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CBAK > SEC Filings for CBAK > Form 10-K on 14-Jan-2014All Recent SEC Filings

Show all filings for CHINA BAK BATTERY INC

Form 10-K for CHINA BAK BATTERY INC


14-Jan-2014

Annual Report


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

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

Overview

Although the business climate in China is recovering, the global economic environment remains weak. We have experienced net losses during the past two fiscal years. We generated revenues of $205.5 million and $185.6 million for the fiscal years ended September 30, 2012 and 2013, respectively, and net losses of $65.8 million and $116.0 million during the same periods, respectively. However, we believe that our accomplishments to date, as well as our strategic plan as described below, will yield long-term growth of revenues and positive net income.

During fiscal year 2013, we continued to explore and capitalize on opportunities to generate additional sources of revenue through new product offerings. We have been primarily seeking to increase the market share of our cylindrical cells and high-power lithium battery cells for electric bicycles and other electric vehicles in China, while battery cell production for cell phones is expected to decrease proportionally while remaining the Company's core business. Demand for high-power lithium batteries from the electric car and bicycle market was continuing to increase, resulting in more sales volume of this product in fiscal year 2013.We supplied high-power lithium battery modules to domestic automakers such as Chery, Brilliance, Changan, and FAW for use in their electric vehicles, and also supply high-power battery cells to battery module manufacturers such as Valence and Pisen. We continued to provide high-power lithium battery modules to electric bicycle manufacturers, such as Geoby, XDS, FSD, and Shenling.


We focused more on sales of our polymer cells as well. We supplied lithium polymer battery packs to major Chinese smartphone brands such as Coolpad, K-touch and Tinno, and MP3 and other consumer audio electronic devices manufactures such as Beautiful Enterprise Co., Ltd and Shinning Year Co., Ltd, and Chinese notebook computer manufacturers for use in tablet computers such as Hanvon Technology Co., Ltd., or Hanvon. We also supplied lithium polymer battery cells to pack battery manufacturers such as Shenzhen DRN battery Co.,Ltd, Sunwoda Electronic Co., Ltd,, and Varta Microbattery. The market demand for this product has been increasing because of the increasing popularity of ultra-thin smartphones and tablet computers.

In addition, we continued to pursue opportunities to generate new sources of revenue and reduce costs of revenue. We continued to develop new products with higher selling prices for use in high-end market, and reduced manufacturing costs and purchase costs of raw materials.

In the near-term, we anticipate continuing operating challenges due to a number of trends facing our business, including in particular declining demand for replacement battery cells and increasing competition from foreign and domestic battery cell manufacturers in China. These challenges may impede our primary strategy to increase our revenues and gross margin through product diversification and manufacturing efficiencies. In response, we will continue to take cost-cutting actions, including employee reductions.

Recent Development

We have net liabilities, a working capital deficiency, accumulated deficit from recurring net losses incurred for the current and prior years and significant short-term debt obligations maturing in less than one year as of September 30, 2013. We have been suffering severe cash flow deficiencies. Because we defaulted on repayment of loans from Bank of China, we are experiencing and, we believe, will continue to experience significant difficulties to renew our credit facilities or refinance loans from banks. Upon request of Bank of China, Shenzhen Municipal Intermediate Court has ordered to freeze all of our properties in Shenzhen BAK Industrial Park and Tianjin Industrial Park Zone near the end of fiscal year 2013 whereby we may not transfer these assets or pledge these assets for any other borrowings. In order to extend the bank loans to various dates through May 2014, we were required by Bank of China to pledge 100% equity interest in Shenzhen BAK and almost all of our assets in Shenzhen and Tianjin, including land use rights and property rights, equipment, accounts receivable and inventories. We repaid our defaulted loans from Bank of China on January 9, 2014 and we expect that our frozen properties will be released by the court shortly. As of September 30, 2013, we had access to $163.5 million in short-term credit facilities and $29.2 million in other lines of credit, all of which were utilized to the extent of short-term bank loans of $151.4 million and bills payable of $41.4 million. These factors raise substantial doubts about our ability to continue as a going concern.

