Overview

Wonder Auto Technology, Inc. is a holding company whose primary business operations are conducted through our subsidiary, Wonder Auto Limited and its subsidiary Halla. Through Halla, Wonder Auto is a China-based manufacturer of automotive electrical parts, specifically, starters and alternators. Wonder Auto's business is focused on designing, developing, manufacturing and selling these automotive electrical parts. Until our acquisition of Wonder Auto on June 22, 2006, our business strategy and ownership changed over the years as a result of several acquisitions of our stock that are discussed in the section below entitled "Our Background and History."

Our Background and History

We were incorporated on June 8, 2000 in the State of Nevada under the name "MGCC Investment Strategies Inc." On August 25, 2006, we amended our Articles of Incorporation and changed our name into Wonder Auto Technology, Inc. From inception until March 16, 2004, WATG's primary business strategy was to provide corporate finance consulting and management advisory services to emerging companies. In particular, its plan was to focus its business in the areas of corporate finance consulting services, business consulting services, broker-client relation services and public relations services. WATG had no business operations during this period.

On March 16, 2004, MyTop purchased 1,025,000 shares of the common stock of WATG and became the owner of approximately 96% of the issued and outstanding capital stock of WATG.

After the stock acquisition, MyTop intended for WATG to engage in business of developing hi-tech product manufacturing and services through the acquisition of other companies. MyTop entered into informal discussions with potential acquisition targets in China, but no agreements were reached.

On August 1, 2005, MyTop changed its name to Hisonic, and on December 19, 2005, Hisonic, as the principal stockholder of WATG, entered into a stock purchase agreement with HFI, pursuant to which Hisonic sold 1,000,000 shares of the common stock of WATG to HFI for $300,000. As a result, HFI became the owner of approximately 86.4% of the issued and outstanding common stock of WATG.

In connection with the sale of common stock to HFI, Timothy P. Halter was elected as WATG's Chairman of the Board, President, Chief Financial Officer and Secretary and WATG effected a 20-for-1 reverse stock split in February 2006.

Until the reverse acquisition of Wonder Auto on June 22, 2006, WATG engaged in no active operations. In connection with the reverse acquisition transaction, Wonder Auto became the wholly owned subsidiary of WATG and is the holding company for all current commercial operations, which are conducted through a variety of subsidiary companies whose business operations originally commenced business in May 1996.

Background and History of Wonder Auto and its Operating Subsidiaries

Wonder Auto Limited was incorporated in British Virgin Islands in March 2004. Its wholly owned subsidiary Man Do Auto Technology Co. Ltd. was incorporated under the law of British Virgin Islands in 2003. Neither Wonder Auto Limited nor Man Do Auto Technology Co. Ltd. has any active business operations other than their ownership of Halla, which is the operating company that primarily manufactures our products. Halla was incorporated in March 1996 with a registered capital of $12 million. Over the years, Halla went through several ownership changes and is now 61% owned by Wonder Auto Limited and 39% owned by Man Do Auto Technology Co. Ltd.

Acquisition of Wonder Auto and Related Financing

On June 22, 2006, Wonder Auto Limited completed a private placement pursuant to which Wonder Auto Limited issued to certain accredited investors 45.277236 shares of its common stock for $12,000,000, such shares were subsequently exchanged for 3,899,996 shares of the common stock of WATG in connection with the reverse acquisition transaction as discussed below.

In addition, on June 22, 2006, Empower Century Limited transferred 30.184824 shares of the common stock of Wonder Auto Limited to certain accredited investors in exchange for $8,000,000. Such shares were subsequently exchanged for 2,599,998 shares of the common stock of WATG in connection with the reverse acquisition transaction as discussed below.

On June 22, 2006, we also completed a reverse acquisition transaction with Wonder Auto Limited whereby we issued to the stockholders of Wonder Auto Limited 21,127,194 shares of our common stock in exchange for all of the issued and outstanding capital stock of Wonder Auto Limited. Wonder Auto Limited thereby became our wholly owned subsidiary and the former stockholders of Wonder Auto Limited became our controlling stockholders.

