ITEM 3.

KEY INFORMATION

 

A.           Selected financial data

 

The selected financial information set forth below has been derived from our audited financial statements (i) for the period from October 16, 2007 (date of inception) to December 31, 2007 and (ii) for the year ended December 31, 2008. The information is only a summary and should be read in conjunction with our audited financial statements and notes thereto contained elsewhere herein. The financial results should not be construed as indicative of financial results for subsequent periods. See “Item 4. Information on the Company” and “Item 5. Operating and Financial Review and Prospects.”

 

 

 

 

B.           Capitalization and Indebtedness

 

Not required.

 

C.           Reasons for the Offer and Use of Proceeds

 

Not required.

 

D.           Risk Factors

 

 

If outstanding warrants are exercised, the underlying ordinary shares will be eligible for future resale in the public market. “Market overhang” from the warrants results in dilution and could reduce the market price of the ordinary shares .

 

Outstanding warrants and unit purchase options to purchase an aggregate of 8,962,500 ordinary shares issued in connection with AutoChina’s initial public offering and the private placement that took place immediately prior to the initial public offering became exercisable after AutoChina’s acquisition of ACG on April 9, 2009. If they are exercised, a substantial number of additional shares of AutoChina’s ordinary shares will be eligible for resale in the public market, which may reduce the market price.

 

Because AutoChina does not intend to pay dividends on its ordinary shares, shareholders will benefit from an investment in AutoChina’s ordinary shares only if it appreciates in value .

 

AutoChina has never declared or paid any cash dividends on its ordinary shares. AutoChina currently intends to retain all future earnings, if any, for use in the operations and expansion of the business. As a result, AutoChina does not anticipate paying cash dividends in the foreseeable future. Any future determination as to the declaration and payment of cash dividends will be at the discretion of AutoChina’s Board of Directors and will depend on factors AutoChina’s Board of Directors deems relevant, including among others, AutoChina’s results of operations, financial condition and cash requirements, business prospects, and the terms of AutoChina’s credit facilities and other financing arrangements. Accordingly, realization of a gain on shareholders’ investments will depend on the appreciation of the price of AutoChina’s ordinary shares. There is no guarantee that AutoChina’s ordinary shares will appreciate in value.

 

AutoChina’s securities are quoted on the OTC Bulletin Board, which may limit the liquidity and price of its securities more than if the securities were quoted or listed on the Nasdaq market .

 

AutoChina’s securities are quoted on the OTC Bulletin Board, a NASD-sponsored and operated inter-dealer automated quotation system. Quotation of AutoChina’s securities on the OTC Bulletin Board will limit the liquidity and price of its securities more than if the securities were quoted or listed on Nasdaq. AutoChina is in the process of applying for listing on Nasdaq, however there can be no assurance that AutoChina will be approved for listing on Nasdaq or that such listing, if approved, will be maintained.

 

AutoChina may choose to redeem its outstanding warrants at a time that is disadvantageous to the warrant holders .

 

Subject to there being a current prospectus under the Securities Act of 1933, AutoChina may redeem all of its outstanding warrants at any time at a price of $.01 per warrant, upon a minimum of 30 days prior written notice of redemption if, and only if, the last sale price of AutoChina’s ordinary shares equals or exceeds $11.50 per share for any 20 trading days within a 30 trading day period ending three business days before AutoChina sends the notice of redemption. Calling all of AutoChina’s outstanding warrants for redemption could force the warrant holders:

 

·

to exercise the warrants and pay the exercise price for such warrants at a time when it may be disadvantageous for the holders to do so;

 

·

to sell the warrants at the then current market price when they might otherwise wish to hold the warrants; or

 

·

to accept the nominal redemption price which, at the time the warrants are called for redemption, is likely to be substantially less than the market value of the warrants.

 

AutoChina’s warrant holders may not be able to exercise their warrants, which may create liability for AutoChina .

 

Holders of the warrants AutoChina issued in its initial public offering and private placement will be able to receive shares upon exercise of the warrants only if (i) a current registration statement under the Securities Act of 1933 relating to the shares of its ordinary shares underlying the warrants is then effective and (ii) such shares are qualified for sale or exempt from qualification under the applicable securities laws of the states in which the various holders of warrants reside. Although AutoChina has agreed to use its best efforts to maintain a current registration statement covering the shares underlying the warrants to the extent required by federal securities laws, and AutoChina intends to comply with such agreement, AutoChina cannot assure you that it will be able to do so. In addition, some states may not permit AutoChina to register the shares issuable upon exercise of its warrants for sale. The value of the warrants will be greatly reduced if a registration statement covering the shares issuable upon the exercise of the warrants is not kept current or if the securities are not qualified, or exempt from qualification, in the states in which the holders of warrants reside. Holders of warrants who reside in jurisdictions in which the shares underlying the warrants are not qualified and in which there is no exemption will be unable to exercise their warrants and would either have to sell their warrants in the open market or allow them to expire unexercised. If and when the warrants become redeemable by AutoChina, AutoChina may exercise its redemption right even if AutoChina is unable to qualify the underlying securities for sale under all applicable state securities laws. Since AutoChina’s obligations in this regard are subject to a “best efforts” standard, it is possible that, even if AutoChina is able to successfully assert a defense to a claim by warrant holders due to the impossibility of registration, a court may impose monetary damages on AutoChina to compensate warrant holders due to the change in circumstances that led to AutoChina being unable to fulfill its obligations.

 

Risks Related to Operations in China

 

Risks related to ACG’s Business

 

ACG depends on its ability to enter into and renew leases for most of its properties. In addition, certain lands or buildings where ACG operates its business in China do not have proper title or the head lessor’s consent for a sub-lease and ACG may fail to, or need to incur further expenses or time to, secure legal right to use certain lands or buildings which it leases in China .

