers that the aforementioned general provisioning policy is adequate and not too excessive and does not expect to change this established policy in the near future.

Impairment of long-lived assets. Long-lived assets are tested for impairment in accordance with ASC 360-10-45 “Impairment or Disposal of Long-Lived Assets” (previously SFAS No. 144), Equity Method of Accounting for Investments in Common Stock, respectively.  The Company periodically evaluates potential impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable.  The Company recognizes impairment of long-lived assets and investment in an affiliate in the event that the net book values of such assets exceed the future undiscounted cashflows attributable to such assets.  During the reporting periods, the Company has not identified any indicators that would require testing for impairment.

Revenue recognition.  Revenue from sales of the Company’s products is recognized when the significant risks and rewards of ownership have been transferred to the buyer at the time when the products are put into use by its customers, the sales price is fixed or determinable and collection is reasonably assured.

Warranty.  It is the policy of the Company to provide after sales support to the product of alternators and starters by way of a warranty program.  The Company provided warranties to certain customers with warranty periods ranging from two years or 50,000 km to three years or 60,000 km, whichever comes first.

Based on the past experience, the Company sets up a policy of making a general provision for warranty such that the closing balance of this provision is equal to certain percentage of relevant sales during the reporting periods as follows :-

Year ended December 31,
 
%
 
       
2009
    1  
2008
    1.5  
2007
    1.5  

As of January 1, 2009, the management of the Company re-assessed the percentage for provision of warranties by reviewing the historical claims information and determined to adjust the percentage from 1.5% to 1.0%. Such decrease was attributable to the improvement in the rate of defects for the Company’s products after introduction of certain new technologies obtained from the Company’s research and development.

Following the acquisition of Yearcity in October, 2008, the Company maintains its policy to provide after sales support to the product of engine valves and tappets by way of a warranty program.  The Company provided warranties to certain customers with warranty periods ranging from 1 to 1.5 years or 3,000 hours, whichever comes first.

 
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Based on the past experience, the Company sets up a policy of making a general provision for warranty in relation to the sales of engine valves and tappets such that the closing balance of this provision is equal to 1.7% of relevant sales during the reporting periods.

Recent Accounting Pronouncements

FASB Accounting Standards Codification (Accounting Standards Update “ASU” 2009-1). In June 2009, the Financial Accounting Standard Board (“FASB”) approved its Accounting Standards Codification (“Codification”) as the single source of authoritative United States accounting and reporting standards applicable for all non-governmental entities, with the exception of the SEC and its staff. The Codification is effective for interim or annual financial periods ending after September 15, 2009 and impacts our financial statements as all future references to authoritative accounting literature will be referenced in accordance with the Codification. There have been no changes to the content of our financial statements or disclosures as a result of implementing the Codification.

As a result of our implementation of the Codification during the quarter ended September 30, 2009, previous references to new accounting standards and literature are no longer applicable. In the current financial statements, we will provide reference to both new and old guidance to assist in understanding the impacts of recently adopted accounting literature, particularly for guidance adopted since the beginning of the current fiscal year but prior to the Codification.

Noncontrolling Interests (Included in amended Topic ASC 810 “Consolidation”, previously SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statements”, an amendment of ARB No. 51). The amended topic establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. We adopted the amended topic on January 1, 2009. As a result, we have reclassified financial statement line items within our Consolidated Balance Sheets and Statements of Income(Loss) and Comprehensive Income(Loss) for the prior period to conform to this amended topic.

Business Combinations (Included in amended Topic ASC 805 “Business Combinations”, previously SFAS No. 141(R)). This ASC guidance addresses the accounting and disclosure for identifiable assets acquired, liabilities assumed, and noncontrolling interests in a business combination. The adoption of this amended topic has no material impact on the Company’s financial statements.

Intangibles-Goodwill and Other (Included in amended Topic ASC 350”, previously FASB staff position (“FSP”) FAS 142-3, Determination of the Useful Life of Intangible Assets). The amended topic amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under FASB Statement No. 142, “Goodwill and Other Intangible Assets”. This new guidance applies prospectively to intangible assets that are acquired individually or with a group of other assets in business combinations and asset acquisitions. The amended topic is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. Early adoption is prohibited. The adoption of this amended topic has no material effect on the Company's financial statements.

Business Combinations (Included in amended Topic ASC 805, previously FSP No. 141R-1 “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies”). Amended topic ASC 805 amends the requirements for the provisions in FASB Statement 141R for the initial recognition and measurement, subsequent measurement and accounting, and disclosures for assets and liabilities arising from contingencies in business combinations. The amended topic eliminates the distinction between contractual and non-contractual contingencies, including the initial recognition and measurement criteria and instead carries forward most of the provisions for acquired contingencies. The amended topic is effective for contingent assets and contingent liabilities acquired in evaluating the impact. The management is in the process of evaluating the impact of adopting this amended topic on the Company’s financial statements.

