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HPJ > SEC Filings for HPJ > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for HIGHPOWER INTERNATIONAL, INC.

Form 10-Q for HIGHPOWER INTERNATIONAL, INC.


14-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion relates to the financial condition and results of operations of Highpower International, Inc. (the "Company") and its wholly-owned subsidiary Hong Kong Highpower Technology Company Limited (referred to herein as "HKHTC"); HKHTC's wholly-owned subsidiaries Shenzhen Highpower Technology Company Limited ("SZ Highpower"), Icon Energy System Company Limited ("ICON") and Highpower Energy Technology (Huizhou) Co. ("HZ Highpower"), which has not yet commenced operations; HKHTC's and SZ Highpower's jointly owned subsidiary, Springpower Technology (Shenzhen) Company Limited ("SZ Springpower"); SZ Highpower's 60%-owned subsidiary, Ganzhou Highpower Technology Company Limited ("GZ Highpower"); and SZ Highpower's wholly-owned subsidiary, Huizhou Highpower Technology Company Limited ("HZ HTC"), which commenced operations in August 2012.

Forward-Looking Statements

This management's discussion and analysis of financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and the related notes that are included in this Quarterly Report and the audited consolidated financial statements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in our Annual Report on Form 10-K for the year ended December 31, 2011 (the "Annual Report").

This Quarterly Report contains forward-looking statements that involve substantial risks and uncertainties. All statements other than historical facts contained in this report, including statements regarding our future financial position, results of operations, cash flows, business strategy and plans and objectives of management for future operations, are forward-looking statements. The words "anticipates," "believes," "expects, "plans," "intends," "seeks," "estimates," "projects," "predicts" "could," "should" "would" "will" "may," "might", and similar expressions, or the negative of such expressions, are intended to identify forward-looking statements. Such statements reflect our management's current views with respect to future events and financial performance and involve risks and uncertainties, including, without limitation, the current economic downturn adversely affecting demand for our products; fluctuations in the cost of raw materials; our dependence on, or inability to attract additional, major customers for a significant portion of our net sales; our ability to increase manufacturing capabilities to satisfy orders from new customers; changes in the laws of the P.R.C. that affect our operations; our ability to complete construction at our new manufacturing facility on time; our ability to control operating expenses and costs related to the construction of our new manufacturing facility; the devaluation of the U.S. Dollar relative to the Renminbi; our dependence on the growth in demand for portable electronic devices and the success of manufacturers of the end applications that use our battery products; our responsiveness to competitive market conditions; our ability to successfully manufacture lithium batteries in the time frame and amounts expected; the market acceptance of our lithium products; changes in foreign, political, social, business and economic conditions that affect our production capabilities or demand for our products; and various other matters, many of which are beyond our control. Actual results may vary materially and adversely from those anticipated, believed, estimated or otherwise indicated should one or more of these risks or uncertainties occur or if any of the risks or uncertainties described in elsewhere in this report or in the "Risk Factors" section of our Annual Report occur. Consequently, all of the forward-looking statements made in this filing are qualified by these cautionary statements and there can be no assurance of the actual results or developments.

Overview

Highpower was incorporated in the state of Delaware on January 3, 2006 and originally organized as a "blank check" shell company to investigate and acquire a target company or business seeking the perceived advantages of being a publicly held corporation. On November 2, 2007, we closed a share exchange transaction, pursuant to which we (i) became the 100% parent of HKHTC and its wholly-owned subsidiary, SZ Highpower, (ii) assumed the operations of HKHTC and its subsidiary and (iii) changed our name from Highpower Technology, Inc. to Highpower International, Inc. on October 20, 2010.

HKHTC was incorporated in Hong Kong in 2003, under the Companies Ordinance of Hong Kong. HKHTC formed HZ Highpower and SZ Springpower in 2008. HZ Highpower has not yet commenced business operations as of August 9, 2012. On September 14, 2012, SZ Springpower increased its registered capital from $1,000,000 to $3,330,000, which increase of $2,330,000 was invested by SZ Highpower. SZ Highpower now holds 69.97% of the outstanding equity interest of SZ Springpower, and HKHTC holds the remaining 30.03%. HKHTC formed another wholly-owned subsidiary, ICON, a company organized under the laws of the P.R.C., in February 2011, and it commenced operations in July 2011.