 

ACG requires substantial storage facilities to store its inventory for motor vehicles (i.e. cars and commercial vehicles). ACG rents or leases most of its storage facilities and dealership lots from third parties under tenancy or lease agreements. Depending on market conditions for real estate, landlords or lessors may increase rentals to a rate not acceptable by ACG and which may lead to ACG not renewing the tenancies or leases upon their expirations. If these tenancies or leases are terminated and if there are no ready alternative locations of storage facilities and dealership lots for ACG to store its inventory and/or sell motor vehicles or if ACG is forced to accept the increased rentals or are not able to relocate to a suitable place, ACG’s business, results of operations and financial conditions could be materially and adversely affected.

 

Approximately 117 of 129 parcels of land and/or buildings in China leased and occupied by ACG for its business operations have certain title defects or lack documentation supporting claim to title and the use of the leased premises may be challenged and ACG may need to relocate its existing business operations.

 

Furthermore, if such plots of land leased to ACG are collectively-owned land and ACG operates its business on them for non-agricultural uses without special permission, subject to the Land Administration Law of the People’s Republic of China, the administrative departments at or above county level may order the termination of such leases.

 

In any of the above events, ACG may be required to terminate the existing leases and relocate its existing business operations. There can be no assurance that ACG can replace the existing leases with other comparative alternative premises without any material adverse effect on its operations.

 

The automotive and truck retailing industry is sensitive to changing economic conditions and various other factors. ACG’s business and results of operations are substantially dependent on new vehicle sales levels in China and in its particular geographic markets and the level of gross profit margins that it can achieve on its sales of new vehicles, all of which are very difficult to predict .

 

ACG believes that many factors affect sales of new vehicles and automotive retailers’ gross profit margins in China and in its particular geographic markets, including the economy, inflation, recession or economic slowdown, consumer confidence, housing markets, fuel prices, credit availability, the level of manufacturers’ production capacity, manufacturer incentives (and consumers’ reaction to such offers), intense industry competition, interest rates, the level of personal discretionary spending, product quality, affordability and innovation, employment/unemployment rates, the number of consumers whose vehicle leases are expiring, and the length of consumer loans on existing vehicles. Changes in interest rates could significantly impact industry new vehicle sales and vehicle affordability, due to the direct relationship between interest rates and monthly loan payments, a critical factor for many vehicle buyers, and the impact interest rates can have on customers’ borrowing capacity and disposable income. If there is a decline in the availability of credit for car purchasers provided by third-party financing companies or if ACG has insufficient resources to purchase adequate numbers of commercial vehicles and to finance their installment sales to customers, the ability of certain customers to purchase vehicles could be limited, resulting in a decline in sales or profits. In addition, the levels of commercial vehicle sales is significantly dependent on the level of shipping of basic materials, such as coal and grain.

 

The overall demand for vehicles increased significantly in China from 2001 to 2008. However, recently, certain adverse financial developments have impacted the global financial markets. Theses developments include a general slowing of economic growth both in China and globally, substantial volatility in equity securities markets, and volatility and tightening of liquidity in credit markets. While ACG conducts market research on the demand for automobiles in China, it is difficult for industry participants, including ACG, to predict how long these conditions will exist and how they will affect the automobile industry and its business. As a result, these developments could continue to present risks for an extended period of time for ACG, including a potential slowdown in its sales to customers, increase in interest expense on its bank borrowings, or reduction of the amount of banking facilities currently available to it.

 

If this economic downturn continues, ACG’s business, financial condition and results of operations would likely be adversely affected, its cash position may further erode and it may be required to seek new financing, which may not be obtainable on acceptable terms or at all. ACG may also be required to reduce its capital expenditures, which in turn could hinder its ability to implement its business plan and to improve its productivity.

 

ACG is dependent upon the success and continued financial viability of the vehicle manufacturers and distributors with which it holds franchises .

 

The success of ACG’s stores is dependent on vehicle manufacturers in several key respects. First, ACG relies exclusively on the various vehicle manufacturers for its new vehicle inventory. ACG’s ability to sell new vehicles is dependent on a vehicle manufacturer’s ability to produce and allocate to its stores an attractive, high quality, and desirable product mix at the right time in order to satisfy customer demand. Second, manufacturers generally support their franchisees by providing direct financial assistance in various areas, including, among others, inventory financing assistance and advertising assistance. Third, manufacturers provide product warranties and, in some cases, service contracts, to customers. ACG’s stores perform warranty and service contract work for vehicles under manufacturer product warranties and service contracts, and directly bill the manufacturer as opposed to invoicing the store customer. At any particular time, it has significant receivables from manufacturers for warranty and service work performed for customers. In addition, ACG relies on manufacturers to varying extents for original equipment manufactured replacement parts, training, product brochures and point of sale materials, and other items for its stores.

 

The core brands of vehicles that ACG sells are manufactured by BMW, Audi, Hyundai, Ford, General Motors (Chevrolet, Buick and Cadillac), ROEWE, Mazda, Ruida Kia, FAW Car, Qingling, Peugeot and FAW Toyota. In particular, Audi represented over 24% of ACG’s new vehicle revenue in 2008. ACG is subject to a concentration of risk in the event of financial distress, including potential bankruptcy, of a major vehicle manufacturer. In the event of such a bankruptcy, among other things, (i) the manufacturer could attempt to terminate all or certain of its franchises, and ACG may not receive adequate compensation for them, (ii) ACG may not be able to collect some or all of its significant receivables that are due from such manufacturers and it may be subject to preference claims relating to payments made by manufacturers prior to bankruptcy, (iii) ACG may not be able to obtain financing for its new vehicle inventory, or arrange financing for its customers for their vehicle purchases and leases, with the manufacturer’s captive finance subsidiary, which may cause ACG to finance its new vehicle inventory, and arrange financing for its customers, with alternate finance sources on less favorable terms, and (iv) consumer demand for their products could be reduced. These events may result in receivables due from such manufacturers and adversely impact its results of operations. In addition, vehicle manufacturers may be adversely impacted by economic downturns or recessions, significant declines in the sales of their new vehicles, increases in interest rates, declines in their credit ratings, labor strikes or similar disruptions (including within their major suppliers), supply shortages or rising raw material costs, rising employee benefit costs, adverse publicity that may reduce consumer demand for their products (including due to bankruptcy), product defects, vehicle recall campaigns, litigation, poor product mix or unappealing vehicle design, governmental laws and regulations, or other adverse events.

