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CBAK > SEC Filings for CBAK > Form 10-Q on 19-Feb-2014All Recent SEC Filings

Show all filings for CHINA BAK BATTERY INC

Form 10-Q for CHINA BAK BATTERY INC


19-Feb-2014

Quarterly Report


ITEM 2. 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. Our financial statements are prepared in U.S. dollars and in accordance with U.S. GAAP.

Special Note Regarding Forward Looking Statements

In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as "believe," "expect," "anticipate," "project," "target," "plan," "optimistic," "intend," "aim," "will" or similar expressions which are intended to identify forward-looking statements. Such statements include, among others, those concerning market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, including those identified in Item 1A, "Risk Factors" described in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013, as well as assumptions, which, if they were to ever materialize or prove incorrect, could cause the results of the Company to differ materially from those expressed or implied by such forward-looking statements.

Readers are urged to carefully review and consider the various disclosures made by us in this report and our other filings with the SEC. These reports attempt to advise interested parties of the risks and factors that may affect our business, financial condition and results of operations and prospects. The forward-looking statements made in this report speak only as of the date hereof and we disclaim any obligation, except as required by law, to provide updates, revisions or amendments to any forward-looking statements to reflect changes in our expectations or future events.

Use of Terms

Except as otherwise indicated by the context and for the purposes of this report only, references in this report to:

"Company," "we," "us" and "our" are to the combined business of China BAK Battery, Inc., a Nevada corporation, and its consolidated subsidiaries;
"BAK International" are to our Hong Kong subsidiary, BAK International Limited;
"BAK Europe" are to our German subsidiary, BAK Europe GmbH;
"BAK Canada" are to our Canadian subsidiary, BAK Battery Canada Ltd.;
"BAK India" are to our Indian subsidiary, BAK Telecom India Private Limited;
"Shenzhen BAK" are to our PRC subsidiary, Shenzhen BAK Battery Co., Ltd.;
"BAK Tianjin" are to our PRC subsidiary, BAK International (Tianjin) Ltd.;
"BAK Battery" are to our PRC subsidiary, BAK Battery (Shenzhen) Co., Ltd.;
"BAK Asia" are to our Hong Kong subsidiary, China BAK Asia Holdings Limited;
"BAK Dalian" are to our PRC subsidiary, Dalian BAK Trading Co., Ltd.;
"Dalian BAK Power" are to our PRC subsidiary, Dalian BAK Power Battery Co., Ltd;
"China" and "PRC" are to the People's Republic of China;
"RMB" are to Renminbi, the legal currency of China;
"U.S. dollar," "$" and "US$" are to the legal currency of the United States;
"SEC" are to the United States Securities and Exchange Commission;
"Securities Act" are to the Securities Act of 1933, as amended; and
"Exchange Act" are to the Securities Exchange Act of 1934, as amended.

On December 27, 2013, Dalian BAK Power, a wholly owned subsidiary of BAK Asia, was incorporated in Dalian. Dalian BAK Power is expected to be engaged in the manufacture of the high power batteries.


Overview

We are a leading global manufacturer of lithium-based battery cells. We produce battery cells for OEM customers and replacement battery manufacturers that are the principal component of rechargeable batteries commonly used to power the following applications:

cellular phones and smartphones;
notebook computers, tablet computers and e-book readers;
portable consumer electronics, such as digital cameras, portable media players, portable gaming devices, personal digital assistants, or PDAs, camcorders, digital cameras and Bluetooth headsets; and
electric bicycles and other light electric vehicles, hybrid electric vehicles and other electric vehicles; cordless power tools; and uninterruptible power supplies, or UPS.

We conduct all of our manufacturing operations in China, in close proximity to China's electronics manufacturing base and its rapidly growing market. Historically, we have primarily manufactured prismatic lithium-ion cells for the cellular phone replacement battery market and the OEM market. Our products are packed into batteries by third-party battery pack manufacturers in accordance with the specifications of manufacturers of portable electronic applications. At the request of our customers that order prismatic battery packs, we assemble our prismatic cells into battery packs at our Shenzhen facility or engage battery pack manufacturers to assemble our cells into batteries for a fee, and then sell battery packs to these customers both for the replacement and OEM markets.

During the first quarter of fiscal year 2014, we continued the implementation of our business plan to expand our high-power lithium battery production capacity in response to evolving market demands. In particular, we developed and supplied cylindrical cell packs for use in high-capacity public-use electric vehicles as part of a strategic cooperation program for electric vehicle development with a major Taiwan-based automobile manufacturer at our Tianjin facility. We are also expanding our prismatic cell production capacity through improvements to our automatic production line for the smartphone market. During the transition period, we gradually reduced our supply to the replacement market. However, due to the intense competition in the lithium Li-ion battery market and that we are still in the process of transitioning to the high end market, our market shares decreased sharply. In addition, as we are facing a more challenging business environment and the Chinese government has placed tightening lending policies on state-owned banks in China, we encountered more difficulties in obtaining funds from local banks, and have a number of past due liabilities to suppliers and third party creditors.