SZ Highpower was founded in 2001 in the P.R.C. SZ Highpower formed a subsidiary, GZ Highpower, which commenced business operations in September 2010. On February 8, 2012, GZ Highpower increased its registered capital from RMB2,000,000 ($293,574) to RMB30,000,000 ($4,762,586). SZ Highpower holds 60% of the equity interest of GZ Highpower and four other founding management members hold the remaining 40%. In March 8, 2012, SZ Highpower founded another wholly-owned subsidiary, HZ HTC, under the P.R.C. laws. HZ HTC engages in the manufacture of batteries.

Through SZ Highpower, we manufacture Nickel Metal Hydride ("Ni-MH") batteries for both consumer and industrial applications. We have developed significant expertise in Ni-MH battery technology and large-scale manufacturing that enables us to improve the quality of our battery products, reduce costs, and keep pace with evolving industry standards. In 2008, we commenced manufacturing two lines of Lithium-Ion ("Li-ion") and Lithium polymer rechargeable batteries through SZ Springpower for higher-end, high-performance applications, such as laptops, digital cameras and wireless communication products. Our automated machinery allows us to process key aspects of the manufacturing process to ensure high uniformity and precision, while leaving the non-key aspects of the manufacturing process to manual labor.

We employ a broad network of sales staff in China and Hong Kong, which target key customers by arranging in-person sales presentations and providing post-sale services. The sales staff works with our customers to better address customers' needs.

In 2010, we began a new materials business in which we buy and resell certain raw materials related to our battery manufacturing operations. This new materials business generates revenue and income and helps us understand our raw material supply chain, control our raw material costs and ensure that we have a steady supply of raw materials for our battery manufacturing operations to reduce our reliance on external suppliers. We will gradually phase out our trading programs, and implement full-scale materials recycling operations after GZ Highpower completes the construction of its recycling plants.

Critical Accounting Policies and Estimates

The Securities and Exchange Commission ("SEC") defines critical accounting policies as those that are, in management's view, most important to the portrayal of our financial condition and results of operations and those that require significant judgments and estimates.

The preparation of these consolidated financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as well as the disclosure of contingent assets and liabilities at the date of our financial statements. We base our estimates on historical experience, actuarial valuations and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Some of those judgments can be subjective and complex and, consequently, actual results may differ from these estimates under different assumptions or conditions. While for any given estimate or assumption made by our management there may be other estimates or assumptions that are reasonable, we believe that, given the current facts and circumstances, it is unlikely that applying any such other reasonable estimate or assumption would materially impact the financial statements. The accounting principles we utilized in preparing our consolidated financial statements conform in all material respects to U.S. GAAP.

Use of Estimates. The preparation of financial statements in conformity with U.S. GAAP requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant items subject to such estimates and assumptions include revenues; the allowance for doubtful receivables; recoverability of the carrying amount of inventory; fair values of financial instruments; and the assessment of deferred tax assets or liabilities. These estimates are often based on complex judgments and assumptions that management believes to be reasonable but are inherently uncertain and unpredictable. Actual results could differ from these estimates.

Accounts Receivable. Accounts receivable are stated at original amount less allowance made for doubtful receivables, if any, based on a review of all outstanding amounts at the period end. An allowance is also made when there is objective evidence that we will not be able to collect all amounts due according to original terms of receivables. Bad debts are written off when identified. We extend unsecured credit to customers in the normal course of business and believe all accounts receivable in excess of the allowances for doubtful receivables to be fully collectible. We do not accrue interest on trade accounts receivable.

Revenue Recognition. We recognize revenue in accordance with ASC Topic 605. All of the following criteria must exist in order for the Company to recognize revenue: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) price to the buyer is fixed or determinable; and (4) collectability is reasonably assured.

We do not have arrangements for returns from customers and do not have any future obligations directly or indirectly related to product resale by the customer. We have no incentive programs.

Inventories. Inventories are stated at the lower of cost or market value. Costs are determined on a weighted-average method. Inventories include raw materials, packing materials, work-in-process, consumables and finished goods. The variable production overhead is allocated to each unit of production on the basis of the actual use of the production facilities. The allocation of fixed production overhead to the costs of conversion is based on the normal capacity of the production facilities. Where there is evidence that the utility of inventories, in their disposal in the ordinary course of business, will be less than cost, whether due to physical deterioration, obsolescence, changes in price levels, or other causes, the inventories are written down to their fair value for the difference with charges to cost of sales.