 

ACG’s new vehicle sales are impacted by the consumer incentive and marketing programs of vehicle manufacturers .

 

Most vehicle manufacturers from time to time have established various incentive and marketing programs designed to spur consumer demand for their vehicles. In addition, certain manufacturers offer extended product warranties or free service programs to consumers. From time to time, manufacturers modify and discontinue these dealer assistance and consumer incentive and marketing programs, which could significantly reduce ACG’s new vehicle and aftermarket product sales, consolidated results of operations, and cash flows.

 

ACG is subject to restrictions imposed by, and significant influence from, vehicle manufacturers that may adversely impact its business, financial condition, results of operations, cash flows, and prospects, including its ability to acquire additional stores .

 

Vehicle manufacturers and distributors with whom ACG holds franchises have significant influence over the operations of ACG’s stores. The terms and conditions of its framework, franchise, and related agreements and the manufacturers’ interests and objectives may, in certain circumstances, conflict with its interests and objectives.

 

ACG’s framework, franchise, and related agreements also grant the manufacturer the right to terminate or compel ACG to sell its franchise for a variety of reasons (including uncured performance deficiencies, any unapproved change of ownership or management, or any unapproved transfer of franchise rights or impairment of financial standing or failure to meet capital requirements), subject to applicable franchise laws. From time to time, certain major manufacturers assert sales and customer satisfaction performance deficiencies under the terms of such framework and franchise agreements. Additionally, ACG’s framework agreements contain restrictions regarding a change in control, which may be outside of its control. While ACG believes that it will be able to renew all of its franchise agreements, it cannot guarantee that all of its franchise agreements will be renewed or that the terms of the renewals will be favorable to it. ACG cannot assure you that its stores will be able to comply with manufacturers’ sales, customer satisfaction performance, and other requirements in the future, which may affect its ability to acquire new stores or renew its franchise agreements, or subject it to other adverse actions, including termination or compelled sale of a franchise, any of which would significantly impact its ability to sell affected vehicles. Furthermore, ACG relies on the protection of state franchise laws in the states in which it operates and if those laws are repealed or weakened, its framework and related agreements may become more susceptible to termination, non-renewal, or renegotiation.

 

ACG’s operations, including, without limitation, its sales of finance and insurance, are subject to extensive governmental laws and regulations .

 

The automotive retailing industry, including ACG’s facilities and operations, is subject to a wide range of central and local laws and regulations, such as those relating to motor vehicle sales, retail installment sales, leasing, sales of finance and insurance, licensing, consumer protection, consumer privacy, escheatment, environmental, vehicle emissions and fuel economy, health and safety, wage-hour and other employment practices. Specifically with respect to motor vehicle sales, retail installment sales, leasing, and the sale of finance and insurance at its stores, ACG is subject to various laws and regulations, the violation of which could subject it to lawsuits or governmental investigations and adverse publicity, in addition to administrative, civil, or criminal sanctions. The violation of other laws and regulations to which ACG are subject also can result in administrative, civil, or criminal sanctions against it, which may include a cease and desist order against the subject operations or even revocation or suspension of its license to operate the subject business, as well as significant fines and penalties.

 

ACG may be subject to broad liabilities arising from environmental protection laws .

 

ACG may be subject to broad liabilities arising out of contamination at its currently and formerly owned or operated facilities, at locations to which hazardous substances were transported from such facilities, and at such locations related to entities formerly affiliated with it. Although for some such liabilities ACG believes it is entitled to indemnification from other entities, ACG cannot assure you that such entities will view their obligations as it does, or will be able to satisfy them.

 

ACG’s growth is dependent upon the availability of suitable sites .

 

ACG leases a majority of the properties where its stores are located. If and when ACG decides to open new stores, the inability to acquire suitable real estate, either through lease or purchase, at favorable terms could limit the expansion of its lot base and could limit its expansion strategy.

 

ACG’s businesses are subject to seasonal fluctuations.

 

The third quarter has historically been the slowest period for car and truck sales. Conversely, the fourth quarter has historically been the busiest time for car and truck sales. Therefore, ACG generally realizes a higher proportion of its revenue and operating profit during the fourth quarter. The demand for repair, maintenance and parts is not highly seasonal. If conditions arise that impair vehicle sales during the fourth quarter, revenues for that year will be significantly reduced.

 

Any security breach involving the misappropriation, loss or other unauthorized disclosure of confidential information, whether by ACG or by third-party service providers, could damage its reputation, expose it to the risks of litigation and liability, disrupt its business or otherwise harm its results of operations .

 

In the normal course of business, ACG collects, processes and retains sensitive and confidential customer information. Despite the security measures it has in place, its facilities and systems, and those of third-party service providers, could be vulnerable to security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming or human errors or other similar events. Any security breach involving the misappropriation, loss or other unauthorized disclosure of confidential information, whether by ACG or by third-party service providers, could damage its reputation, expose it to the risks of litigation and liability, disrupt its business or otherwise harm its results of operations.

