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HPJ > SEC Filings for HPJ > Form 10-K on 31-Mar-2014All Recent SEC Filings

Show all filings for HIGHPOWER INTERNATIONAL, INC.

Form 10-K for HIGHPOWER INTERNATIONAL, INC.


31-Mar-2014

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. On October 8, 2013, SZ Springpower further increased its registered capital to $15,000,000. SZ Highpower holds 69.97% of the equity interest of SZ Springpower, and HKHTC holds the remaining 30.03%.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 PRC, which commenced operations in July 2011.

SZ Highpower was founded in 2001 in the PRC. SZ Highpower formed GZ Highpower in September 2010. As of December 31, 2013, the paid-in capital of GZ Highpower was RMB30,000,000 ($4,807,847).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 Mainland 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 Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures 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, 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 these estimates.

Accounts Receivable. Accounts receivable are stated at original amount less an 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 the 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 believes 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 criteria exist: (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 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 includes raw materials, packing materials, work-in-progress, 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.

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 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 PRC 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 the US$. Assets and liabilities of HKHTC and the PRC 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, 2013 and 2012, both in dollars and as a percentage of net sales.

Consolidated Statements of
Operations                                             Year Ended December 31,
                                              2013                                    2012
                                        (in thousands except share and per share information)

Net Sales                               132,850              100.0              112,649           100.0 %

Cost of Sales                          (106,466 )            (80.1 %)           (88,943 )         (79.0 %)

Gross profit                             26,384               19.9 %             23,706            21.0 %

Research and development
expenses                                 (5,711 )             (4.3 %)            (4,611 )          (4.1 %)

Selling and distribution
expenses                                 (6,188 )             (4.7 %)            (5,348 )          (4.7 %)

General and administrative
expenses including
share-based compensation                (12,093 )             (9.1 %)           (11,479 )         (10.2 %)

Loss on exchange rate
difference                                 (553 )             (0.4 %)              (220 )          (0.2 %)

Gain on derivative
instruments                                 326                0.2 %                731             0.6 %

Income from operations                    2,165                1.6 %              2,779             2.5 %

Other income                              1,539                1.2 %                631             0.6 %

Interest expenses                        (1,647 )             (1.2 %)              (705 )          (0.6 %)

Income before tax                         2,057                1.5 %              2,705             2.4 %

Income tax expense                         (718 )              0.5 %             (1,133 )          (1.0 %)

Net income                                1,339                1.0 %              1,572             1.4 %

Less: loss attributable to
non-controlling interest                   (112 )             (0.1 %)              (145 )          (0.1 %)
Net income attributable to
the company                               1,451                1.1 %              1,717             1.5 %

Income per common share
- Basic                                    0.11                                    0.13
-Diluted                                   0.11                                    0.13

Weighted average common
shares outstanding
-Basic                               13,671,169                              13,582,106
-Diluted                             13,687,698                              13,582,106
Dividends declared per
common share                                  -                                       -

Years ended December 31, 2013 and 2012

Net sales for the year ended December 31, 2013 were $132.8 million compared to $112.6 million for the year ended December 31, 2012, an increase of $20.3 million, or 17.9%. The increase was due to a $20.0 million increase in net sales of our lithium batteries (resulting from a 49.6% increase in the volume of batteries per ampere hour sold and a 2.0% increase in the average selling price of such batteries) and a $1.1 million increase in net sales of our Ni-MH batteries (resulting from a 10.1% increase in the number of Ni-MH battery units sold which was partly offset a 7.9% decrease in the average selling price of such batteries) and a $843,058 decrease in revenue from our new material business. The increase in the number of Ni-MH battery units sold in 2013 was primarily attributable to increased orders from our new customers and the increase in the volume of lithium batteries sold in 2013 was primarily attributable to increased orders from our new and existing customers due to the growth in global demand for lithium batteries.

Cost of sales mainly consists of nickel, cobalt, lithium derived materials, labor, and overhead. Cost of sales were $106.5 million for the year ended December 31, 2013 as compared to $88.9 million for the comparable period in 2012. As a percentage of net sales, cost of sales increased to 80.1% for the year ended December 31, 2013 compared to 79.0% for the comparable period in 2012. This increase was attributable to increase in labor cost.

