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HPJ > SEC Filings for HPJ > Form 10-K on 2-Apr-2013All Recent SEC Filings

Show all filings for HIGHPOWER INTERNATIONAL, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for HIGHPOWER INTERNATIONAL, INC.


2-Apr-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS

Forward-Looking Statements

The following discussion should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report. This report contains forward-looking statements. The words "anticipated," "believe," "expect, "plan," "intend," "seek," "estimate," "project," "could," "may," and similar expressions are intended to identify forward-looking statements. These statements include, among others, information regarding future operations, future capital expenditures, and future net cash flows. Such statements reflect our management's current views with respect to future events and financial performance and involve risks and uncertainties, including, without limitation, general economic and business conditions, changes in foreign, political, social, and economic conditions, regulatory initiatives and compliance with governmental regulations, the ability to achieve further market penetration and additional customers, and various other matters, many of which are beyond our control. Our actual results could differ materially from those anticipated in these forward-looking statements, which are subject to a number of risks, uncertainties and assumptions described in the "Risk Factors" section and elsewhere in this report. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements and there can be no assurance of the actual results or developments.

Overview

Highpower International 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 to Hong Kong Highpower Technology, Inc. We subsequently changed our name to Highpower International, Inc. in October 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 commenced operations as of March 25, 2013. In February 2011, HKHTC formed another wholly-owned subsidiary, Icon Energy System Company Limited, a company organized under the laws of the P.R.C., which commenced operations in July 2011.

SZ Highpower was founded in 2001 in the P.R.C. SZ Highpower formed GZ Highpower in September 2010. On February 8, 2012, GZ Highpower increased its paid-in capital from RMB2,000,000 ($293,574) to RMB15,000,000 ($2,381,293). SZ Highpower holds 60% of the equity interest of GZ Highpower, and the four founding management members of GZ Highpower hold the remaining 40%. SZ Highpower formed HZ HTC in March 2012, which engages in the manufacture of batteries.

Through SZ Highpower, we manufacture 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 ("lithium") 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 salespersons 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.

Critical Accounting Policies, Estimates and Assumptions

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 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 generally accepted accounting principles in the United States of America.

Use of Estimates. The preparation of financial statements in conformity with U.S. GAAP requires the management to make estimates and assumptions that affect the reported amounts of assets revenues and expenses, and related disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Significant items subject to such estimates and assumptions include, but are not limited to, 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 those 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 the Company will not be able to collect all amounts due according to original terms of receivables. Bad debts are written off when identified. The Company extends 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. The Company does not accrue interest on trade accounts receivable.

Revenue Recognition. The Company recognizes revenue when all of the following are exist in order: (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.

The Company does not have arrangements for returns from customers and does not have any future obligations directly or indirectly related to product resale by the customers. The Company has no incentive programs.

Inventories. Inventories are stated at the lower of cost or market value. Costs are determined on a weighted average method. Inventory includesraw materials, packing materials, work in progress 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.

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 tax 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 International'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 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

The following table sets forth the consolidated statements of operations of the Company for the years ended December 31, 2012 and 2011, both in dollars and as a percentage of net sales.

Consolidated Statements of Operations                                  Year Ended December 31,
                                                     2012                                       2011
                                                        (in thousands except share and per share information)

Net Sales                                                112,649              100.0 %           110,600           100.0 %

Cost of Sales                                            (88,943 )             79.0 %           (92,852 )          84.0 %

Gross profit                                              23,706               21.0 %            17,748            16.0 %

Research and development expenses                         (4,611 )              4.1 %            (3,239 )           2.9 %

Selling and distribution expenses                         (5,348 )              4.7 %            (4,452 )           4.0 %

General and administrative expenses
including stock-based compensation                       (11,479 )             10.2 %            (9,740 )           8.8 %

Litigation expenses                                            -                  -              (1,500 )           1.4 %

Loss on exchange rate difference                            (220 )              0.2 %              (852 )           0.8 %

Gain (loss) on derivative instruments                        731                0.6 %               (54 )             -

Equity loss in an associate                                    -                  -                (108 )           0.1 %