 

Automotive manufacturers exercise significant control over ACG’s operations and ACG depends on them in order to operate its business .

 

Manufacturers exercise a great degree of control over ACG’s operations. For example, manufacturers can require ACG to meet specified standards of appearance, require it to meet specified financial criteria such as maintenance of minimum net working capital and, in some cases, minimum net worth, impose minimum customer service and satisfaction standards, set standards regarding the maintenance of inventories of vehicles and parts and govern the extent to which its businesses can utilize the manufacturers’ names and trademarks. In many cases the manufacturer must consent to the replacement of the principal.

 

ACG’s manufacturers generally require that the premises meet defined image and facility standards and may direct it to implement costly capital improvements as a condition for renewing certain franchise agreements. All of these requirements could impose significant capital expenditures on ACG in the future .

 

Pursuant to ACG’s franchise agreements, its operations are required to maintain a certain minimum working capital, as determined by the manufacturers. This requirement could force ACG to utilize available capital to maintain manufacturer-required working capital levels thereby limiting its ability to apply profits generated from one subsidiary for use in other subsidiaries or, in some cases, at the parent company. These factors, either alone or in combination, could cause ACG to divert its financial resources to capital projects from uses that management believes may be of higher long-term value to it.

 

ACG is subject to a number of risks associated with importing vehicles .

 

ACG’s business involves the sale of new and used vehicles, vehicle parts or vehicles composed of parts that are manufactured outside China. As a result, ACG’s operations are subject to customary risks associated with imported merchandise, including fluctuations in the value of currencies, import duties, exchange controls, differing tax structures, trade restrictions, transportation costs, work stoppages and general political and economic conditions in foreign countries.

 

The countries from which ACG’s vehicles and/or parts are imported may, from time to time, impose new quotas, duties, tariffs or other restrictions, or adjust presently prevailing quotas, duties or tariffs on imported merchandise. Any of those impositions or adjustments could affect ACG’s operations and its ability to purchase imported vehicles and parts at reasonable prices.

 

Substantial competition in automotive sales and services may adversely affect ACG’s profitability due to its need to lower prices to sustain sales and profitability .

 

The automotive retail industry in China is highly competitive. Depending on the geographic market, ACG competes with:

 

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franchised automotive dealerships in its markets that sell similar makes of new and used vehicles that it offers, occasionally at lower prices than it does;

 

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other national or regional affiliated groups of franchised dealerships;

 

·

private market buyers and sellers of used vehicles; and

 

·

independent service and repair shops.

 

ACG may face significant competition as it strives to gain market share. Some of ACG’s competitors may have greater financial, marketing and personnel resources and lower overhead and sales costs than it has. ACG typically relies on advertising, merchandising, sales expertise, service reputation and dealership location in order to sell new vehicles. Although its franchise agreements with manufacturers grant ACG the right to sell their products within certain geographic areas, its revenues and profitability may be materially and adversely affected if competing dealerships expand their market share or are awarded additional franchises by manufacturers that supply its dealerships. Additionally, market practice in the PRC allows multiple non-exclusive dealerships distributing the same brand of motor vehicles in the same city or region.

 

ACG also competes with other independent dealers, and to a lesser degree with (i) the used vehicle retail operations of franchised automotive dealerships, (ii) independent used vehicle dealers, and (iii) individuals who sell used vehicles in private transactions. ACG competes for both the purchase and resale of used vehicles. ACG’s competitors may sell the same or similar makes of vehicles that it offers in the same or similar markets at competitive prices. Increased competition in the market, including new entrants to the market, could result in increased wholesale costs for used vehicles and lower-than expected vehicle sales and margins. Further, if any of ACG’s competitors seek to gain or retain market share by reducing prices for used vehicles, it would likely reduce its prices in order to remain competitive, which may result in a decrease in its sales and profitability and require a change in its operating strategies.

 

In addition to competition for vehicle sales, ACG’s dealerships compete with independent garages for non-warranty repair and routine maintenance business. ACG’s dealerships compete with other automotive dealers, service stores and automobile parts retailers in their parts operations. ACG believes that the principal competitive factors in service and parts sales are the quality of customer service, the use of factory-approved replacement parts, familiarity with a manufacturer’s brands and models, convenience, the competence of technicians, location, and price.

 

Claims that the software products and information systems that ACG relies on are infringing on the intellectual property rights of others could increase its expenses or inhibit it from offering certain services, which could adversely affect its results of operations .

 

A number of entities, including some of ACG’s competitors, have sought, or may in the future obtain, patents and other intellectual property rights that cover or affect software products and other components of information systems that ACG relies on to operate its business.

 

Litigation may be necessary to determine the validity and scope of third-party rights or to defend against claims of infringement. If a court determines that one or more of the software products or other components of information systems ACG uses infringe on intellectual property owned by others or ACG agrees to settle such a dispute, it may be liable for money damages. In addition, ACG may be required to cease using those products and components unless it obtains licenses from the owners of the intellectual property, redesign those products and components in such a way as to avoid infringement or cease altogether the use of those products and components. Each of these alternatives could increase ACG’s expenses materially or impact the marketability of its services. Any litigation, regardless of the outcome, could result in substantial costs and diversion of resources and could have a material adverse effect on ACG’s business. In addition, a third-party intellectual property owner might not allow ACG to use its intellectual property at any price, or on terms acceptable to it, which could compromise ACG’s competitive position.

 

ACG relies on an adequate supply of skilled field personnel .

