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CBAK > SEC Filings for CBAK > Form 10-Q on 20-May-2014All Recent SEC Filings

Show all filings for CHINA BAK BATTERY INC

Form 10-Q for CHINA BAK BATTERY INC


20-May-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 manufacturing 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 second 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 since fiscal 2008. We generated revenues from the manufacture of lithium ion rechargeable batteries of $32.8 million and $44.1 million for the three months ended March 31, 2014 and 2013, respectively. We also generated revenues from property lease and management of $1.4 million and $nil for the three months ended March 31, 2014 and 2013, respectively. We recorded net losses of $9.3 million and $19.7 million during the same periods, respectively. As of March 31, 2014, we had an accumulated deficit of $240.9 million and net liabilities of $56.5 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 March 31, 2014. 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 ordered a freeze of all of our properties in Shenzhen BAK Industrial Park and Tianjin Industrial Park Zone near the end of fiscal year 2013. 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. In order to extend the bank loans to various dates to March 2015, we were required to pledge our assets in Shenzhen, including land use rights and property rights, equipment and inventories. As of March 31, 2014, we had access to $67.1 million in short-term credit facilities and $25.8 million in other lines of credit, almost all of which were utilized to the extent of short-term bank loans of $65.3 million and bills payable of $25.8 million, leaving only $1.8 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 have intentions to dispose of our 100% equity interest in BAK International and its subsidiaries (including all their assets and liabilities), and the properties in Tianjin. Prior to the completion of these disposals, the potential buyers lent loans to the Company to help us repay past due and maturing bank loans.


In December 2013 and January 2014, Mr. Jinghui Wang, the sole shareholder of the potential buyer of BAK International, lent a total of $83.7 million (RMB520 million) to us which is secured by our 100% equity interest in BAK International, guaranteed by BAK International and us, bearing interest at 20% per annum and repayable by March 31, 2014. In April 2014, we received a notice from Mr. Wang claiming that we defaulted on repayment of loans and interest accrued up to March 31, 2014 totaling approximately $87.7 million (RMB545 million), demanding immediate payment. Prior to receipt of the notice from Mr. Wang, we had been negotiating with Mr. Wang for a settlement of amounts owed by us, and following receipt of the notice, we continue to work with Mr. Wang towards a settlement. We cannot, however, give assurance that we and Mr. Wang will be able to reach a mutually satisfactory settlement agreement. If no settlement is reached, Mr. Wang may foreclose on the ownership of BAK International, which constitutes a substantial portion of our total assets.

In November 2013 and January 2014, Tianjin Zhantuo, the potential buyer of our Tianjin campus land use rights and properties, lent a total of $19.2 million (RMB119.5 million) to us pursuant to a loan agreement whereby Tianjin Zhantuo agreed to provide loan financing to us to the extent of $20.9 million (RMB130 million) to help us repay the bank loans upon maturities. The loans from Tianjin Zhantuo are interest-free, secured by the other receivable due from Tianjin Zhantuo amounting $6.4 million (RMB39.7 million) and repayable on demand.

Starting from the three months ended December 31, 2014, we are also engaged in the business segment of property lease and management of our Research and Development Centre in Shenzhen, which was completed in July 2013.

If these assets are disposed , 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 $24.1 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.

Second Quarter Financial Performance Highlights

The following are some financial highlights for the second quarter of our 2014 fiscal year:

Net revenues: Net revenues decreased by $9.7 million, or 22.2%, to $34.3 million for the three months ended March 31, 2014, from $44.0 million for the same period in 2013.

Gross profit: Gross profit was $3.7 million for the three months ended March 31, 2014, an improvement of $7.2 million from a gross loss of $3.6 million for the same period in 2013.

Operating loss: Operating loss was $2.8 million for the three months ended March 31, 2014, an improvement of $13.8 million, or 83.2%, from an operating loss of $16.6 million for the same period in 2013.

Net loss: Net loss was $9.3 million for the three months ended March 31, 2014, a decrease of $10.4 million, or 52.9%, from $19.7 million for the same period in 2013.

Fully diluted net loss per share: Fully diluted net loss per share was $0.73 for the three months ended March 31, 2014, as compared to $1.56 for the same period in 2013.


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. A provision for sales returns is 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 activities, 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, 2013 and up to October 2014. BAK Battery is subject to an income tax rate of 25%. Both of companies did not incur any enterprise income tax for the calendar years 2013 and 2014 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 March 31, 2014 and 2013