We intend to sell part of our low efficiency assets and appreciating land and properties to repay our short term debts and to provide cash for the development of more promising products such as high power batteries and Electric Vehicle batteries. We transferred our 100% equity interest in Tianjin Meicai to an unrelated party on August 27, 2013. We also have intention to sell 100% equity interest in BAK International and its subsidiaries (including all their assets and liabilities), and the properties in Tianjin. We are in negotiation with the potential buyers about contract terms and clauses. We intend to obtain the approval of our shareholders before we close the transactions. Prior to the completion of these disposals, the potential buyers preliminarily agreed in November and December 2013 that they would lend sufficient money to us to help us repay past due and maturing bank loans, on the condition that we make certain pledges and guarantees, including pledging our 100% equity interest in BAK International. On December 17, 2013, Shenzhen BAK entered into a loan agreement, or the Loan Agreement, with Mr. Jinghui Wang, the sole shareholder of a potential buyer, pursuant to which, Mr. Wang agreed to lend us in the aggregate amount of RMB370 million (approximately $60.4 million) initially. On January 14, 2014, BAK International entered into a corporate guarantee with Mr. Wang, or BAK International Corporate Guarantee, under which, BAK International irrevocably and unconditionally guarantees to the lender timely performance by Shenzhen BAK of all its obligations under the Loan Agreement. On the same date, China BAK Battery, Inc. entered into a corporate guarantee with Mr. Wang, or China BAK Corporate Guarantee, to irrevocably and unconditionally guarantee timely performance by Shenzhen BAK of all its obligations under the Loan Agreement. In addition, on January 14, 2014, China BAK Battery, Inc. and BAK International entered into a Share Mortgage with Mr. Wang, or Share Mortgage, under which, China BAK Battery, Inc. pledges 100% equity interest in BAK International to the lender as security for the performance of Shenzhen BAK's obligations under the Loan Agreement. If Shenzhen BAK defaults on its repayment obligation under or in connection with the Loan Agreement, the lender, as the pledgee, will be entitled to dispose of the pledged equity interests. BAK International Corporate Guarantee, China BAK Corporate Guarantee and Share Mortgage are attached hereto as exhibits 10.13, 10.14 and 10.15, and are hereby incorporated by reference. Up to the date of this Form 10-K, we have received RMB370 million (approximately $60.4 million) pursuant to the Loan Agreement and an additional RMB150 million (approximately $24.6 million) from Mr. Wang. We also repaid RMB85 million (approximately $13.9 million) and renewed short term bank loans of RMB71 million (approximately $11.6 million) with Ping An Bank and repaid an amount of RMB445.9 million (approximately of $72.8 million) of bank loans of Bank of China and Agricultural Bank of China and bills payable of RMB49.2 million (approximately of $8.1 million) to Bank of China. In addition, we have entered a letter of intent with a potential buyer of BAK Tianjin for a consideration of RMB150 million, pursuant to which, we have received RMB50 million (approximately $8.2 million) in advance on November 19, 2013 to repay the same amount of loan from Bank of Dalian matured on November 20, 2013.

After the disposal of these assets, we will retain BAK Asia and its subsidiary, BAK Dalian. It is our understanding that the Dalian government will grant certain government subsidies to us, including but not limited to land use rights at a favorable price. As of September 30, 2013, we received a subsidy of RMB150 million (approximately $24.5 million) from the Management Committee of Dalian Economic Zone, to finance our removal of operating assets from Tianjin to Dalian. We intend to build a new manufacturing site in Dalian with all the operating assets, primarily machinery and equipment, moved from BAK Tianjin, while retaining its customers, employees, patents and technologies. BAK Dalian will focus on the new energy high power battery business, for use in electric vehicle, light electric vehicles and other high power applications. We believe with the significant reduction of liabilities and disposal of traditional low margin battery business, we can continue as a going concern and return to profitability.


It is expected that after the restructuring mentioned above, China BAK will continue to be a US listing company with a low level of liabilities.

Financial Statement Presentation

Net revenues. Our net revenues represent the invoiced value of our products sold, net of value added taxes, or VAT, sales returns, trade discounts and allowances. We are subject to VAT, which is levied on most of our products at the rate of 17% on the invoiced value of our products. Provision for sales returns are recorded as a reduction of revenue in the same period that revenue is recognized. The provision for sales returns represents our best estimate of the amount of goods that will be returned from our customers based on historical sales return data.

Cost of revenues. Cost of revenues consists primarily of material costs, employee remuneration for staff engaged in production activity, share-based compensation, depreciation and related expenses that are directly attributable to the production of products. Cost of revenues also includes write-downs of inventory to lower of cost or market. Cost of revenues from the sales of battery packs includes the fees we pay to pack manufacturers for assembling our prismatic cells into battery packs.

Research and development expenses. Research and development expenses primarily consist of remuneration for R&D staff, share-based compensation, depreciation and maintenance expenses relating to R&D equipment, and R&D material costs.