 

In order to continue to provide high quality repair and maintenance services, ACG requires an adequate supply of skilled field managers and technicians. Trained and experienced automotive field personnel are in high demand, and may be in short supply in some areas. ACG cannot assure that it will be able to attract, motivate and maintain an adequate skilled workforce necessary to operate its existing and future stores efficiently, or that labor expenses will not increase as a result of a shortage in the supply of skilled field personnel, thereby adversely impacting its financial performance. While the automotive repair industry generally operates with high field employee turnover, any material increases in employee turnover rates in ACG’s stores or any widespread employee dissatisfaction could also have a material adverse effect on its business, financial condition and results of operations.

 

 

Store closings result in unexpected costs that could adversely affect ACG’s results of operations.

 

From time to time, in the ordinary course of ACG’s business, it closes certain stores, generally based on considerations of store profitability, competition, strategic factors and other considerations. Closing a store could subject ACG to costs including the write-down of leasehold improvements, equipment, furniture and fixtures. In addition, ACG could remain liable for future lease obligations.

 

ACG’s business is affected by advances in automotive technology .

 

The demand for ACG’s parts and repair and maintenance services could be adversely affected by continuing developments in automotive technology. Automotive manufacturers are producing cars that last longer and require service and maintenance at less frequent intervals in certain cases. Quality improvement of manufacturers’ original equipment parts has in the past reduced, and may in the future reduce, demand for ACG’s products and services, adversely affecting its sales. For example, manufacturers’ use of stainless steel exhaust components has significantly increased the life of those parts, thereby decreasing the demand for exhaust repairs and replacements. Longer and more comprehensive warranty or service programs offered by automobile manufacturers and other third parties also could adversely affect the demand for ACG’s non-warranty repair and maintenance services. In addition, advances in automotive technology continue to require ACG to incur additional costs to update its diagnostic capabilities and technical training programs.

 

Significant defaults by financing customers could significantly reduce ACG’s revenues .

 

ACG’s commercial vehicle sales and leasing business generates income from financing customers. Although ACG does extensive pre-sale credit research on its customers and has a security interest in its leased vehicles, if customers fail to make payments when due ACG may not be able to fully recover the outstanding fee and it could significantly reduce ACG’s revenues.

 

A loss of distribution rights granted by ACG's suppliers, or any material disputes between ACG and its suppliers may adversely affect the results of operations and financial condition of ACG.

 

ACG relies on dealership rights granted by motor vehicle manufacturers for distribution of their products. All of these dealership or supply agreements are not on an exclusive basis and have an expiration date.

 

 

These dealership contracts are generally for one to three year terms and are subject to termination by ACG or the principal with prior written notice in accordance with the terms of such contracts. Complete or partial termination of these distribution rights agreements could materially and adversely affect ACG's business operations and financial performance. For example, such termination could result from disagreements regarding differences between sales targets and actual achievements, disputes regarding advertising and promotion expenses or changes in business strategy. There can be no assurance that any particular supplier will not terminate these distribution rights in the future. ACG may also be unable to obtain or renew these dealership supply agreements on commercially acceptable terms and may not be able to continue to distribute these products after the expiration date.

 

In addition, there may be a material dispute between ACG and a supplier in connection with the performance of a party's obligations or the scope of a party's responsibilities under the relevant dealership or supply agreements with its motor vehicle principals or consumer product supplier.

 

If any of the above happens, the business and operations of ACG may suffer and the dealership agreements may even be terminated by mutual consent of the parties, unilaterally or as a result of a material breach by one of them.

 

The loss of any key members of the management team may impair ACG’s ability to identify and secure new contracts with customers or otherwise manage its business effectively .

 

ACG’s success depends, in part, on the continued contributions of its senior management. In particular, Mr. Yong Hui Li has been appointed by the Board of Directors to oversee and supervise the strategic direction and overall performance of ACG.

 

ACG relies on its senior management to manage its business successfully. In addition, the relationships and reputation that members of ACG’s management team have established and maintained with its customers contribute to ACG’s ability to maintain good customer relations, which is important to the direct selling strategy that ACG adopts. Employment contracts entered into between ACG and its senior management cannot prevent its senior management from terminating their employment, and the death, disability or resignation of Mr. Yong Hui Li or any other member of ACG’s senior management team may impair ACG’s ability to maintain business growth and identify and develop new business opportunities or otherwise to manage its business effectively.

 

ACG relies on its information technology, billing and credit control systems, and any problems with these systems could interrupt ACG’s operations .

 

ACG’s business cannot be managed effectively without its integrated information technology system. Accordingly, ACG runs various “real time” integrated information technology management systems for its motor vehicle sales and financing business. These systems include ACG Information Management System. ACG’s operations are heavily dependent on its integrated information technology system to enable it to manage its sales and services effectively.

 

In addition, sophisticated billing and credit control systems are critical to ACG’s ability to increase revenue streams, avoid revenue loss and potential credit problems, and bill customers in a proper and timely manner. If adequate billing and credit control systems and programs are unavailable, or if upgrades are delayed or not introduced in a timely manner, or if ACG is unable to integrate such systems and software programs into its billing and credit systems, ACG may experience delayed billing which may negatively affect ACG’s cash flow and the results of its operations.

 

 

In case of a failure of ACG’s data storage system, ACG may lose critical operational or billing data or important email correspondence with its customers and suppliers. Any such data stored in the core data center may be lost if there is a lapse or failure of the disaster recovery system in backing up these data, or if the periodic offline backup is insufficient in frequency or scope. An interruption or breakdown in ACG’s integrated information technology system may have a material adverse effect on its business, financial conditions and results of operations due to disruption of its operations.

 

Natural disasters and adverse weather events can disrupt ACG’s business .