Income (loss) from operations                              2,779                2.5 %            (2,197 )           2.0 %

Other income                                                 631                0.6 %               753             0.7 %

Interest expenses                                           (705 )            0.6%,                (546 )           0.5 %

Income (loss) before tax                                   2,705                2.4 %            (1,990 )           1.8 %

Income tax expense                                        (1,133 )              1.0 %              (464 )           0.4 %

Net income (loss) for the year                             1,572                1.4 %            (2,454 )           2.2 %

Less: loss attributable to non-controlling
interest                                                    (145 )              0.1 %                 -
Net income (loss) attributable to the
company                                                    1,717                1.5 %            (2,454 )           2.2 %

Income (loss) per common share - basic and
diluted                                                     0.13                                  (0.18 )

Weighted average common shares outstanding
-basic and diluted                                    13,582,106                             13,582,106

Dividends declared per common share                            -                                      -

Years ended December 31, 2012 and 2011

Net sales for the year ended December 31, 2012 were $112.6 million compared to $110.6 million for the year ended December 31, 2011, an increase of $2.0 million, or 1.9%. The increase was due to a $15.2 million increase in net sales of our lithium batteries (resulting from a 74.2% increase in the volume of batteries sold which was partially offset by a 4.0% decrease in the average selling price of such batteries) and a $1.3 million increase in net sales of our Ni-MH battery units (resulting from a 5.9% increase in the number of Ni-MH battery units sold which was partially offset by a 3.7% decrease in the average selling price of such batteries), which was partly offset by an decrease in revenues from our material business from $17.4 million in 2011 to $2.9 million in 2012. This decrease was due to the strategic shift from materials trading to preparing for materials processing and recycling platform in our Ganzhou Facility. The increase in the number of both Ni-MH and lithium battery units sold in 2012 was primarily attributable to increased orders from our new and existing customers.

Cost of sales consists of the cost of mainly nickel, cobalt, lithium derived materials, labor, and overhead. Cost of sales were $88.9 million for the year ended December 31, 2012 as compared to $92.9 million for the comparable period in 2011. As a percentage of net sales, cost of sales decreased to 79.0% for the year ended December 31, 2012 compared to 84.0% for the comparable period in 2011. This decrease was attributable to decreases of raw material prices from the comparable period in 2011. In addition, it was attributable to a lower percentage of materials revenue with lower margin during the year ended December 31, 2012 as compared to the comparable period in 2011.

Gross profit for the year ended December 31, 2012 was $23.7 million, or 21.0% of net sales, compared to $17.7 million, or 16.0% of net sales, respectively, for the comparable period in 2011. Management considers gross profit to be a key performance indicator in managing our business. Gross profit margins are usually a factor of cost of sales, product mix and demand for products. This increase was largely attributable to decreases of raw material prices, including a 23% decrease in the average price of nickel from the comparable period in 2011. In addition, revenue from our New Materials business decreased to $2.9 million for the year ended December 31, 2012 from $17.4 million for the year ended December 31, 2011, which business has lower gross profit margins than our other business operations.

To cope with pressure on our gross margins we control production costs by preparing budgets for each department and comparing actual costs with our budgeted figures monthly and quarterly. 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., Russia, Europe and India, and by expanding our sales team with more experienced sales personnel. We have also begun production capacity expansion for our lithium batteries business as to take advantage of the strong demand globally.

Selling and distribution expenses were $5.3 million for the year ended December 31, 2012, or 4.7% of net sales, compared to $4.5 million for the comparable period in 2011, or 4.0% of net sales, an increase of 20.1%. Selling and distribution expenses increased due to the expansion of our sales force and marketing activities, such as participation in industry trade shows and international travels to promote and sell our products abroad.

General and administrative expenses were $11.5 million, or 10.2% of net sales, for the year ended December 31, 2012, compared to $9.7 million, or 8.8% of net sales, for the comparable period in 2011. The primary reason for the increase was the $1.6 million increase in the provision for bad debt expenses over the year ended December 31, 2012.

Research and development expenses were $4.6 million, or 4.1% of net sales, for the year ended December 31, 2012, as compared to $3.2 million, or 2.9% of net sales, for the comparable period in 2011. The increase was due to the expansion of our workforce to expand our research and development and management functions.