Sales and marketing expenses. Sales and marketing expenses consist primarily of remuneration for staff involved in selling and marketing efforts, including staff engaged in the packaging of goods for shipment, advertising cost, depreciation, share-based compensation and travel and entertainment expenses. We do not pay slotting fees to retail companies for displaying our products, engaging in cooperative advertising programs, participating in buy-down programs or similar arrangements. No material estimates are required by management to determine our actual marketing or advertising costs for any period.

General and administrative expenses. General and administrative expenses consist primarily of employee remuneration, share-based compensation, professional fees, insurance, benefits, general office expenses, depreciation, liquidated damage charge and bad debt expenses.

Property, plant and equipment impairment charges. Impairment charges consist primarily of impairment losses for long-lived assets. These losses reflect the amounts by which the carrying values of these assets exceed their estimated fair value as determined by their estimated future discounted cash flows.

Government Grant Income. We present the government subsidies received as part of other income unless the subsidies received are earmarked to compensate a specific expense, which have been accounted for by offsetting the specific expense, such as research and development expense or interest expenses. Unearned government subsidies received are deferred for recognition until the criteria for such recognition could be met. Grants applicable to land are amortized over the life of the depreciable facilities constructed on it. For research and development expenses, we match and offset the government grants with the expenses of the research and development activities as specified in the grant approval document in the corresponding period when such expenses are incurred.

Finance Costs, Net. Finance costs consist primarily of interest income, interest on bank loans and net of capitalized interest.

Income Taxes. Since Shenzhen BAK was acknowledged as a "New and High technology enterprise," it is entitled to a preferential tax rate of 15% for each of the calendar years 2011, 2012 and 2013. BAK Battery's income tax rates were 11% and 24% for calendar years 2010 and 2011, respectively, and starting in calendar year 2012, it was subject to an income tax rate of 25%. BAK Battery did not incur any enterprise income tax for the calendar year 2013 due to the current tax losses carried forward from calendar years 2011 and 2012. BAK Tianjin is currently paying no enterprise income tax due to cumulative tax losses. Our Canadian, German, Indian, and Hong Kong subsidiaries-BAK Canada, BAK Europe, BAK India and BAK International-are subject to profits tax in their respective countries at rates of 38%, 25%, 30%, and 16.5%, respectively. However, because they do not have any assessable income derived from or arising in those countries, they have not paid any such tax.


Pursuant to the Provisional Regulation of China on Value Added Tax and its implementing rules, all entities and individuals that are engaged in the sale of goods, the provision of repairs and replacement services and the importation of goods in China are generally required to pay VAT at a rate of 17% of the gross sales proceeds received, less any deductible VAT already paid or borne by the taxpayer. Further, when exporting goods, the exporter is entitled to some or all of the refund of VAT that it has already paid or borne. Our imported raw materials that are used for manufacturing exported products and deposited in bonded warehouses are exempt from import VAT.

Results of Operations

The following table sets forth key components of our results of operations for the years indicated, both in dollars and as a percentage of our revenue.

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

                                    Year Ended September 30,               Change
                                      2012             2013            $             %
Net revenues                     $     205,519    $    185,553   $   (19,966 )        (9.7 )
Cost of revenues                      (204,300 )      (202,160 )      (2,140 )        (1.0 )
Gross profit (loss)                      1,219         (16,607 )     (17,826 )    (1,462.3 )
Operating expenses:
Research and development                (1,844 )        (5,368 )      (3,524 )      (191.1 )
expenses
Sales and marketing expenses            (8,489 )        (7,645 )         844           9.9
General and administrative             (18,058 )       (17,491 )         566           3.1
expenses
Provision for (recovery of)            (22,635 )         8,958        31,593         139.6
doubtful accounts
Impairment charge on property,          (3,919 )       (62,527 )     (58,608 )    (1,495.5 )
plant and equipment
Total operating expenses               (54,945 )       (84,073 )     (29,129 )       (53.0 )
Operating loss                         (53,726 )      (100,680 )     (46,955 )       (87.4 )
Finance costs, net                     (10,904 )       (11,523 )        (618 )        (5.7 )
Government grant income                  1,190             132        (1,058 )       (88.9 )
Other income                                26           2,162         2,136       8,215.3
Loss before income taxes               (63,414 )      (109,909 )     (46,495 )       (73.3 )
Provision for income tax                (2,393 )        (6,120 )      (3,727 )       155.7
Net loss                         $     (65,807 )  $   (116,029 ) $   (50,222 )        76.3

Net revenues. Net revenues were $185.6 million for the fiscal year ended September 30, 2013, as compared to $205.5 million for the fiscal year of 2012, a decrease of $20.0 million, or 9.7%.