 

ACG’s stores are concentrated in provinces and regions in China, including primarily Hebei, Shanxi, Shandong, Henan, Inner Mongolia Autonomous Region and Tianjin, in which actual or threatened natural disasters and severe weather events (such as severe snowstorms, earthquakes, fires and landslides) may disrupt store operations, which may adversely impact its business, results of operations, financial condition, and cash flows. In addition to business interruption, the automotive retailing business is subject to substantial risk of property loss due to the significant concentration of property values at store locations. Although ACG has, subject to certain deductibles, limitations, and exclusions, substantial insurance, it cannot assure you that it will not be exposed to uninsured or underinsured losses that could have a material adverse effect on its business, financial condition, results of operations, or cash flows. Additionally, ACG generally relies on third-party transportation operators and distributors for the delivery of vehicles from the manufacturer to ACG’s stores. Delivery may be disrupted for various reasons, many of which are beyond ACG’s control, including natural disasters, weather conditions or social unrest and strikes, which could lead to delayed or lost deliveries. For example, recently the southern regions of China experienced the most severe winter weather in nearly 50 years, causing, among other things, severe disruptions to all forms of transportation for several weeks in late January and early February 2008. This natural disaster also impacted the delivery of vehicles to stores. In addition, transportation conditions are often generally difficult in some of the regions where ACG sells automobiles and commercial vehicles. ACG currently does not have business interruption insurance to offset these potential losses, delays and risks, so a material interruption of its business operations could severely damage its business.

 

ACG’s ongoing expansion into commercial vehicle sales and leasing may be costly, time-consuming and difficult. If ACG does not successfully expand this business, its results of operations and prospects would not be as positive as anticipated.

 

ACG’s future success is dependent upon its ability to successfully expand its commercial vehicle sales and leasing business which it commenced in April 2008. ACG opened 103 commercial vehicle financing centers in 2008 and 2 additional commercial vehicle financing centers in January 2009, and it plans to open an additional 45 centers in China in 2009. ACG has limited experience with this business and may not be able to expand its sales in its existing or new markets due to a variety of factors, including the risk that customers in some areas may be unfamiliar with its brand or the commercial vehicle sales and leasing business model. Furthermore, ACG may fail to anticipate and address competitive conditions in the commercial vehicle sales and lease market. These competitive conditions may make it difficult or impossible for ACG to effectively expand this business. If ACG’s expansion efforts in existing and new markets are unsuccessful, its results of operations and prospects would be materially and adversely affected.

 

 

If required financing for ACG’s commercial leasing business were not available or not available on acceptable terms, the commercial leasing business might not be able to expand as quickly as expected, reducing ACG’s operating results .

 

ACG’s ability to expand its commercial truck financing business is dependent on its ability to purchase commercial trucks for resale. Presently, such financing is arranged through financing arrangements with Beiguo Commercial Building Limited (“Beiguo”). The terms provided by Beiguo are on terms which are more favorable than ACG has historically been able to obtain from PRC commercial banks. However there can be no assurance that ACG can continue to receive such financing from Beiguo on such commercially favorable terms, or at all.

 

If financing from Beiguo were not available, ACG would fund its commercial vehicle purchases from its own cash reserves or financing provided by third-party financial institutions. There can be no assurance that ACG will have sufficient resources or be able to obtain adequate third party financing on as commercially favorable terms as that provided by Beiguo or at all. If suitable financing were not available, ACG would not be able to expand its commercial leasing business in as quickly as expected.

 

ACG may not succeed in identifying suitable acquisition targets, which could limit its ability to expand its operations and service offerings and enhance its competitiveness .

 

ACG has pursued and may in the future pursue strategic acquisition opportunities to increase its scale and geographic presence and expand the number of its product offerings. However, ACG may not be able to identify suitable acquisition or investment candidates, or, even if it does identify suitable candidates, it may not be able to complete those transactions on terms commercially favorable to it or at all, which could limit its competitiveness and its growth prospects.

 

ACG may face unforeseen liabilities and have difficulty integrating the operations of companies it acquires in the future .

 

If ACG acquires other companies in the future, it could face the following risks:

 

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difficulty in assimilating the target company’s personnel, operations, products, services and technology into its operations;

 

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the presence of unforeseen or unrecorded liabilities;

 

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entry into unfamiliar markets;

 

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inability to generate sufficient revenues to offset acquisition costs;

 

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tax and accounting issues;

 

 

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incurrence of significantly higher capital expenditures and operating expenses;

 

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disrupting its ongoing business;

 

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impairing relationships with employees, manufacturers and customers;

 

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incorrectly valuing acquired entities; and

 

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failing to obtain or retain key personnel at new or acquired dealerships.

 

In addition, employees from acquired companies may decide not to work with ACG or to leave shortly after joining it. These difficulties could disrupt ACG’s ongoing business, distract its management and current employees and increase its expenses, including write-offs or impairment charges. Acquired companies also may not perform to ACG’s expectations for various reasons, including the loss of key personnel, key distributors, key suppliers or key customers, and its strategic focus may change. As a result, ACG may not realize the benefits it anticipated from the acquisition. If ACG fails to integrate acquired businesses or realize the expected benefits, it may lose the return on the investment in these acquisitions or incur additional transaction costs and its operations may be negatively impacted as a result. Further, any acquisition or investment that ACG attempts, whether or not completed, or any media reports or rumors with respect to any such transactions, may adversely affect its competitiveness, its growth prospects, and the value of its ordinary shares.

 

ACG’s business is capital intensive and ACG’s growth strategy may require additional capital that may not be available on favorable terms or at all .