We have experienced net losses during the past two fiscal years. We generated revenues of $42.4 million and $63.7 million for the three months ended December 31, 2013 and 2012, respectively, and net losses of $5.3 million and $28.2 million during the same periods, respectively. As of December 31, 2013, we had an accumulated deficit of $231.6 million and net liabilities of $48.6 million.

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 December 31, 2013. We have been suffering severe cash flow deficiencies. Because we defaulted on repayment of loans from Bank of China in August 2013, 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 to pledge 100% of our 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 our frozen properties were released by the court on January 13, 2014. As of December 31, 2013, we had access to $154.2 million in short-term credit facilities and $38.2 million in other lines of credit, almost all of which were utilized to the extent of short-term bank loans of $153.1 million and bills payable of $36.7 million, leaving only $2.6 million of short-term funds available under our credit facilities for additional cash needs 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 intend to sell our 100% equity interest in BAK International and its subsidiaries (including all their assets and liabilities), and the properties in Tianjin. We are in negotiations 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 initially lend us the aggregate amount of RMB370 million (approximately $61.1 million) . On January 14, 2014, BAK International entered into a corporate guarantee with Mr. Wang, 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, we entered into a corporate guarantee with Mr. Wang, to irrevocably and unconditionally guarantee timely performance by Shenzhen BAK of all its obligations under the Loan Agreement. In addition, on January 14, 2014, we and BAK International entered into a Share Mortgage with Mr. Wang, under which, China BAK Battery, Inc. pledges 100% of its 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. Up to the date of this quarterly report, we have received RMB370 million (approximately $61.1 million) pursuant to the Loan Agreement and an additional RMB150 million (approximately $24.8 million) from Mr. Wang.

In addition, we have entered a letter of intent with a potential buyer of BAK Tianjin for a consideration of RMB150 million (approximately $24.8 million) and the potential buyer agreed to lend us the aggregate amount of RMB130 million (approximately $21.5 million). Up to the date of this quarterly report, we have received RMB119.5 million (approximately $19.7 million).

Up to the date of this quarterly report, we had repaid RMB595.6 million (approximately $98.4 million) of bank loans.

After the disposal of these assets, we will retain BAK Asia and its subsidiaries, BAK Dalian and Dalian BAK Power. 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. During fiscal 2013, we received a subsidy of RMB150 million (approximately $24.8 million) from the Management Committee of Dalian Economic Zone, to finance our removal of operating assets from Tianjin to Dalian. We are building 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 vehicles, light electric vehicles and other high power applications. We believe with the significant reduction of liabilities and disposal of the 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.

First Quarter Financial Performance Highlights

The following are some financial highlights for the first quarter of our fiscal year ending September 30, 2014:

Net revenues: Net revenues decreased by $21.3 million, or 33.4%, to $42.4 million for the three months ended December 31, 2013, from $63.7 million for the same period in 2012.

Gross profit: Gross profit was $3.5 million for the three months ended December 31, 2013, a change of $7.7 million from a gross loss of $4.2 million for the same period in 2012.

Operating loss: Operating loss was $1.9 million for the three months ended December 31, 2013, an improvement of $16.0 million, or 89.4%, from an operating loss of $17.9 million for the same period in 2012.

Net loss: Net loss was $5.3 million for the three months ended December 31, 2013, a decrease of $22.9 million, or 81.2%, from $28.2 million for the same period in 2012.

Fully diluted net loss per share: Fully diluted net loss per share was $0.42 for the three months ended December 31, 2013, as compared to $2.23 for the same period in 2012.


Financial Statement Presentation

Net revenues. Our net revenues from sale of batteries 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. Rental income for commercial property leases and management is recognized on a straight-line basis over the respective lease terms.

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 and our property leases and management. 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 and depreciation.

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 other borrowings and are 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 is 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

Comparison of Three Months Ended December 31, 2013 and 2012

The following tables set forth key components of our results of operations for
the periods indicated, both in dollars and as a percentage of net revenues.

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

                               Three months ended December 31,              Change
                                  2012                 2013             $            %
Net revenues
   Manufacture of
batteries                  $         63,732    $          41,206   $  (22,526 )      (35.3 )
   Property lease and
management                                -                1,164        1,164        100.0
                           $         63,732    $          42,370   $  (21,362 )      (33.5 )
Cost of revenues
   Manufacture of
batteries                  $        (67,971 )  $         (38,560 ) $  (29,411 )      (43.3 )
   Property lease and
management                                -                 (309 )        309        100.0
Cost of revenues                    (67,971 )            (38,869 )    (29,102 )      (42.8 )
Gross (loss) profit                  (4,239 )              3,501       (7,740 )     (182.6 )
Operating expenses:
Research and development
expenses                              1,545                1,284         (261 )      (16.9 )
Sales and marketing
expenses                              2,188                1,453         (735 )      (33.6 )
General and administrative
expenses                              3,767                4,206          439         11.7
Provision for (recovery
of) doubtful accounts                 6,200               (1,557 )     (7,757 )     (125.1 )
Total operating expenses             13,700                5,386       (8,314 )      (60.7 )
Operating loss                      (17,939 )             (1,885 )    (16,054 )      (89.5 )
Finance costs, net                   (2,734 )             (3,894 )      1,160         42.4
Loss arising from loan
guarantees                           (7,361 )                  -       (7,361 )     (100.0 )
Government grant income                  18                   33          (15 )      (83.3 )
Other (expense) income                 (118 )                480         (598 )     (506.8 )
Income tax expenses                     (32 )                (16 )        (16 )      (50.0 )
Net loss                   $        (28,166 )  $          (5,282 ) $  (22,884 )      (81.2 )