Gross profit for the year ended December 31, 2013 was $26.4 million, or 19.9% of net sales, compared to $23.7 million, or 21.0% of net sales, respectively, for the comparable period in 2012. 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 decrease was attributable to decrease in the average selling price of Ni-MH batteries and increase in labor cost.

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.

Research and development expenses were $5.7 million, or 4.3% of net sales, for the year ended December 31, 2013, as compared to $4.6 million, or 4.1% of net sales, for the comparable period in 2012. The increase of 23.9% was due to R&D activities in high end power batteries and systems in transportation and industrial energy storage areas, and the expansion of our workforce to improve research in basic materials and electrochemical system to increase battery energy density such as high voltage and silicon anode technologies, and fast charge performance, etc.

Selling and distribution expenses were $6.2 million, or 4.7% of net sales, for the year ended December 31, 2013 compared to $5.3 million, or 4.7% of net sales, for the comparable period in 2012, an increase of 15.7%. Selling and distribution expenses increased due to the expansion of our increased sales and marketing activities, including participation in industry trade shows and international travels to promote and sell our products abroad.

General and administrative expenses were $12.1 million, or 9.1% of net sales, for the year ended December 31, 2013, compared to $11.5 million, or 10.2% of net sales, for the comparable period in 2012. The increase was mainly due to the increase of overall management staff cost.

We experienced a loss of $552,669 and $220,597on the exchange rate difference between the U.S. Dollar and the RMB in the years ended December 31, 2013 and 2012, respectively. The loss in exchange rate difference 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 $326,222 in the year ended December 31, 2013, which included a gain of $519,750 on settled currency forwards and a loss of $193,528 on unsettled currency forwards, as compared to a gain of $730,591 for the comparable period in 2012, which included a gain of $493,882 on settled currency forwards and a gain of $236,709 on unsettled currency forwards.

Interest expense was $1.6 million for the year ended December 31, 2013, as compared to $705,218 which resulted from a $1.2 million of total interest expense deducted by capitalized interest expense of $541,998 for the respective comparable period in 2012. The change was $399,939 due to an increase in bank borrowings

Other income, which consists of bank interest income, government grants and sundry income, was $1.5 million for the year ended December 31, 2013, as compared to $630,842 for the year ended December 31, 2012, an increase of $907,676. The increase was mainly due to an increase of $387,299 in bank interest income and of $423,782 in government grants.

During the year ended December 31, 2013, we recorded a provision for income tax expense of $718,016, as compared to $1.1 million for the comparable period in 2012. The decrease was due to the net income during this period.

Net income attributable to the Company (excluding net loss attributable to non-controlling interest) for the year ended December 31, 2013 was $1.5million compared to net income attributable to the Company (excluding net loss attributable to non-controlling interest) of $1.7 million for the comparable period in 2012.

Liquidity and Capital Resources

We had cash and cash equivalents of approximately $8.0 million as of December 31, 2013, as compared to $6.6 million as of December 31, 2012. Our funds are kept in financial institutions located in the PRC, which do not provide insurance for amounts on deposit. Moreover, we are subject to the regulations of the PRC which restrict the transfer of cash from the PRC, except under certain specific circumstances. Accordingly, such funds may not be readily available to us to satisfy obligations which have been incurred outside the PRC.

In 2013, we completed the construction of our large scale lithium battery production facility in Huizhou. The Company has been leveraging from various Chinese banks to fund our expansion to meet the demand from the fast growing lithium battery market in mobile and portable consumer devices, vehicles of various sizes, and energy storage systems. As of December 31, 2013, we had in place general banking facilities with nine financial institutions aggregating $74.6 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, 2013, we had utilized approximately $45.3 million under such general credit facilities and had available unused credit facilities of $29.3 million. The Company's debt asset ratio reached 77% as of December 31, 2013.