 

ACG has, in the past, entered into loan agreements in order to raise additional capital. ACG’s business requires significant capital and although it believes that its current cash, cash flow from operations and the cash of AutoChina will be sufficient to meet its present and reasonably anticipated cash needs, it may, in the future, require additional cash resources due to changed business conditions, implementation of its strategy to expand its store network or other investments or acquisitions it may decide to pursue. If ACG’s own financial resources are insufficient to satisfy its capital requirements, it may seek to sell additional equity or debt securities or obtain additional credit facilities following the acquisition. The sale of additional equity securities could result in dilution to ACG’s shareholders. The incurrence of indebtedness would result in increased debt service obligations and could require ACG to agree to operating and financial covenants that would restrict its operations. Financing may not be available in amounts or on terms acceptable to ACG, if at all. Any failure by ACG to raise additional funds on terms favorable to it, or at all, could limit its ability to expand its business operations and could harm its overall business prospects.

 

Due to ACG’s rapid growth in recent years, its past results may not be indicative of its future performance and evaluating its business and prospects may be difficult .

 

AutoChina’s business has grown and evolved rapidly in recent years as demonstrated by its growth in net income for the nine months ended September 30, 2008 to $6.1 million, from $2.2 million for the prior period in 2007. AutoChina may not be able to achieve similar growth in future periods, and its historical operating results may not provide a meaningful basis for evaluating its business, financial performance and prospects. Therefore, you should not rely on AutoChina’s past results or its historical rate of growth as an indication of its future performance.

 

 

ACG requires various approvals, licenses, authorizations, certificates, filings and permits to operate its business and the loss of or failure to obtain or renew any or all of these approvals, licenses, authorizations, certificates, filings and permits could limit its ability to conduct its business .

 

In accordance with the laws and regulations of the PRC, ACG is required to maintain various approvals, licenses, authorizations, certificates, filings and permits in order to operate ACG’s business. ACG’s business could be affected by the promulgation of new laws and regulations introducing new requirements (such as new approvals, licenses, authorizations, certificates filings and/or permits). In addition, companies incorporated in the PRC will be required to pass an annual inspection conducted by the respective Administration of Industry and Commerce in order to retain valid business approvals, license, authorizations, certificates, filings and permits for their operations. As the PRC’s legislative system evolves, it is also not uncommon for new laws and regulations to be promulgated and put into effect on short notice. Failure to comply with these laws and regulations, pass these inspections, or the loss of or failure to renew its licenses, permits and certificates or any change in the government policies, could lead to temporary or permanent suspension of some of ACG’s business operations or the imposition of penalties on ACG, which could limit its ability to conduct its business.

 

Failure by ACG’s suppliers to introduce new models that are accepted by the market may cause it to lose market share and fail to gain the anticipated economic benefits of such new products .

 

ACG’s future success will be largely dependent on the ability of ACG’s motor vehicles suppliers to launch new models to suit changing customers’ needs in China and to continually enhance the performance and reliability of their existing automobile models. If the vehicles manufactured by ACG’s suppliers do not receive the anticipated market reception or customer preferences or the market for its products change, ACG’s future development and market share in the industry, and therefor its overall financial condition, may be materially and adversely affected.

 

AutoChina’s ability to pay dividends and utilize cash resources of its subsidiaries is dependent upon the earnings of, and distributions by, AutoChina’s subsidiaries and jointly-controlled enterprises .

 

AutoChina a holding company with substantially all of ACG’s business operations conducted through its subsidiaries and jointly-controlled enterprises. AutoChina’s ability to make dividend payments depends upon the receipt of dividends, distributions or advances from its subsidiaries and jointly-controlled enterprises. The ability of its subsidiaries and jointly-controlled enterprises to pay dividends or other distributions may be subject to their earnings, financial position, cash requirements and availability, applicable laws and regulations and to restrictions on making payments to AutoChina or ACG contained in financing or other agreements. These restrictions could reduce the amount of dividends or other distributions that AutoChina receives from its subsidiaries and jointly-controlled enterprises, which could restrict its ability to fund its business operations and to pay dividends to its shareholders. AutoChina’s future declaration of dividends may or may not reflect its historical declarations of dividends and will be at the absolute discretion of the Board of Directors.

 

 

 

Yan Wang, the wife of Yong Hui Li, the chairman and chief executive officer of ACG and a director and the chairman and chief executive officer of AutoChina, is the beneficial owner of a substantial amount of AutoChina’s ordinary shares and Ms. Wang may take actions with respect to such shares which are not consistent with the interests of the other shareholders .

 

Yan Wang, the wife of Yong Hui Li, the chairman and chief executive officer of ACG and a director and the chairman and chief executive officer of AutoChina, beneficially owns approximately 80.31% of the outstanding ordinary shares of AutoChina as of the date of this report, without taking into account AutoChina’s outstanding warrants and assuming that there are no other changes to the number of ordinary shares outstanding. Under SEC rules, Mr. Li can be deemed to beneficially own such shares. Ms. Wang may take actions with respect to such shares without the approval of other shareholders and which are not consistent with the interests of the other shareholders, including the election of the directors and other corporate actions of AutoChina such as:

 

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its merger with or into another company;

 

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a sale of substantially all of its assets; and

 

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amendments to its memorandum and articles of incorporation.

 

The decisions of Ms. Wang may conflict with AutoChina’s interests or the interests of AutoChina’s other shareholders.

 

Prior to AutoChina’s acquisition of ACG on April 9, 2009, AutoChina had not had operations, and ACG had not operated as a public company. Fulfilling AutoChina’s obligations incident to being a public company will be expensive and time consuming .

 

Prior to AutoChina’s acquisition of ACG on April 9, 2009, AutoChina had not had operations, and ACG had not operated as a public company. Each of AutoChina and ACG have maintained relatively small finance and accounting staffs. Neither AutoChina nor ACG currently has an internal audit group. Although AutoChina has maintained disclosure controls and procedures and internal control over financial reporting as required under the Federal securities laws with respect to its very limited activities, it has not been required to maintain and establish these disclosure controls and procedures and internal control as will be required with respect to businesses such as ACG with substantial operations. Under the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the U.S. Securities and Exchange Commission (“SEC”), AutoChina will need to implement additional corporate governance practices and adhere to a variety of reporting requirements and complex accounting rules. Compliance with these obligations will require significant management time, place significant additional demands on AutoChina’s and ACG’s finance and accounting staffs and on their financial, accounting and information systems, and increase their insurance, legal and financial compliance costs. AutoChina may also need to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge.

