TMCnet News
CHINA BAK BATTERY INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.(Edgar Glimpses Via Acquire Media NewsEdge) 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, 2012, 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: º "Company," "we," "us" and "our" are to the combined business of China BAK Battery, Inc., a Nevada corporation, and its consolidated subsidiaries; º "BAK International" are to our Hong Kong subsidiary, BAK International Limited; º "BAK Europe" are to our German subsidiary, BAK Europe GmbH; º "BAK Canada" are to our Canadian subsidiary, BAK Battery Canada Ltd.; º "BAK India" are to our Indian subsidiary, BAK Telecom India Private Limited; º "Shenzhen BAK" are to our PRC subsidiary, Shenzhen BAK Battery Co., Ltd.; º "BAK Tianjin" are to our PRC subsidiary, BAK International (Tianjin) Ltd.; º "BAK Electronics" are to our PRC subsidiary, BAK Electronics (Shenzhen) Co., Ltd.; º "Tianjin Meicai" are to our PRC subsidiary, Tianjin Meicai New Material Technology Co., Ltd.; º "China" and "PRC" are to People's Republic of China; º "RMB" are to Renminbi, the legal currency of China; º "U.S. dollar," "$" and "US$" are to the legal currency of the United States; º "SEC" are to the United States Securities and Exchange Commission; º "Securities Act" are to the Securities Act of 1933, as amended; and º "Exchange Act" are to the Securities Exchange Act of 1934, as amended. 2 -------------------------------------------------------------------------------- We completed a reverse stock split on October 26, 2012, pursuant to which every five shares of our common stock were combined into one share of common stock. All references in this report to share and per share data have been adjusted, including historical data which have been retroactively adjusted, to give effect to the reverse stock split unless specified otherwise. 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: º cellular phones and smartphones; º notebook computers, tablet computers and e-book readers; º 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 º 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 2013, we continued the implementation of our business plan to expand our lithium-ion polymer and 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. We also expanded our prismatic cell production capacity for the smartphone market. During the transition period, we gradually reduced our supply to the replacement market. As a result, we have derived and expect to continue to derive an increasing portion of our revenues from these other products. We have experienced net losses during the past two fiscal years and for the current quarter ended December 31, 2012. We generated revenues of $63.7 million and $71.8 million for the three months ended December 31, 2012 and 2011, respectively, and net losses of $25.2 million and $1.8 million during the same periods, respectively. However, we believe that our accomplishments to date, as well as our business plan, will yield long-term growth of revenues and positive net income. To help us finance and expand our operations, we had access to $218.1 million in short-term credit facilities and $24.1 million in long-term credit facilities as of December 31, 2012. As of December 31, 2012, the principal outstanding amounts included short-term bank loans of $157.4 million under credit facilities and long-term bank loans of $22.3 million maturing in over one year, and bills payable of $75.8 million under credit facilities, leaving $32.6 million of short-term funds available under our credit facilities for additional cash needs. We had a working capital deficiency, accumulated deficit from recurring net losses incurred for the current and prior periods as of December 31, 2012 and significant short-term debt obligations maturing in less than one year. These factors raise substantial doubts about our ability to continue as a going concern. Accordingly, we have continued to develop a strategic plan. Under this plan, we will continue to increase our presence in the OEM market both domestically and internationally with more aggressive marketing strategies to expand and secure our market base. We will also continue to implement measures to reduce both manufacturing costs and operating expenses, improve profit margins as well as reduce receivable turnover days through stronger credit controls. 3 -------------------------------------------------------------------------------- First Quarter Financial Performance Highlights The following are some financial highlights for the first quarter of our fiscal year ended September 30, 2013: º Net revenues: Net revenues decreased by $8.0 million, or 11.2%, to $63.7 million for the three months ended December 31, 2012, from $71.8 million for the same period in 2011. º Gross loss: Gross loss was $4.2 million for the three months ended December 31, 2012, a change of $18.2 million from gross profit of $14.0 million for the same period in 2011. º Operating loss: Operating loss was $15.1 million for the three months ended December 31, 2012, a change of $17.4 million from operating income of $2.3 million for the same period in 2011. º Net loss: Net loss was $25.2 million for the three months ended December 31, 2012, an increase of $23.4 million, or 1,286%, from $1.8 million for the same period in 2011. º Fully diluted net loss per share: Fully diluted net loss per share was $2.00 for the three months ended December 31, 2012, as compared to $0.14 for the same period in 2011. 