The management of the Company has taken and will take a number of actions and will continue to address our high debt level in order to restore the Company to a sound financial structure with an appropriate business strategy going forward. These actions can include marketing more higher-margin lithium battery products and systems; controlling cost in operating expenses by improving management efficiency; and stock sales to strategic investors.

We believe that our existing balances of cash and cash equivalents and amounts expected to be provided by operating activities and stock sales will provide us with sufficient financial resources to meet our cash requirements for operations, working capital, and capital expenditures for the next twelve months.

However, in the event of unforeseen circumstances, unfavorable market developments or unfavorable results from operations, there can be no assurance that the above actions could be successfully implemented as expected, and cash flows may be adversely affected.

For the year ended December 31, 2013, net cash provided by operating activities was approximately $9.4 million, as compared to net cash provided by operating activities of $3.8 million for the comparable period in 2012. The net cash increase of $5.5 million provided by operating activities is primarily attributable to, among other items, a decrease of $7.9 million in cash outflow of accounts payable, a decrease of $5.7 million in cash outflow of other payables and accrued liability, which was significantly offset by a decrease of approximately $2.9 million in inflow from accounts receivable, a decrease of $2.7 million in prepayment and a decrease of 1.3 million in allowance for doubtful accounts .The cash outflow decreases in accounts payable was, to a great extent, attributable to the more favorable credit period granted by our suppliers .

Net cash used in investing activities was $20.0 million for the year ended December 31, 2013 compared to $13.0 million for the comparable period in 2012. The net increase of $7.0 million cash used in investing activities was primarily attributable to an increase in spending on the construction and deployment of plant and equipment in 2013 for the Huizhou factory that is expected to commence operation in the first quarter of 2014. We are equipping the factory with new and more advanced manufacturing capability machines.

Net cash provided by financing activities was $11.4 million for the year ended December 31, 2013 as compared to net cash provided by financing activities of $10.0 million for the comparable period in 2012. The net increase of $1.4 million cash provided by financing activities was primarily attributable to an increase of $19.5 million in proceeds from short-term bank loans, a decrease of $2.9 million in repayment of letters of credit, an decrease of $14.3 million in restricted cash, which was partly offset by an increase of $15.0 million in repayment of short-term bank loans, an increase of $8.8 million in repayment of notes payable, a decrease of $1.1 million in proceeds from notes payable and an increase of $1.6 million in repayment long-term bank loans.

For fiscal year 2013 and 2012, our inventory turnover was 5.8 and 5.9 times, respectively. The average days outstanding of our accounts receivable at December 31, 2013 was 80 days, as compared to 74 days at December 31, 2012. Inventory turnover and average days outstanding of accounts receivables are key operating measures that management relies on to monitor our business.

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 $134,480 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 30 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: (i) paying our suppliers under payment terms ranging from 60 to 120 days; and (ii) 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, 2013 and the guarantors of each loan:

                                              Amount        Unused line
              Name of Bank                   Granted         of credit       Maturity date   Guaranteed by
Bank of China                              $  3,689,129     $    247,582       1/25/2014     Dang Yu Pan
Bank of China                                12,707,001        1,674,876       1/10/2014     Dang Yu Pan
Ping An Bank Co., Ltd                      $ 11,477,291     $  7,564,027       9/17/2014     Dang Yu Pan
China Everbright Bank                      $  8,438,433     $  1,382,194       5/29/2014     Dang Yu Pan
China Everbright Bank                         1,147,729                -       9/3/2014      Dang Yu Pan
Industrial and Commercial Bank of China    $  6,558,452     $  1,803,574       7/25/2015     Dang Yu Pan
China Citic Bank                           $  7,378,259     $  5,738,646       3/29/2014     Dang Yu Pan
Industrial Bank Co., Ltd                   $  8,198,065     $  6,558,452       7/24/2014     Dang Yu Pan
Jiang Su Bank Co., Ltd                     $  4,918,839                -       6/20/2014     Dang Yu Pan
The Shanghai Commercial & Saving bank      $  3,000,000        1,250,000       8/29/2014     -
. . .
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