 

 

Risks Relating to the Motor Vehicle Industry in China

 

Excess supply in the PRC automobile market could reduce ACG’s profits and growth .

 

Automobile sales in the PRC have been growing rapidly between 2001 and 2007, and this growth has encouraged industry participants to enter the automobile retail market through import or expansion of production capacities. This may have resulted, and may continue to result, in an excess supply of automobiles in the market, particularly in light of the recent economic slowdown in China and around the world, which in turn can reduce ACG’s car and truck sales.

 

Imposition of fuel economy standards on PRC automotive manufacturers and the proposed imposition of higher automobile consumption taxes may have a negative effect on the revenues and profits of PRC automobile importers, dealers and distributors, including ACG .

 

The PRC government adopted new automobile consumption taxes on April 1, 2006 which increased the consumption tax rate on passenger cars with cylinder capacity of more than 2.0 litres. In particular, the tax on passenger cars with a cylinder capacity of more than 2.0 litres and up to 2.5 litres has been increased by 1%; those with a cylinder capacity of more than 2.5 litres and up to 3.0 litres has been increased by 4%; those with a cylinder capacity of more than 3.0 litres and up to 4.0 litres has been increased by 7%; and those with a cylinder capacity of more than 4.0 litres has been increased by 12%. AutoChina cannot assure you that the automobile consumption tax rate will not be raised in the future, which would increase the costs of vehicles with relatively large cylinder capacity. Car importers, dealers and distributors in the PRC might not be able to successfully pass on the tax increase as higher prices to customers. Even if such increased costs are added to selling prices, such increase in prices could result in a decline in vehicle sales. Such an increase in cost of good sold or decline in demand may have an adverse effect on the revenues and profits of car importers, dealers and distributors in the PRC, including ACG.

 

Automobile importers, dealers and distributors in the PRC, including ACG, may expend considerable resources in order to comply with the Regulations on Recall of Defective Automotive Products, which took effect in October 2004 .

 

The PRC’s Regulations on Recall of Defective Automotive Products came into effect on October 1, 2004. This regulation requires automotive distributors to assist automobile manufacturers to undertake service actions or recall campaigns. Any such actions or campaigns may require automotive distributors to expend considerable resources in detecting and reporting to the regulatory authorities of any potential design defects, defective component parts or assembly defects in the automobile-related products distributed, which could influence purchasing decisions of potential purchasers of the vehicles distributed by ACG or adversely affect the reputation of the products distributed by ACG, thereby negatively affecting sales and profitability of ACG. Material failures by automobile distributors to perform their obligations under such regulations may also subject the distributors to certain penalties and fines.

 

 

The proposed adoption of the “three guarantees” policy on vehicles sold in the PRC may have a negative effect on the revenues and profits of ACG .

 

The PRC government is considering adopting the Regulations on Non-Commercial Passenger Vehicle Repair, Exchange and Return Responsibilities (commonly referred to as the “three guarantees” policy) in the near future. The new regulations are designed to make it easier for buyers of vehicles which are to be used for non-commercial purposes to hold the dealers primarily responsible for quality defects in motor vehicles, regardless of the contractual allocation of such liabilities between the manufacturers and dealers. These regulations provide, among other things, that a purchaser can return a vehicle to the dealers at no cost or, in some circumstances, at a nominal cost, if (i) a major quality problem occurs within 30 days of the purchase or, (ii) such vehicle has the same quality problem after five repair attempts or (iii) the aggregate time for all quality-related repairs of such vehicle exceeds 35 days over a specified term (usually two years).

 

If these regulations are introduced as described above or in a similar form, the costs of compliance with such regulations and the potential product defect liability, if it occurs, could reduce ACG’s profitability. Even if ACG passes along such costs to consumers in the form of higher selling prices, the increase in sales prices could cause a decline in market demand and result in a material adverse effect on the revenues and profits of ACG.

 

Any trade or other political disputes between countries may affect ACG’s selection of motor vehicles to be imported and sales turnover .

 

Approximately 2.1% of the motor vehicles sold by ACG are imported from Japan, Europe and U.S. There may be occasions when trade or other political disputes or tensions arise between countries of imports and the countries of exports which are beyond ACG’s control. Depending on the response of society to the government’s stance to such disputes, the demand for the products imported from the countries which are subject to the trade disputes may be affected, and hence affect ACG’s selection of the product as well as the overall sales turnover. There is no assurance that the customers would prefer one brand over the other or the vehicles made by one country over the other country. In any of such events, this will cause a decline in ACG’s sales turnover and affect ACG’s financial condition and results of operations.

 

Fuel shortages and fluctuations in fuel prices may adversely affect the demand for automobiles .

 

Fuel prices are inherently volatile and have experienced significant rise from 2001 to 2008. Any surge in fuel prices will have an adverse effect on world economies and, in particular, on the world’s automobile industries. For example, in 2007, rising global oil prices and rising demand for fuel have led to fuel shortages in China. This is due in part to increased automobile ownership as well as government controls over fuel prices.

 

If the PRC central government continues to control the price of domestic refined oil to stabilize the market and demand for fuel in China continues to increase in line with rising annual GDP, it is possible that further shortages will occur. If the cost of fuel in the China continues to increase, consumers may elect to use alternative means of transportation, and demand for automobiles, particularly those with larger engine capacities, may decline.