The following table sets forth the breakdown of our net revenues by battery cell type.

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

                                     Year Ended September 30,              Change
                                      2012              2013            $           %
Prismatic cells
   Aluminum-case cells           $      76,065    $       28,788   $  (47,277 )   (62.2 )
   Battery packs                        55,320            63,690        8,370      15.1
Cylindrical cells                       45,336            45,986          650       1.4
Lithium polymer cells                   18,326            30,607       12,281      67.0
High-power lithium battery cells        10,472            16,482        6,010      57.4
Total                            $     205,519    $      185,553   $  (19,966 )    (9.7 )


The following table sets forth the breakdown of our net revenues from reconditioned and normal products.

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

                                           Year Ended September 30, 2013
                            Reconditioned sales      Normal sales         Total sales
Prismatic cells
   Aluminum-case cells    $              17,925   $          10,863   $          28,788
   Battery packs                         16,566              47,124              63,690
Cylindrical cells                             -              45,986              45,986
Lithium polymer cells                    10,318              20,289              30,607
High-power lithium                            -              16,482              16,482
battery cells
Total                     $              44,809   $         140,744   $         185,553

Net revenues from sales of aluminum-case cells decreased to $28.8 million in fiscal year 2013, from $76.1 million in the fiscal year 2012, a decrease of $47.3 million, or 62.2%, resulting from a decrease of 42.0% in sales volume as well as a decrease of 32.4% in average selling price. The decrease of sales volume was because of the decrease in demand for aluminum-case cells in view of the popularity of polymer smartphone batteries. Also, there was an intense competition in the aluminum-case cells market. We put more effort into developing a high ended aluminum-case product to sizable customers. In order to cope with the market change, we continued to aggressively clear our re-conditioned and low-end products in the year ended September 30, 2013, and focus on selling high end products with a high unit selling price. However, our margin was still adversely affected by our clearing of re-conditioned products resulting in a gross loss for this period. We recorded a gross loss on our aluminum-case cell products of 85% for the fiscal year 2013 compared to gross loss of 2% for the fiscal year 2012.

Net revenues from sales of battery packs, which are a crucial component of smartphones, increased to $63.7 million in the fiscal year ended September 30, 2013, from $55.3 million in the fiscal year 2012, an increase of $8.4 million, or 15.1%. This resulted from an increase in sales volume of 33.4% offset by a decrease in the average price of 13.6%. The increase in sales volume was attributable to the strong market demand for smartphones and our ability to develop high end products to meet market demand this year. We sold proportionately less re-conditioned and low-end products in the year ended September 30, 2013. As such, we were able to record a higher gross profit of 21% from our sales of battery packs for the fiscal year 2013 compared to 12% for the fiscal year 2012.

Net revenues from sales of cylindrical cells increased to $46.0 million in the fiscal year ended September 30, 2013, from $45.3 million in the fiscal year 2012, an increase of $0.7 million, or 1.4%. This resulted from a decrease in sales volume of 8.9% offset by an increase in sales price of 11.3% because we changed market strategy to high-end products, and as a result, more high-end products with higher unit selling prices were sold in fiscal year 2013. Although sales volume as a whole decreased, we were able to achieve a higher gross profit. We recorded gross profit of 28% from our sales of cylindrical cells for the fiscal year 2013 compared to 22% for the fiscal year 2012.

We sold $30.6 million in lithium polymer cells for the fiscal year ended September 30, 2013, compared to $18.3 million in lithium polymer cells in the fiscal year 2012, representing an increase of $12.3 million, or 67.0%, resulting from an increase in sales volume of 149.0% offset by a decrease in sales price of 32.9%. The increase in sales volume was mainly attributable to our effort to expand our market share. We reduced the selling price in fiscal year 2013 to attract new customers. Also, our margin was adversely affected by our clearing of re-conditioned products, resulting gross loss for this year. We recorded a gross loss of 64.0% from our sales of lithium polymer cells for the fiscal year ended September 30, 2013 compared to a gross loss of 72% for the fiscal year 2012.

We also sold approximately $16.5 million in high-power lithium battery cells and packs for the fiscal year ended September 30, 2013, as compared to $10.5 million in fiscal year 2012, an increase of $6.0 million, or 57.4%, resulting from an increase of 64.1% in sales volume offset by a decrease in sales price of 4.1%.This increase in sales volume was mainly due to the increasing demand from the electric car market and the electric bicycle market. We reduced our selling price to attract customers. We recorded gross profit of 9% from our sales of high-power lithium battery for the fiscal year 2013 compared to 0% for the fiscal year 2012.