 
44

 

Fair Value Measurements and Disclosures (Included in amended Topic ASC 820, previously FSP No. 157-4, “Determining Whether a Market is Not Active and a Transaction Is Not Distressed”.) The amended topic clarifies when markets are illiquid or that market pricing may not actually reflect the “real” value of an asset. If a market is determined to be inactive and market price is reflective of a distressed price then an alternative method of pricing can be used, such as a present value technique to estimate fair value. The amended topic identifies factors to be considered when determining whether or not a market is inactive. The amended topic would be effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009 and shall be applied prospectively. The adoption of this amended topic has no material effect on the Company's financial statements.

Investments - Debt and Equity Securities - Overall - Transition and Open Effective Date Information (Included in amended Topic ASC 320, previously FASB Staff Position No. 115-2 and Statement of Financial Accounting Standards No. 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments”). The amended topic amends the other-than-temporary impairment guidance in U.S. GAAP for debt securities through increased consistency in the timing of impairment recognition and enhanced disclosures related to the credit and noncredit components of impaired debt securities that are not expected to be sold. In addition, increased disclosures are required for both debt and equity securities regarding expected cash flows, credit losses, and securities with unrealized losses. The adoption of this amended topic has no material impact on the Company’s financial statements.

Interim Disclosures about Fair Value of Financial Instruments (Included in amended Topic ASC 825 “Financial Instruments”, previously FSP SFAS No. 107-1). This guidance requires that the fair value disclosures required for all financial instruments be included in interim financial statements. This guidance also requires entities to disclose the method and significant assumptions used to estimate the fair value of financial instruments on an interim and annual basis and to highlight any changes from prior periods. The amended topic was effective for interim periods ending after September 15, 2009. The adoption of this amended topic has no material impact on the Company’s financial statements.

Subsequent Events (Included in amended Topic ASC 855 “Subsequent Events”, previously SFAS No. 165). The amended topic establishes accounting and disclosure requirements for subsequent events. The amended topic details the period after the balance sheet date during which we should evaluate events or transactions that occur for potential recognition or disclosure in the financial statements, the circumstances under which we should recognize events or transactions occurring after the balance sheet date in its financial statements and the required disclosures for such events. We adopted this amended topic effective June 1, 2009.

Accounting for Transfers of Financial Assets (Included in amended Topic ASC 860 “Transfers and Servicing”, previously SFAS No. 166, “Accounting for Transfers of Financial Assets - an Amendment of FASB Statement No. 140.”). The amended topic addresses information a reporting entity provides in its financial statements about the transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets. Also, the amended topic removes the concept of a qualifying special purpose entity, limits the circumstances in which a transferor derecognizes a portion or component of a financial asset, defines participating interest and enhances the information provided to financial statement users to provide greater transparency. The amended topic is effective for the first annual reporting period beginning after November 15, 2009 and will be effective for us as of January 1, 2010. The management is in the process of evaluating the impact of adopting this amended topic on the Company’s financial statements.

 
45

 

Consolidation of Variable Interest Entities – Amended (Included in amended Topic ASC 810 “Consolidation”, previously SFAS 167 “Amendments to FASB Interpretation No. 46(R)”). The amended topic requires an enterprise to perform an analysis to determine the primary beneficiary of a variable interest entity; to require ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity and to eliminate the quantitative approach previously required for determining the primary beneficiary of a variable interest entity. The amended topic also requires enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity. The amended topic is effective for the first annual reporting period beginning after November 15, 2009 and will be effective for us as of January 1, 2010. The management is in the process of evaluating the impact of adopting this amended topic on the Company’s financial statements

In August 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-05 (“ASU Update 2009-05”), an update to ASC 820, Fair Value Measurements and Disclosures. This update provides amendments to reduce potential ambiguity in financial reporting when measuring the fair value of liabilities. Among other provisions, this update provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the valuation techniques described in ASU Update 2009-05. ASU Update 2009-05 will become effective for the Company’s annual financial statements for the year ended December 31, 2009. The adoption of this ASU update has no material impact on the Company’s financial statements.