Income Taxes. The Company recognizes deferred assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates, applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

Foreign Currency Translation and Transactions. Highpower's functional currency is the United States dollar ("US$"). HKHTC's functional currency is the Hong Kong dollar ("HK$"). The functional currency of the Company's subsidiaries in the P.R.C.is the Renminbi ("RMB").

At the date a foreign currency transaction is recognized, each asset, liability, revenue, expense, gain, or loss arising from the transaction is measured initially in the functional currency of the recording entity by use of the exchange rate in effect at that date. The increase or decrease in expected functional currency cash flows upon settlement of a transaction resulting from a change in exchange rates between the functional currency and the currency in which the transaction is denominated is recognized as foreign currency transaction gain or loss that is included in determining net income for the period in which the exchange rate changes. At each balance sheet date, recorded balances that are denominated in a foreign currency are adjusted to reflect the current exchange rate.

The Company's reporting currency is US$. Assets and liabilities of HKHTC and the P.R.C. subsidiaries are translated at the current exchange rate at the balance sheet dates, revenues and expenses are translated at the average exchange rates during the reporting periods, and equity accounts are translated at historical rates. Translation adjustments are reported in other comprehensive income.

Results of Operations

Three Months Ended September 30, 2012 and 2011

Net sales for the three months ended September 30, 2012 were $31.9 million compared to $28.1 million for the three months ended September 30, 2011, an increase of 13.4%. The net increase was primarily due to an increase of $5.3 million in revenue from sales of our lithium batteries and an increase of $1.7 million in revenue from sales of our Ni-MH batteries, which was partially offset by a decrease of $3.2 million in revenue from our New Materials business. Revenue from sales of our lithium batteries and sales of our Ni-MH batteries increased 87.7% and 9.1%, respectively. The increase in revenues from our lithium batteries business was due to a 55.6% increase in the volume of batteries sold and a 20.6% increase in the average selling price resulting from our sale of higher quality and higher capacity battery products. The increase in revenues attributable to our Ni-MH batteries business was due to an 11.8% increase in the volume of Ni-MH battery units sold, which was partly offset a 2.5% decrease in the average selling price of Ni-MH battery units sold. In addition, revenues from our New Materials business dropped to $641,239 for the three months ended September 30, 2012 from $3.8 million for the three months ended September 30, 2011, a decrease of 83.2%. The decrease in revenues from our New Materials business was due to our strategic shift to implement a full scale battery and e-waste recycling business.

Cost of sales consists of the cost of direct materials, direct labor and overhead allocated. Costs of sales were $24.3 million for the three months ended September 30, 2012, as compared to $24.2 million for the same period in 2011. As a percentage of net sales, cost of sales decreased to 76.1% for the three months ended September 30, 2012 compared to 86.2% for the same period in 2011. This decrease was attributable to decreases of raw material prices, including a 26.0% decrease in the average price of nickel, from the comparable period in 2011.

Gross profit for the three months ended September 30, 2012 was $7.6 million, or 23.9% of net sales, compared to $3.9 million, or 13.8% of net sales, for the same period in 2011. Management considers gross profit margin a key performance indicator in managing our business. Gross profit margins are usually a factor of cost of sales, product mix and demand for product. This increase was attributable to decreases of raw material prices including a 26.0% decrease in the average price of nickel, from the comparable period in 2011. In addition, revenue from our New Materials business decreased to $641,239 for the three months ended September 30, 2012 from $3.8 million for the three months ended September 30, 2011, which business has lower gross profit margins than our other business operations.

To cope with pressure on our gross margins we intend to control production costs by entering into long term contracts to lock in the raw material prices at the appropriate timing. Additionally, we have reorganized the Company's production structure and have focused more attention on employee training to enhance efficiency. We also intend to expand our market share by investing in greater promotion of our products in regions such as the U.S. and Europe, and by expanding our sales team with more experienced international sales personnel. We have also begun production capacity expansion for our lithium batteries business to take advantage of the strong demand for such products globally.

Research and development expenses were approximately $1.1 million, or 3.6% of net sales for the three months ended September 30, 2012, as compared to approximately $823,735, or 2.9% of net sales for the comparable period in 2011, an increase of 39.3%. The increase was due to the expansion of our workforce to expand our research and development and management functions.