Upon the closing of the reverse acquisition, Timothy Halter submitted his resignation letter pursuant to which he resigned from all offices of WATG that he held and from his position as our director that became effective in July 2006. Qingjie Zhao was appointed to the board of the directors at the effective time of the resignation of Timothy Halter. In addition, our executive officers were replaced by the Wonder Auto executive officers upon the closing of the reverse acquisition as indicated in more detail below.

For accounting purposes, the share exchange transaction was treated as a reverse acquisition with Wonder Auto as the acquirer and WATG as the acquired party. When we refer in this Report to business and financial information for periods prior to the consummation of the reverse acquisition, we are referring to the business and financial information of Wonder Auto on a consolidated basis unless the context suggests otherwise.

Subsequent Transactions

On August 23, 2006, Wonder Auto entered into a share purchase agreement with Winning to purchase Winning's 50% interest in Dong Woo, one of our primary suppliers for $4.85 million to be paid in two installments subject to adjustment based on Dong Woo's financial performance. We paid $2.43 in 2006, $400,000 on February 13, 2007 and are in the process of arranging for the payment of the remaining balance. Under this agreement, Wonder Auto may designate three out of five members of the board of directors of Dong Woo.

On September 21, 2006, Halla together with two independent parties established Wonder Friends in the PRC. Halla contributed $0.5 million to Wonder Friends registered capital representing a 20.41% equity interest. Wonder Friends is principally engaged in the manufacture of piston rods, vibration-dampers and rotary axes for motor vehicles.

Industry Wide Factors that are Relevant to Our Business

Management believes that the Chinese auto parts industry is expanding. According to the China Council for the Promotion of International Trade, individual vehicle ownership more than doubled to 13.65 million units in 2004 from 6.25 million units in 2000. According to the China Automotive Industry Yearbook (1955-2005), the Chinese automobile market maintained an average growth rate of 10% to 15% over the past 15 years. In 2006, according to China Auto Mobile Information Net, the total automobile production in China reached 7.28 million units, representing a 27.32% increase over 2005. China is now the second largest auto market in the world, with sales volume for 2006 reaching 7.22 million units. Of the 5.23 million passenger cars manufactured in 2006, 5.17 million were sold, representing 32.76% and 30.02% increase over 2005, respectively. It is expected that production of autos in China will exceed 8.50 million units in 2007. (Source: Beijing Daily). Among the 7.22 million vehicles sold, 60% of them were purchased by private owners of which 2.08 million were small cars with engine displacements between 1 to 1.6 liters. It is estimated by market specialists that the number of cars owned by private owners will have reached 22 million by the end of 2006, making China the second largest new car market in the world, especially for privately owned autos. It is estimated that there are about 30 automobiles per 1000 people in China, which lags behind the global average of approximately120 automobiles per 1000 people. Largely based on these statistics, the consensus is that the Chinese automobile market may have considerable potential for growth in the coming years. (Source: Xinhua Net, Yunnan Channel). We believe that the increasing number of automobile sales will also increase the size of the automotive aftermarket. As the automotive aftermarket increases and vehicle owners use older automobiles, the need for replacement parts and maintenance increases. We believe this trend will create an increasing demand for our products.

Another important trend that has an effect on our financial condition is the increasing demand for automobiles that utilize small engines and automobiles that can be sold at a lower cost. Management believes that a variety of factors contribute to this increasing demand. The first factor is fuel prices. If fuel costs remain at or above current levels, consumers may seek automobiles that utilize less fuel to save money and our products are designed for use in these fuel efficient vehicles. In addition, the Chinese government promulgated regulations in April 2006 that further encourage the consumption of small engine vehicles. These regulations provide for an upward adjustment of the tax rate applicable to larger vehicles in order to encourage consumers to purchase smaller engine vehicles. The top tax rate applicable to vehicles with engine displacements larger than 2 liters was raised to as high as 20% from 8%. Since we manufacture auto parts for vehicles that do not fall within the category of vehicles subject to the increased taxes, we anticipate that we will benefit from this regulation because as more smaller engine vehicles are sold and the aftermarket in these vehicles increases, we believe there will be an increased demand for parts and maintenance for these vehicles.