In order to address our net liabilities and recurring losses, we intend to sell part of our low efficiency assets and appreciating land and properties in Shenzhen and Tianjin to repay our short term debts and to provide cash for the development of more promising products such as high power batteries and Electric Vehicle batteries. We intend to build a new manufacturing site in Dalian with all the operating assets, primarily machinery and equipment, moved from BAK Tianjin, while retaining its customers, employees, patents and technologies. BAK Dalian will focus on the new energy high power battery business, for use in electric vehicle, light electric vehicles and other high power applications. After the above disposals and removal to Dalian, our revenues will mainly come from sale of high-power lithium battery cells.

Cost of revenues. Cost of revenues decreased to $202.2 million for the year ended September 30, 2013, as compared to $204.3 million for fiscal year 2012, a decrease of $2.1 million, or 1%. Included in cost of revenues were write-downs of obsolete inventories of $9.7 million and $59.6 million for fiscal years 2012 and 2013 respectively. The Company writes down the inventory value whenever there is an indication that they are impaired. However, as the market conditions continued to deteriorate, further write-downs were necessary.

Gross profit/(loss). Gross loss for the year ended September 30, 2013 was $16.6 million, or 9.0% of net revenues as compared to gross profit of $1.2 million, or 0.6% of net revenues, for fiscal year 2012. The gross loss was primarily due to the increased impairment of our inventories and re-conditioned products being sold at a deeper loss in fiscal 2013 than 2012 as we increased our efforts to clear these products.

Research and development expenses. Research and development expenses increased to $5.4 million for the year ended September 30, 2013, as compared to $1.8 million for fiscal year 2012, an increase of $3.5 million, or 191.1%. Our expenditures for research and development activities for fiscal years 2012 and 2013, before offset of government subsidies, were $5.8 million and $5.5 million, or 2.8% and 2.9% of net revenues, respectively. Minimal government subsidies were offset against R&D expenditures in fiscal 2013 while $3.9 million were offset against R&D expenditures in fiscal 2012.

Sales and marketing expenses. Sales and marketing expenses decreased to $7.6 million for the year ended September 30, 2013, as compared to $8.5 million for fiscal year 2012, a decrease of $0.8 million, or 9.9%. As a percentage of revenues, sales and marketing expenses remained at 4.1% for both fiscal years 2012 and 2013.

General and administrative expenses. General and administrative expenses decreased to $17.5 million, or 9.4% of revenues, for the year ended September 30, 2013, as compared to $18.1 million, or 8.8% of revenues, for fiscal year 2012, a decrease of $0.6 million, or 3.1%.

Property, plant and equipment impairment charge. The property, plant and equipment impairment charge increased to $62.5 million for the year ended September 30, 2013, as compared to $3.9 million for fiscal year 2012, representing an increase of $58.6 million, or 1,495.5%. During the course of our strategic review of our operations for years ended September 30, 2013 and 2012, we assessed the recoverability of the carrying value of certain property, plant and equipment which resulted in impairment losses of $62.5 million and $3.9 million, respectively, representing the excess of the carrying value of our property, plant and equipment of the production facilities in Shenzhen and Tianjin over their estimated fair value.

Operating loss. As a result of the above, our operating loss totaled $100.7 million for the year ended September 30, 2013, as compared to $53.7 million for the prior fiscal year, a decrease of $47.0 million, or 87.4%.

Finance costs, net. Finance costs, net, increased to $11.5 million for the year ended September 30, 2013, as compared to $10.9 million for the prior year, an increase of $0.6 million, or 5.7%. The increase in net finance costs is mainly attributable to higher interest charge on our bank loans temporarily extended by our banks in the last quarter of fiscal year 2013.

Government grant income. Government grant income was approximately $132,000 for the year ended September 30, 2013, as compared to $1.2 million for fiscal year 2012. Government grant income for the year ended September 30, 2013 mainly consisted of the energy conservation and an emission reduction subsidy of $113,000 granted by the China Financial Committee.

Income tax expense. Income tax expense was $6.1 million for the year ended September 30, 2013, as compared to $2.4 million for fiscal year 2012. This was mainly due to the net valuation allowance totaling $5.8 million on deferred income tax assets arising on tax losses primarily before the fiscal year 2012. Since we continued to experience significant losses for the year ended September 30, 2013, we are uncertain that we can generate sufficient profit to claim these . . .

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