The FASB issued Accounting Standards Update (ASU) No. 2009-13, Revenue Recognition (Topic 605): Multiple Deliverable Revenue Arrangements - A Consensus of the FASB Emerging Issues Task Force.” This update provides application guidance on whether multiple deliverables exist, how the deliverables should be separated and how the consideration should be allocated to one or more units of accounting. This update establishes a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence, if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific or third-party evidence is available. The Company will be required to apply this guidance prospectively for revenue arrangements entered into or materially modified after January 1, 2011; however, earlier application is permitted. The management is in the process of evaluating the impact of adopting this ASU update on the Company’s financial statements.

The FASB issued ASU-2010-09 (Topic 855) to amend guidance on subsequent events to remove the requirement for SEC filers (as defined in ASU 2010-09) to disclose the date through which an entity has evaluated subsequent events. This change alleviates potential conflicts with current SEC guidance. An SEC filer is still required to evaluate subsequent events through the date financial statements are issued, but disclosure of that date is no longer required. The amendments in ASU 2010-09 became effective upon issuance of the guidance.

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

Interest Rate Risk

We are exposed to interest rate risk primarily with respect to our short-term bank loans and long-term bank loans. Although the interest rates, which are based on the banks’ prime rates with respect to our short-term loans are fixed for the terms of the loans, the terms are typically three to twelve months for short-term bank loans and interest rates are subject to change upon renewal.  There were no material changes in interest rates for short-term bank loans renewed during the year ended December 31, 2009.

 A hypothetical 1.0% increase in the annual interest rates for all of our credit facilities under which we had outstanding borrowings as of December 31, 2009, would decrease net income before provision for income taxes by approximately $7.8 million for the year ended December 31, 2009.  Management monitors the banks’ prime rates in conjunction with our cash requirements to determine the appropriate level of debt balances relative to other sources of funds.  We have not entered into any hedging transactions in an effort to reduce our exposure to interest rate risk.

 
46

 

Foreign Exchange Risk

While our reporting currency is the U.S. Dollar, all of our consolidated revenues and consolidated costs and expenses are denominated in RMB.  All of our assets are denominated in RMB except for cash.  As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between U.S. Dollars and RMB.  If RMB depreciates against the U.S. Dollar, the value of our RMB revenues, earnings and assets as expressed in our U.S. Dollar financial statements will decline. In addition, we also have bank loan denominated in Euro and our payment obligation may be affected by fluctuations in the exchange rate between the Euro and RMB.  Assets and liabilities are translated at exchange rates at the balance sheet dates and revenue and expenses are translated at the average exchange rates and shareholders’ equity is translated at historical exchange rates.  Any resulting translation adjustments are not included in determining net income but are included in determining other comprehensive income, a component of shareholders’ equity.  We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.
 
The value of the RMB against the U.S. dollar, Euro and other currencies is affected by, among other things, changes in China’s political and economic conditions. Since July 2005, the RMB has not been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar or Euro in the medium to long term.  Moreover, it is possible that in the future, PRC authorities may lift restrictions on fluctuations in RMB exchange rate and lessen intervention in the foreign exchange market.

Inflation

Inflationary factors such as increases in the cost of our product and overhead costs may adversely affect our operating results.  Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of net revenues if the selling prices of our products do not increase with these increased costs.
 
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The full text of our audited consolidated financial statements as of December 31, 2009 and 2008 and for the years ended December 31, 2009, 2008 and 2007 begins on page F-1 of this annual report.

The following table sets forth certain unaudited financial information for each of the eight quarters ended December 31, 2009 and 2008. The consolidated financial statements for each of these quarters have been prepared on the same basis as the audited consolidated financial statements included in this annual report and, in the opinion of management, include all adjustments necessary for the fair presentation of the results of operations for these periods. This information should be read together with our audited consolidated financial statements and the related notes included elsewhere in this annual report.

(All amounts in millions of U.S. dollars)

   
Year Ended December 31, 2009
   
Year Ended December 31, 2008
 
   
First
Quarter
   
Second
Quarter
   
Third
Quarter
   
Fourth
Quarter
   
First
Quarter
   
Second
Quarter
   
Third
Quarter
   
Fourth
Quarter
 
Revenue
  $ 39,976     $ 49,651     $ 58,962     $ 62,435     $ 31,117     $ 36,659     $ 39,266     $ 34,148  
Gross profit
    10,094       12,219       13,954       15,096       8,173       9,504       10,126       8,637  
Income before income taxes and noncontrolling interests
    6,315       6,279       7,857       6,628       4,900       6,756       7,594       4,293  
Net income attributable to WATG
    5,172       5,376       6,507       5,804       3,986       5,267       6,354       3,304  
Net income per share
                                                               
Basic
    0.19       0.20       0.24       0.19       0.15       0.20       0.24       0.11  
Diluted
    N/A       N/A       N/A       0.19       N/A