We believe that other regulatory measures by the Chinese government will also contribute to the growth in demand for our products. The Measures for the Administration of Import of Automobile Components and Parts Featuring Complete Vehicles issued by the National Development and Reform Commission of the PRC Ministry of Finance and the Ministry of Commerce is a regulation that encourages automakers to use parts manufactured by local Chinese auto parts manufacturers. Pursuant to this regulation, which became effective on July 1, 2006, the Chinese government charges automakers a tariff of up to 25% if more than 40% of the components and parts of an automobile are imported. We believe that this regulation will have a positive impact on the sales of our products.

We also believe that sales to foreign markets may represent an opportunity for us and we plan to enhance our sales efforts to foreign markets, which accounted for approximately 5% of our total sales in 2006. In 2003, we began to sell a small quantity of products directly to overseas customers. For the year ended December 31, 2006, we sold our products to consumers in South Korea, US and Turkey which resulted in total sales of approximately $3.8 million.

Uncertainties that Affect our Financial Condition

Our primary challenge is our potential inability to produce enough of our products to satisfy the increased demand for our products. In order to increase our capacity, we will be required to make investments that improve the efficiency and capacity of our properties, plant and equipment. The utilization rates of our alternator and starter production lines as of December 31, 2005 and 2006, were approximately 81% and 140%, respectively, assuming two work shifts per day of eight hours and five days per week. In order to meet the projected demand for our products in 2006, we need to build additional manufacturing lines. We have raised a total of $12 million in the private placement that we closed in June 2006, approximately $6 million of which were used and will be used to build additional production lines. We expect that two more production lines will be operational by June 2007 and shall be able to satisfy the projected demands for our products for the foreseeable future.

Results of Operations

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

All amounts are in thousands of U.S. dollars.

                                                      Year ended December 31,
                                                    2006          2005          2004
      Revenue
      Sales                                    $  72,150     $  48,063     $  42,266
      Cost of sales                              (57,342 )     (35,963 )     (32,795 )

      Gross profit                                14,808        12,100         9,471

      Operating expenses
      Administrative expenses                      1,918         1,155           890
      Research and development expenses              948           824           279
      Selling expenses                             2,138         2,148         1,514
      Unusual charge - Make good provision         7,508             -             -
                                                  12,511         4,128         2,684

      Income from operations                       2,297         7,972         6,787
      Interest income                                 97            29            14
      Other income                                   357           137           148
      Finance costs                               (1,034 )        (839 )        (643 )
      Equity in net income of unconsolidated
       affiliates                                    371             -             -

      Income before income taxes                   2,088         7,298         6,306
      Income taxes                                (1,270 )        (897 )        (718 )
      Minority interests                            (102 )           -             -

      Net income                               $     716     $   6,401     $   5,587



                                          Year Ended December 31,
Components of Revenue In thousands        2006         2005         2004

Total Revenues                        $ 72,150     $ 48,063     $ 42,266

Revenues by Product or Product line
alternator                              45,216       30,118       28,119
starter                               $ 26,934     $ 17,945     $ 14,147

Year Ended December 31, 2006 Compared with Year Ended December 31, 2005

Sales Revenue. Sales revenue increased $24.09 million, or 50.12% to $72.15 million for the year ended December 31, 2006 from $48.06 million for the same period in 2005. This increase was mainly attributable to the increased market demand for our products in the small and medium engine sedan market in China spurred in part by governmental incentives, our expanded production capacity and increased sales to our existing customers.

Cost of Goods Sold. Our cost of goods sold increased $21.38 million to $57.34 million for the year ended December 31, 2006 from $35.96 million during the same period in 2005. As a percentage of sales revenue, the cost of goods sold increased to 79.48% during the year ended December 31, 2006 from 74.82% in the same period of 2005. This increase is attributable to the rise in the cost of raw materials we use in our products. The price of raw materials rose by 8.92% in 2006 which resulted in an increase of 8.24% in the overall cost of goods sold despite our relatively stable labor and manufacturing costs.

Gross Profit. Our gross profit increased $2.71 million to $14.81 million for the year ended December 31, 2006 from $12.10 million for the same period in 2005. Gross profit as a percentage of sales revenue was 20.52% for the year ended December 31, 2006, as compared to 25.18% during the same period in 2005. The rise in the cost of raw materials dampened gross profit by offsetting any benefits, which could have otherwise accrued from a decrease in our labor and manufacturing costs and an increase in product price.