We experienced loss on the exchange rate difference between the U.S. Dollar and the RMB of $220,597 and $851,899, respectively, in the years ended December 31, 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 $730,591 in the year ended December 31, 2012, which included a gain of $493,882 on settled currency forwards and a gain of $236,709 on unsettled currency forwards, as compared to a loss of $54,229 for the comparable period in 2011, which included a loss of $721,364 on the forward contract of nickel, a gain of $654,388 on settled currency forwards and a gain of $12,747 on unsettled currency forwards.

Other income consists of subsidy income, bank interest income and sundry income. Other income was $630,842 for the year ended December 31, 2012, as compared to $752,875 for the year ended December 31, 2011. The decrease was due to a decrease of $375,117 of subsidy income from the government, which was partially offset by increases of $121,820 in bank interest income and $131,264 in sundry income.

Interest expenses were $705,218 for the year ended December 31, 2012, as compared to $545,884 for the respective comparable period in 2011. The fluctuation was due to a $412,121 increase in interest expense related to increasing bank borrowings, which was partially offset by a $252,787 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.

During the year ended December 31, 2012, we recorded a provision for income taxes of $1.1 million, as compared to $0.5 million for the respective comparable period in 2011. The change was due to an increase of income before taxes during this period.

Net income for the year ended December 31, 2012 was $1.7 million, compared to net loss of $2.5 million for the comparable period in 2011.

Liquidity and Capital Resources

We had cash and cash equivalents of approximately $6.6 million as of December 31, 2012, as compared to $5.2 million as of December 31, 2011. Our funds are kept in financial institutions located in the P.R.C., which do not provide insurance for amounts on deposit. Moreover, we are subject to the regulations of the P.R.C. which restrict the transfer of cash from the P.R.C., except under certain specific circumstances. Accordingly, such funds may not be readily available to us to satisfy obligations which have been incurred outside the P.R.C.

To provide liquidity and flexibility in funding our operations, we borrow amounts under bank facilities and other external sources of financing. As of December 31, 2012, we had in place general banking facilities with seven financial institutions aggregating $69.2 million. The maturity of these facilities is generally within one year. The facilities are subject to annual review and approval. Certain of these banking facilities are guaranteed by our Chief Executive Officer, Mr. Dang Yu Pan, and contain customary affirmative and negative covenants for secured credit facilities of this type. However, these covenants do not have any impact on our ability to undertake additional debt or equity financing. Interest rates are generally based on the banks' reference lending rates. No significant commitment fees are required to be paid for the banking facilities. As of December 31, 2012, we had utilized approximately $34.5 million under such general credit facilities and had available unused credit facilities of $34.7 million.

For the year ended December 31, 2012, net cash provided by operating activities was approximately $3.8 million, as compared to net cash provided by operating activities of $3.7 million for the comparable period in 2011. The net cash increase of $0.1 million provided by operating activities is primarily attributable to, among other items, an increase of $3.5 million in cash inflow from accounts payable, an increase of $3.0 million in cash inflow from prepayments, an increase of $1.5 million in cash inflow from income taxes payable, an increase of $4.0 million in cash inflow from net income, which was significantly offset by a decrease of approximately $5.8 million in accounts receivable, a decrease of $4.4 million in inventories. The cash inflow increases in accounts payable and prepayments were, to a great extent, attributable to the more favorable credit period granted by our suppliers as well as reduce in prepayments. The cash outflow increase in inventories was mainly due to an increase in our purchases of raw materials. The cash outflow increase in accounts receivable was due to extending payment terms from 67 days to 74 days.

Net cash used in investing activities was $13.0 million for the year ended December 31, 2012 compared to $7.7 million for the comparable period in 2011. The net increase of $5.3 million cash used in investing activities was primarily attributable to an increase in spending on the construction and deployment of plant and equipment in 2012 for the Huizhou factory that is expected to commence operation in the third quarter of 2013. We are equipping the factory with new and more advanced manufacturing capability machines.