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. Government grant income for the three months ended December 31, 2012 mainly consisted of receipt of grants to fund certain lithium battery research projects and to subsidize the payment for land use rights of BAK Industrial Park. No present or future obligation arises from the receipt of such amount. Finance costs, net. Finance costs consist primarily of interest income, interest on bank loans, net of capitalized interest, and bank charges. Income taxes. On March 16, 2007, the National People's Congress of China passed the EIT Law, and on November 28, 2007, the State Council of China passed its implementing rules, both of which took effect on January 1, 2008. The EIT Law unifies the application scope, tax rate, tax deduction and preferential policy for both domestic enterprises and FIEs. The EIT Law gives existing FIEs a five-year grandfather period during which they can continue to enjoy their existing preferential tax treatments. 4 -------------------------------------------------------------------------------- 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 Electronics' 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 Electronics did not incur any enterprise income tax for the calendar year 2012 due to the current tax losses carried forward from calendar years 2010 and 2011. 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 are deposited in bonded warehouses are exempt from import VAT. Results of Operations Comparison of Three Months Ended December 31, 2012 and 2011 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, 2012 2011 Change % Change Net revenues $ 63,732 $ 71,755 $ (8,023 ) (11.2 ) Cost of revenues 67,971 57,724 10,247 17.8 Gross (loss) / profit (4,239 ) 14,031 (18,270 ) (130.2 ) Operating expenses: Research and development expenses 1,567 1,244 323 26.0 Sales and marketing expenses 2,188 1,958 230 11.7 General and administrative 7,089 5,789 1,300 22.5 expenses Impairment charge - 2,708 (2,708 ) (100.0 ) Total operating expenses 10,844 11,699 (855 ) (7.3 ) Operating loss/(income) (15,083 ) 2,332 (17,415 ) (746.8 ) Finance costs, net (2,734 ) (2,882 ) 148 5.1 Loss arising from loan guarantees (7,361 ) - (7,361 ) (100.0 ) Government grant income 103 825 (722 ) (87.5 ) Other (expense)/income (118 ) 19 (137 ) (721 ) Income tax expenses (32 ) (2,114 ) 2,082 (98.5 ) Net loss $ (25,225 ) $ (1,820 ) $ (23,405 ) 1,286.0 5 -------------------------------------------------------------------------------- Net revenues. Net revenues were $63.7 million for the three months ended December 31, 2012, as compared to $71.8 million for the same period in 2011, a decrease of $8.0 million, or 11.2%. 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 2011 Prismatic cells Aluminum-case cells $ 9,317 $ 34,251 Battery packs 22,436 20,839 Cylindrical cells 19,600 12,973 Lithium polymer cells 6,935 2,634 High-power lithium battery cells 5,444 1,058 Total $ 63,732 $ 71,755 Net revenues from sales of aluminum-case cells decreased to $9.3 million in the three months ended December 31, 2012, from $34.3 million in the same period in 2011, a decrease of $24.9 million, or 72.8%, resulting from a decrease in sales volume of 32.4% accompanied by a decrease in our average selling price of 59.8%. This was mainly due to the adjustments in our marketing strategy to focus on high end markets and high-value customers thereby increasing sales of lithium-ion polymer smartphone batteries and reducing sales of of aluminum-case cells. The polymer batteries have a higher capacity and are safer than prismatic batteries and therefore more suitable for use in smartphones. This also led to a sharp drop in the price of prismatic cells. Net revenues from sales of battery packs increased to $22.4 million in the three months ended December 31, 2012, from $20.8 million in the same period in 2011, an increase of $1.6 million, or 7.7%. This resulted from an increase in sales volume of 5.1% as well as an increase in the average price of 2.5%. There was a strong market demand for our battery packs during this period. Net revenues from sales of cylindrical cells increased to $19.6 million in the three months ended December 31, 2012, from $13.0 million in the same period in 2011, an increase of $6.6 million, or 51.1%. This resulted from an increase in sales volume of 59.9%, offset by a decrease in our average selling price of 5.5%. The increase in sales volume was mainly attribute to the strong market demand and our effort to expand our market share. We sold $6.9 million in lithium polymer cells for the three months ended December 31, 2012, compared to $2.6 million in lithium polymer cells in the same period in 2011, an increase of $4.3 million, or 163.3%, resulting from an increase in sales volume of 738.7%, offset by a decrease in the average selling price 68.6%. The increase in sales volume was mainly due to the increased demand for our lithium polymer cells from the booming smartphone market. Also, the market price of polymer decreased this year due to increased competition from more manufacturers. We also sold approximately $5.4 million in high-power lithium battery cells for the three months ended December 31, 2012, as compared to $1.1 million in high-power lithium battery cells in the same period in 2011, resulting from an increase in sales volume of 429.2%, offset by a decrease in the average selling price of 2.8%. This was mainly due to the increased demand from the electric bicycle market, especially electric car manufacturers. Cost of revenues. Cost of revenues increased to $68.0 million for the three months ended December 31, 2012, as compared to $57.7 million for the same period in 2011, an increase of $10.3 million, or 17.8%. The increase in cost of revenues was due to the increase in raw material cost and labor cost. In addition, we disposed of obsolete inventories with higher costs in the current quarter. 