Administrative Expenses. Our administrative expenses increased $0.76 million, or 65.99%, to $1.92 million for the year ended December 31, 2006 from $1.16 million for the same period in 2005. As a percentage of sales revenue, administrative expenses increased to 2.66% for the year ended December 31, 2006 from 2.40% for the same period in 2005. The increases in amount and percentage were attributable to the increase in expenses incurred in the financing activities in the U.S., as well as audit expenses.

Research and Development Expenses. Our research and development expenses increased $0.12 million, or 14.99%, to $0.95 million for the year ended December 31, 2006 from $0.82 million for the same period in 2005. As a percentage of net revenues, research and development expenses decreased to 1.31% for the year ended December 31, 2006 from 1.71% for the same period in 2005. This percentage decrease is primarily a function of our net revenues increasing faster than our research and development expenses.

Selling Expenses. Our selling expenses decreased $10,573 to $2.14 million for the year ended December 31, 2006 from $2.15 million for the same period in 2005. As a percentage of sales revenue, our selling expenses decreased to 2.96% for the year ended December 31, 2006 from 4.47% for the same period in 2005. This percentage decrease was primarily attributable to our utilization of more efficient controls that stabilized our selling expenses and improved the quality of our products resulting in less expenses related to repairs and replacements.

Unusual Charge - Make Good Provision.

In connection with the Company's private placement which closed in June 2006, two of the Company's shareholders Choice Inspire Limited ("CIL") and Empower Century Limited ("ECL") pledged and deposited into escrow 3,300,000 shares of the Company's 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 the Company 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, stockholders' of CIL and ECL transferred their right to receive the 1,650,000 shares in escrow for no consideration to Xiangdong Gao who ultimately received the escrowed shares. Compensation expense should be recognized equal to the amount of the market value of the shares as of the date when the performance goal was met. We achieved our net income threshold for 2006, accordingly, the Company recognized a non-cash expense of $7.5 million in 2006.

Total expenses. Our total expenses increased $8.38 million to $12.51 million for the year ended December 31, 2006 from $4.13 million for the same period in 2005. As a percentage of sales revenue, our total expenses increased to 17.34% for the year ended December 31, 2006 from 8.59% for the same period in 2005. The increases in amount and percentage were primarily attributable to the non-cash expenses of $7.51 million related to the make good arrangement recognized in 2006 as discussed above.

Income Before Income Taxes. Income before income taxes decreased $5.21 million, or 71.39%, to $2.09 million during the year ended December 31, 2006 from $7.30 million during the same period in 2005. Income before income taxes as a percentage of sales revenue decreased to 2.89% during the year ended December 31, 2006 from 15.18% during the same period in 2005. Such decrease in income before income tax was mainly attributable to the non-cash expenses related to the make good arrangement as discussed above.

Provision for income taxes. We are subject to U.S. tax at the rate of 34%. No provision for income taxes in the United States have been made as the taxable income for year ended December 31, 2006 was set-off by a net operating loss carry forward from previous years and we had no taxable income for the years ended December 31, 2005 and 2004.

Wonder Auto and Man Do Auto are incorporated in the BVI and, under current laws of the BVI, not subject to income taxes.

Our subsidiary Halla is subject to Chinese enterprises income tax ("EIT") at a rate of 27% of the assessable profits, consisting of a 24% national tax and a 3% local tax. As approved by the local tax authority in the PRC, Halla was entitled to a two-year exemption from EIT followed by 50% tax exemption for the next three years, commencing from the first cumulative profit-making year in the fiscal financial year of 2001. Accordingly, Halla was subject to a tax rate of 13.5% for 2004, 2005 and 2006. Furthermore, Halla, as a Foreign Investment Enterprise ("FIE"), is engaged in advanced technology industry, Halla was approved to enjoy a further 50% tax exemption for 2007 and 2008.

In addition, as a FIE, Halla was entitled to another two special tax concessions. First, equivalent to 40% of the purchase price of qualifying domestic capital expenditure as defined and approved under the relevant PRC income tax rule can be used to offset against EIT. Second, if there is a 10% increase of the domestic development expenses in the current year over the prior year, amount equivalent to 50% of the current year's expenses can be used to offset against EIT.

Provision for income taxes increased approximately $0.37 million to $1.27 million during the year ended December 31, 2006 from $0.90 million during the same period in 2005. Our effective tax rate for the year ended December 31, 2006, was 13.5%.