Selling and distribution expenses were $1.4 million, or 4.5% of net sales, for the three months ended September 30, 2012 compared to $1.5 million, or 5.3% of net sales, for the same period in 2011. The percentage decrease was mainly due to the implementation of meastures to control our expenses.

General and administrative expenses were $4.0 million, or 12.7% of net sales, for the three months ended September 30, 2012, compared to $2.2 million, or 7.8% of net sales, for the same period in 2011. The primary reason for the increase was the $784,735 increase in the provision for bad debt expenses over the three months ended September 30, 2012.

We experienced loss on the exchange rate difference between the U.S. Dollar and the RMB of approximately $200,488 and $186,879, respectively, for the three months ended September 30, 2012 and 2011. The difference on exchange rate loss was due to the appreciation of the RMB relative to the U.S. Dollar over the respective periods.

We experienced a gain on derivative instruments of approximately $207,576 in the three months ended September 30, 2012, which included a gain of $77,752 on settled currency forwards and a gain of $129,824 on unsettled currency forwards, as compared to a gain of $97,411 for the comparable period in 2011, which included a loss of $22,779 on the forward contract of nickel, a gain of $202,148 on settled currency forwards and a loss of $81,958 on unsettled currency forwards.

Interest expense was approximately $63,935 for the three months ended September 30, 2012, as compared to approximately $105,115 of interest expense for the same period in 2011. The fluctuation was primarily due to a $132,197 increase in interest expense related to increased bank borrowings, which is offset by a $173,377 increase in capitalized interest expenses. The increase in capitalized interest expenses was due to an increase in payments for the construction of the Huizhou facilities. Further increases in borrowing rates would further increase our interest expense, which would have a negative effect on our results of operations.

Other income, which consists of bank interest income, government grants and sundry income, was approximately $176,265 for the three months ended September 30, 2012, as compared to approximately $239,831 for the three months ended September 30, 2011, a decrease of $63,566. The slight decrease was due to a decrease in government grants.

During the three months ended September 30, 2012, we recorded a provision for income tax expense of $526,947, as compared to income tax benefit of $73,683 for the same period in 2011. The increase was due to the increased income before taxes during this period.

Net income attributable to the Company for the three months ended September 30, 2012 was $644,362, compared to net loss attributable to the Company of $630,510 for the same period in 2011.

Nine Months Ended September 30, 2012 and 2011

Net sales for the nine months ended September 30, 2012 were $81.8 million compared to $84.8 million for the nine months ended September 30, 2011, a decrease of 3.4%. The net decrease of $3.0 million was primarily due to a $15.1 million decrease in revenue from our New Materials business, which was partially offset by an increase of $10.1 million in revenue from sales of our lithium batteries and an increase of $2.0 million in revenue from sales of our Ni-MH batteries. Revenue from sales of our lithium batteries and sales of our Ni-MH batteries increased 64.2% and 3.9%, respectively. The increase in revenues attributable to our lithium batteries business is due to a 39.0% increase in the volume of batteries sold and a 18.1% increase in the average selling price resulting from our sale of higher quality and higher capacity battery products, The increase in revenues attributable to our Ni-MH batteries business is due to a 4.9% increase in the volume of Ni-MH battery units sold which was partly offset by a 0.9% decrease in the average selling price of Ni-MH battery units sold. In addition, revenues from our New Materials business dropped to $1.4 million for the nine months ended September 30, 2012 from $16.5 million for the nine months ended September 30, 2011, a decrease of 91.7%. The decrease in New Materials business was due to our strategic shift to implement a full scale battery and e-waste recycling business.

Cost of sales consists of the cost of direct materials, direct labor and overhead allocated. Costs of sales were $64.6 million for the nine months ended September 30, 2012, as compared to $72.1 million for the same period in 2011. As a percentage of net sales, cost of sales decreased to 78.9% for the nine months ended September 30, 2012 compared to 85.1% for the same period in 2011. This decrease was attributable to decreases of raw material prices including a 27.4% decrease in the average price of nickel, from the comparable period in 2011.