Net revenues. Net revenues were $42.4 million for the three months ended December 31, 2013, as compared to $63.7 million for the same period in 2012, a decrease of $21.4 million, or 33.5% . This decrease was primarily attributable to the reduction in our revenue from our manufacture of batteries segment with revenue decreasing from $63.7 million for the three months ended December 31, 2012 to $41.2 million for the three months ended December 31, 2013, offset by an increase in our revenue from our property lease and management segment amounting $1.2 million. We leased out the Research and Development Test Centre starting from September 2013 onwards.


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

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

                                     Three Months Ended December 31,
                                        2012                 2013
Prismatic cells
   Aluminum-case cells           $          9,317    $          13,125
   Battery packs                           22,436               17,158
Cylindrical cells                          19,600                5,450
Lithium polymer cells                       6,935                1,600
High-power lithium battery cells            5,444                3,873
Total                            $         63,732    $          41,206

The following table sets forth the breakdown of our net revenues from reconditioned and normal products for the three months ended December 31, 2013 and 2012, respectively.

                                           Three Months Ended December 31, 2013
                                   Reconditioned sales     Normal sales     Total sales
Prismatic cells
   Aluminum-case cells           $              12,076   $        1,049   $      13,125
   Battery packs                                 6,238           10,920          17,158
Cylindrical cells                                    -            5,450           5,450
Lithium polymer cells                              865              735           1,600
High-power lithium battery cells                     -            3,873           3,873
Total                            $              19,179   $       22,027   $      41,206



                                           Three Months Ended December 31, 2012
                                   Reconditioned sales     Normal sales     Total sales
Prismatic cells
   Aluminum-case cells           $               5,726   $        3,591   $       9,317
   Battery packs                                 2,906           19,530          22,436
Cylindrical cells                                    -           19,600          19,600
Lithium polymer cells                            5,595            1,340           6,935
High-power lithium battery cells                     -            5,444           5,444
Total                            $              14,227   $       49,505   $      63,732

Net revenues from sales of aluminum-case cells increased to $13.1 million for the three months ended December 31, 2013, from $9.3 million in the same period in 2012, an increase of $3.8 million, or 40.9%, resulting from a rise of 134% in average selling price, offset by a decrease of 39.0% in sales volume. The decrease in sales volume was because of the decrease in demand for aluminum-case cells in view of the popularity of polymer smartphone batteries and fewer reconditioned products sold in this period. The increase in average selling price was because we disposed of a large quantity of obsolete and low quality products at a lower selling price in the same period last year.

Net revenues from sales of battery packs, which is a crucial component of smartphones, decreased to $17.2 million in the three months ended December 31, 2013, from $22.4 million in the same period in 2012, a decrease of $5.2 million, or 23.2% . This resulted from a decrease of 21.2% in sales volume as well as a decrease of 3.0% in average selling price. Due to our intense cash flow conditions in this period, some of our main cell phone customers reduced their orders and purchased more from our competitors. We continued to decrease our unit price in order to retain our market share and accordingly, the unit selling price dropped in this period as compared with the corresponding period of last year.

Net revenues from sales of cylindrical cells decreased to $5.5 million in the three months ended December 31, 2013, from $19.6 million in the same period in 2012, a decrease of $14.1 million, or 71.9% . This resulted from a decrease of 70.4% in sales volume accompanied with a decrease of 5.7% in average selling price. The decrease in sales volume and price were attributable to the fierce competition in cylindrical cells, especially from South Korean competitors. Our sales volume was adversely impacted by such competition and we had to reduce price in order to maintain our market share.


Lithium polymer cells are generally used for smart phones. We sold $1.6 million in lithium polymer cells for the three months ended December 31, 2013, compared to $6.9 million in lithium polymer cells in the same period in 2012, a decrease of $5.3 million, or 76.8%, resulting from a decrease of 76.2% in sales volume accompanied by a decrease of 3% in average selling price. Decrease in sale volume was mainly because fewer sales of reconditioned products in this period.

We also sold approximately $3.9 million in high-power lithium battery cells for the three months ended December 31, 2013, as compared to $5.4 million in high-power lithium battery cells in the same period in 2012, a decrease of $1.5 million, or 27.8%, resulting from both a decrease of 12.3% in sales volume and . . .

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