Net Income. Net income decreased $5.68 million, or 88.81%, to $0.72 million during the year ended December 31, 2006 from $6.40 million during the same period in 2005. Such decrease was attributable to the non-cash expenses related to the make good arrangement as discussed above.

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

Sales Revenue. Sales revenue increased $5.79 million or 13.72% to $48.06 million in 2005 from $42.27 million in 2004. This increase was mainly attributable to the increased market demand for our products due to growth in the small and medium engine sedan market.

Cost of Goods Sold. Our cost of goods sold increased $3.17 million or 9.66% to $35.96 million in 2005 from $32.79 million in 2004. This increase was mainly attributable to the increase of sales volumes. As a percentage of net revenues, our cost of goods sold in 2005 decreased 2.77% from 74.82% in 2005 to 77.59% in 2004 mainly because the sale of products with higher profit margins constituted a higher percentage of our sales revenue in 2005 as compared with 2004.

Gross Profit. Our gross profit increased $2.63 million or 27.76% to $12.10 million in 2005 from $9.47 million in 2004. Gross profit as a percentage of sales revenue increased 2.77% in 2005 as compared with 2004 for the reason stated above.

Administrative Expenses. Our administrative expenses increased approximately $0.26 million, or 29.75%, to $1.16 million in 2005 from approximately $0.89 million in 2004. As a percentage of sales revenue, administrative expenses increased 0.29% to 2.40% in 2005 from 2.11% in 2004. This dollar increase was primarily attributable to salary increases resulting from the establishment of three new vice president positions and the increase cost for repairing our facilities.

Research and Development Expenses. Our research and development expenses increased $0.55 million, or 195.63%, to $0.82 million for the year ended December 31, 2005 from $0.28 million for the same period in 2004. As a percentage of sales revenue, research and development expenses increased to 1.71% for the year ended December 31, 2005 from 0.07% for the same period in 2004. This percentage increase is primarily the result of the increased investment in research and development.

Selling Expenses. Our selling expenses increased $0.63 million, or 42.25%, to $2.15 million in 2005 from $1.51 million in 2004. As a percentage of sales revenue, our selling expenses in 2005 increased 0.90% as compared with 2004. This dollar increase was primarily attributable to our increased marketing efforts and the increase of the sales volumes. We believe the increase of selling expenses is generally in line with the increase of sales revenue.

Total Expenses. Our total expenses increased $1.44 million, or 53.82%, to $4.13 million in 2005 from $2.68 million in 2004. As a percentage of sales revenue, our total expenses increased to 8.59% in 2005 from 6.35% in 2004. This dollar increase was primarily attributable to the factors described above.

Income Before Income Taxes. Income before income taxes increased $0.99 million, or 15.73%, to $7.29 million in 2005 from $6.31 million in 2004. Income before income taxes as a percentage of sales revenue increased 0.26% in 2005 as compared to 2004. This increase was primarily a result of increase of the sales revenue and gross margin.

Income Taxes. We incurred income taxes of $897,000 in 2005. This is an increase of 24.93% from the taxes we incurred in 2004, which amounted to $718,000. We paid more taxes in 2005 mostly as a result of higher income in 2005 compared to 2004.

Net Income. Net income increased $813,000, or 14.55%, to $6.40 million in 2005 from $5.59 million in 2004, because of the factors described above.

Allowance for doubtful debts

Our trade receivables totaled $24.70 million as of December 31, 2006, an increase of $6.23 million or 33.73% from $18.47 million in the year ended December 31, 2005. Our allowance of doubtful accounts totaled $32,150 for year ended December 31, 2006, a 17.03% decrease from the $38,745 for the year ended December 31, 2005.

The seemingly disproportionate increase of our trade receivable as compared to the decrease of our allowance of doubtful accounts was mainly due to the increase in our sales revenue and our policy to generally account a trade receivable as a doubtful account only if it remains uncollected for more than one year. Our allowance for doubtful debts accounts for only an insignificant portion of the receivable balance in spite of the increasing trade receivable balance throughout the reporting periods because almost all the outstanding debts were aged less than one year. Many of our customers have long business relationship with us and with good settlement history. In the absence of significant bad debt experience, we consider the existing provisioning policy as adequate.