Net cash provided by financing activities was $10.0 million for the year ended December 31, 2012 as compared to net cash provided by financing activities of $0.2 million for the comparable period in 2011. The net increase of $9.8 million cash provided by financing activities was primarily attributable to an increase of $7.9 million in proceeds from long-term bank loans, a decrease of $12.4 million in repayment of short-term bank loans, an increase of $950,992 in proceeds from non-controlling interest, an increase of $9.7 million in proceeds from notes payable, a decrease of $7.0 million in repayment of letters of credit which was partly offset by an increase of $8.8 million in repayment of notes payable, a decrease of $11.4 million in proceeds from letters of credit and an increase of $8.4 million in restricted cash. The increase was mainly due to an increase in our long-term loan to fund the new factory located in Huizhou. We also utilize notes payable to meet our working capital needs. The increase in restricted cash was caused by the increase in proceeds from notes payable and foreign currency loans.

For fiscal year 2012 and 2011, our inventory turnover was 5.9 and 6.8 times, respectively. The average days outstanding of our accounts receivable at December 31, 2012 was 74 days, as compared to 67 days at December 31, 2011. Inventory turnover and average days outstanding of accounts receivables are key operating measures that management relies on to monitor our business. In the next 12 months, we expect to expand our research, development and manufacturing of lithium-based batteries and anticipate additional capital expenditures of approximately $8.0 million.

We are required to contribute a portion of our employees' total salaries to the Chinese government's social insurance funds, including retirement pension, medical insurance, unemployment insurance and job injuries insurance, and a housing assistance fund, in accordance with relevant regulations. We expect these contributions will contribute to administrative and other operating expenses in an amount of approximately $84,554 per month based on the size of our current workforce. We expect the amount of our contribution to the government's social insurance funds to increase in the future as we expand our workforce and operations.

Based upon our present plans, we believe that cash on hand, cash flows from operations and funds available under our bank facilities will be sufficient to fund our capital needs for the next 12 months. However, our ability to maintain sufficient liquidity depends partially on our ability to achieve anticipated levels of revenue, while continuing to control costs. If we did not have sufficient available cash, we would have to seek additional debt or equity financing through other external sources, which may not be available on acceptable terms, or at all. Failure to maintain financing arrangements on acceptable terms would have a material adverse effect on our business, results of operations and financial condition.

The use of working capital is primarily for the maintenance of our accounts receivable and inventory. We provide our major customers with payment terms ranging from 10 to 90 days. Additionally, our production lead time is approximately 30 to 40 days, from the inspection of incoming materials, to production, testing and packaging. We need to keep a large supply of raw materials and work in process and finished goods inventory on hand to ensure timely delivery of our products to our customers. We use two methods to support our working capital needs: (1) paying our suppliers under payment terms ranging from 30 to 90 days; and (2) using short-term bank loans. We use accounts receivable as collateral for our loans. Upon receiving payment for accounts receivable, we pay our short-term loans. Our working capital management practices are designed to ensure that we maintain sufficient working capital.

Guarantees of Bank Loans

Mr. Dang Yu Pan, our Chairman and Chief Executive Officer, has provided personal guarantees under certain of our outstanding banking facilities. The following table shows the amount outstanding on each of our bank loans as of December 31, 2012 and the guarantors of each loan:

                                                          Amount
                                      Amount           Outstanding
         Name of Bank                 Granted           Under Loan          Guaranteed by
Bank of China                     $   8.0 million     $  0.5 million     Land use rights
Shenzhen Development Bank Co.,    $  22.5 million     $ 13.6 million     Dang Yu Pan
Ltd
Industrial and Commercial Bank    $   6.4 million     $  2.3 million     Dang Yu Pan
of China
The Shanghai Commercial &         $  12.6 million     $   3.9million     Cash (RMB) in bank
Savings bank
China Resources Bank of Zhuhai    $   6.4 million     $  6.4 million     Dang Yu Pan
China Everbright Bank             $   8.0 million     $  8.0 million     Dang Yu Pan
Wing Lung Bank (Hong Kong)        $    5.3million     $            0     Cash (RMB) in bank
Total:                            $  69.2 million     $ 34.7 million

. . .

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