6 -------------------------------------------------------------------------------- Gross (loss) / profit. Gross loss for the three months ended December 31, 2012 was $4.2 million, or 6.6% of net revenues, as compared to gross profit of $14.0 million, or 19.6% of net revenues, for the same period in 2011. Our significant change from gross profit to gross loss was largely due to the significant decrease in sales of lithium prismatic cells and the sale of low priced and obsolete products with low or even negative gross margin as a result of severe market competition. Research and development expenses. Research and development expenses increased to $1.5 million for the three months ended December 31, 2012, as compared to $1.2 million for the same period in 2011, an increase of $0.3 million, or 26.0%. This increase was mainly due to an increase in certification fees of $0.2 million. Sales and marketing expenses. Sales and marketing expenses increased to $2.2 million for the three months ended December 31, 2012, as compared to $2.0 million for the same period in 2011, an increase of $0.2 million, or 11.7%, primarily due to the increase in transportation and packing expenses of $0.3 million. As a percentage of revenues, sales and marketing expenses increased to 3.4% for the three months ended December 31, 2012, from 2.7% for the same period in 2011, primarily due to the decrease in revenue. General and administrative expenses. General and administrative expenses increased to $7.1 million, or 11.1% of revenues, for the three months ended December 31, 2012, as compared to $5.8 million, or 8.1% of revenues, for the same period in 2011, an increase of $1.3 million, or 22.5%. The primary reason for the increase was that bad debt provision increased by $2.2 million. Other G&A expense decreased in the first quarter of fiscal 2013 as compared to the same quarter in fiscal 2012 due to the Company's efforts to cut costs and expenses in order to improve working capital. Property, plant and equipment impairment charge. There was no impairment on property, plant and equipment for the three months ended December 31, 2012, as compared to a $2.7 million impairment charge for the same period in 2011. During the course of our strategic review of our operations for the three months ended December 31, 2012 and 2011, we assessed the recoverability of the carrying value of certain property, plant and equipment which resulted in impairment losses of $nil and $2.7 million, respectively, from an assessment that the total net book value of assets was lower than their undiscounted cash flows from the identified cash-generating unit. Operating (loss)/income. As a result of the above, our operating loss totaled $15.1 million for the three months ended December 31, 2012, as compared to operating income of $2.3 million for the same period in 2011. As a percentage of net revenues, our operating loss was 23.7% for the three months ended December 31, 2012, as compared to operating income of 3.3% for the same period in 2011. Finance costs, net. Finance costs, net, decreased to $2.7 million for the three months ended December 31, 2012, as compared to $2.9 million for the same period in 2011, an decrease of $0.2 million, or 5.1%. The decrease in net finance costs is mainly attributable to the increase in capitalized interest of $0.56 million for the three months ended December 31, 2012. Government grant income / Loss arising from loan guarantees/ Other (expenses)/income. Government grant income was approximately $103,000 and other loss was approximately $118,000 for the three months ended December 31, 2012, as compared to government grant income of $825,000 and other income of $19,000 for the same period in 2011. Shenzhen Langjin Technology Development Co. Ltd. had defaulted on bank loans guaranteed by us and the bank demanded full payment from us. A loss of $7,360,706 was recognized in the three months ended December 31, 2012. Income tax expense. Income tax expense was approximately $32,000 for the three months ended December 31, 2012, as compared to $2.1 million income tax expenses for the same period in 2011.This was mainly due to the recognition of a $2.1 million deferred income tax charge in the same period of 2011. Net loss. As a cumulative result of the foregoing, we had a net loss of $25.2 million for the three months ended December 31, 2012, compared to a net loss of $1.8 million for the three months ended December 31, 2011. Liquidity and Capital Resources We have historically financed our liquidity requirements from a variety of sources, including short-term bank loans, long-term bank loans and bills payable under bank credit agreements, factoring of bills receivable to banks and issuance of capital stock. As of December 31, 2012, we had cash and cash equivalents of $9.3 million. In addition, we had pledged deposits amounting to $4.9 million. Typically, banks will require borrowers to maintain deposits of approximately 10% to 100% of the outstanding loan balances and bills payable. The individual bank loans have maturities ranging from six to twelve months which coincide with the periods the cash remains pledged to the banks. 7 -------------------------------------------------------------------------------- As of December 31, 2012, we had access to $218.1 million in short-term credit facilities and $24.1 million in long-term credit facilities. As of December 31, 2012, the principal outstanding loan amounts included short-term bank loans of $157.4 million under credit facilities and long-term bank loans of $22.3 million maturing in over one year, and bills payable of $75.8 million under credit facilities, leaving $32.6 million of short-term and $1.8 million of long-term funds available under our credit facilities for additional cash needs. The following table sets forth a summary of our cash flows for the periods indicated: |