Gross profit for the nine months ended September 30, 2012 was $17.3 million, or 21.1% of net sales, compared to $12.6 million, or 14.9% net sales, for the same period in 2011. Management considers gross profit margin a key performance indicator in managing our business. Gross profit margins are usually a factor of cost of sales, product mix and demand for product. This increase was attributable to decreases of raw material prices including a 27.4% decrease in the average price of nickel from the comparable period in 2011.In addition, revenue from our New Materials business decreased to $1.4 million for the nine months ended September 30, 2012 from $16.5 million for the nine months ended September 30, 2011, which business has lower gross profit margins than our other business operations.

Research and development expenses were approximately $3.3 million, or 4.0% of net sales, for the nine months ended September 30, 2012 as compared to approximately $2.3 million, or 2.7% of net sales, for the comparable period in 2011, an increase of 41.8%. The increase was due to the expansion of our workforce to expand our research and development and management functions.

Selling and distribution expenses were $3.9 million, or 4.8% of net sales, for the nine months ended September 30, 2012 compared to $3.7million, or 4.3% of net sales, for the same period in 2011.The percentage increase was mainly due to the expansion of our sales team with more experienced international sales personnel.

General and administrative expenses were $8.3 million, or 10.2% of net sales, for the nine months ended September 30, 2012, compared to $6.4 million, or 7.6% of net sales, for the same period in 2011. The primary reason for the increase was the $1.0 million increase in the provision for bad debt expenses over the nine months ended September 30, 2012.

We experienced loss on the exchange rate difference between the U.S. Dollar and the RMB of approximately $78,458 and $657,581, respectively, in the nine months ended September 30, 2012 and 2011. The difference on exchange rate loss was due to the appreciation of the RMB relative to the U.S. Dollar over the respective periods.

We experienced a gain on derivative instruments of approximately $240,532 in the nine months ended September 30, 2012, which included a gain of $141,987 on settled currency forwards and a gain of $98,545 on unsettled currency forwards, as compared to a loss of $136,786 for the comparable period in 2011, which included a loss of $717,383 on the forward contract of nickel,a gain of $368,699 on settled currency forwards and a gain of $211,898 on unsettled currency forwards.

Interest expense was approximately $377,376 for the nine months ended September 30, 2012, as compared to approximately $365,257 of interest expense for the same period in 2011. The fluctuation was due to a $310,460 increase in interest expense related to increased bank borrowings, which was partially offset by a $298,341 increase in capitalized interest expenses. The increase in capitalized interest expenses was due to an increase in payments for the construction of the Huizhou facilities. Further increases in borrowing rates would further increase our interest expense, which would have a negative effect on our results of operations.

Other income, which consists of bank interest income, government grants and sundry income, was approximately $404,483 for the nine months ended September 30, 2012, as compared to approximately $458,086 for the nine months ended September 30, 2011, a decrease of $53,603. The decrease was due to an decrease in government grants.

During the nine months ended September 30, 2012, we recorded a provision for income tax expense of $943,213, as compared to income tax expense of $69,095 for the same period in 2011. The increase was due to the income before taxes during this period.

Net income attributable to the Company for the nine months ended September 30, 2012 was $1,151,261, compared to net loss attributable to the Company of $596,767 for the same period in 2011.

Foreign Currency and Exchange Risk

Though the reporting currency is the US$, the Company maintains its financial records in the functional currency of Renminbi ("RMB"). Substantially all of our operations are conducted in the P.R.C. and we pay the majority of our expenses in RMB. Approximately 75% of our sales are made in U.S. Dollars. During the nine months ended September 30, 2012, the exchange rate of the RMB to the U.S. Dollar appreciated 1.5% from the level at the end of December 31, 2011. A future appreciation of the RMB against the U.S. Dollar would increase our costs when translated into U.S. Dollars and could adversely affect our margins unless we make sufficient offsetting sales. Conversion of RMB into foreign currencies is regulated by the People's Bank of China through a unified floating exchange rate system. Although the P.R.C. government has stated its intention to support the value of the RMB, there can be no assurance that such exchange rate will not continue to appreciate significantly against the U.S. Dollar. Exchange rate fluctuations may also affect the value, in U.S. Dollar terms, of our net assets. In addition, the RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. Due to the volatility of the US Dollar to our functional currency, the Company put into place in 2008 a hedging program to attempt to protect it from significant changes to the U.S. Dollar which affects the value of its U.S. Dollar receivables and sales. As of September 30, 2012, the Company had a series of currency forwards totaling a notional amount $30.5 million expiring from October 2012 to May 2013. The terms of these derivative contracts are generally . . .

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