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 March 31,         Change
                                   2013                2014        $                 %
Net revenues
Manufacture of batteries     $        44,066    $         32,838   $  (11,228 )      (25.5 )
Property lease and manager                 -               1,446        1,446        100.0
                             $        44,066    $         34,284   $   (9,782 )      (22.2 )
Cost of revenues
Manufacture of batteries     $       (47,619 )  $        (30,323 ) $   17,296         36.3
Property lease and
management                                                  (309 )        309        100.0
Cost of revenues             $       (47,619 )  $        (30,632 ) $  (16,987 )       35.7
Gross (loss) profit                   (3,553 )             3,652        7,205        202.8
Operating expenses:
Research and development
expenses                               1,315               1,227          (88 )       (6.7 )
Sales and marketing expenses           1,915               1,244         (671 )      (35.0 )
General and administrative
expenses                               5,308               3,786       (1,522 )      (28.7 )
(Recovery of) provision for
bad debt provision                    (6,900 )               188        7,088        102.7
Impairment charge on
property, plant and
equipment                             11,396                   -      (11,396 )     (100.0 )
Total operating expenses              13,034               6,445       (6,589 )      (50.6 )
Operating loss                       (16,587 )            (2,793 )     13,794         83.2
Finance costs, net                    (1,705 )            (6,699 )     (4,994 )     (292.9 )
Recovery of loss arising
from loan guarantees                   4,550                   -       (4,550 )     (100.0 )
Government grant income                    -                  19           19        100.0
Other income                              48                 208          160        333.3
Income tax expenses                   (5,994 )                 -        5,994        100.0
Net loss                     $       (19,688 )  $         (9,265 ) $   10,423         52.9

Net revenues. Net revenues were $34.3 million for the three months ended March 31, 2014, as compared to $44.0 million for the same period in 2013, representing a decrease of $9.7 million, or 22.2% . This decrease was primarily attributable to the reduction in our revenue from our manufacture of batteries segment with revenue decreasing from $44.0 million for the three months ended March 31, 2013 to $32.8 for the three months ended March 31, 2014, offset by an increase in our revenue from our property lease and management segment amounting $1.4 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 March 31,
                                       2013                2014
Prismatic cells
   Aluminum-case cells           $         8,987    $          8,000
   Battery packs                          17,384              15,591
Cylindrical cells                         10,691                 487
Lithium polymer cells                      2,916               5,582
High-power lithium battery cells           4,088               3,178
Total                            $        44,066    $         32,838

The following table sets forth the breakdown of our net revenues from reconditioned and normal products for the three months ended March 31, 2014 and 2013, respectively.

                                            Three months ended March 31, 2014
                                   Reconditioned sales     Normal sales     Total sales
Prismatic cells
   Aluminum-case cells           $               6,464   $        1,536   $       8,000
   Battery packs                                    53           15,538          15,591
Cylindrical cells                                    -              487             487
Lithium polymer cells                            5,401              181           5,582
High-power lithium battery cells                     -            3,178           3,178
Total                            $              11,918   $       20,920   $      32,838



                                            Three months ended March 31, 2013
                                   Reconditioned sales     Normal sales     Total sales
Prismatic cells
   Aluminum-case cells           $               7,270   $        1,717   $       8,987
   Battery packs                                 7,287           10,097          17,384
Cylindrical cells                                    -           10,691          10,691
Lithium polymer cells                              316            2,600           2,916
High-power lithium battery cells                     -            4,088           4,088
Total                            $              14,873   $       29,193   $      44,066

Net revenues from sales of aluminum-case cells decreased to $8.0 million for the three months ended March 31, 2014, from $9.0 million in the same period in 2013, a decrease of $1.0 million, or 11.0%, resulting from a rise of 52.9% in average selling price, offset by a decrease of 41.7% in sales volume. The decrease in sales volume was because of the continuing 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 corresponding period of last year.

Net revenues from sales of battery packs, which are a crucial component of smartphones, decreased to $15.6 million in the three months ended March 31, 2014, from $17.4 million in the same period in 2013, a decrease of $1.8 million, or 10.3% . This resulted from a decrease of 11.9% in sales volume, partially offset by a slight increase of 2.2% in average selling price. Due to our difficult cash flow conditions in this period, some of our main cell phone customers reduced their orders from us and purchased more from our competitors.


Net revenues from sales of cylindrical cells decreased to $0.5 million in the three months ended March 31, 2014, from $10.7 million in the same period in 2013, a decrease of $10.2 million, or 95.5% . This resulted from a decrease of 94.6% in sales volume accompanied by a decrease of 15.3% 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 remain competitive.

Lithium polymer cells are generally used for smart phones. We sold $5.6 million in lithium polymer cells for the three months ended March 31, 2014, compared to $2.9 million in lithium polymer cells in the same period in 2013, an increase of $2.7 million, or 91.4%, resulting from an increase of 131.7% in sales volume partially offset by a decrease of 17.8% in average selling price. The decrease in price was attributable to the fierce competition in the battery market. Increase in sales volume was mainly because of more sales of reconditioned products in this period. We made more marketing efforts to sell our reconditioned polymer cells in order to generate quicker cash.

We also sold approximately $3.2 million in high-power lithium battery cells for the three months ended March 31, 2014, as compared to $4.1 million in high-power lithium battery cells in the same period in 2013, a decrease of $0.9 million, or 22.2%, resulting from a decrease of 55.5% in sales volume partially offset by an increase of 74.0% in average selling price. The light electric vehicle market was becoming more competitive. We intend to give up low value customers while trying to retain high-end customers.

Cost of revenues. Cost of revenues decreased to $30.6 million for the three months ended March 31, 2014, as compared to $47.6 million for the same period in 2013, a decrease of $17.0 million, or 35.7% . Included in cost of revenues were write-downs of inventories of $6.5 million and $1.0 million for the three months . . .

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