12,626,264 Shares
CHINA BAK BATTERY, INC. Filed Pursuant to Rule 424(b)(3)
Registration No. 333-122209
Prospectus Common Stock
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This is an offering of 12,626,264 shares of the common stock, $.001 par
value per share, of China BAK Battery, Inc. by the selling stockholders
identified elsewhere in this prospectus. The shares are being registered to
permit public secondary trading of the shares that are being offered by the
selling stockholders named in this prospectus. We will not receive any of the
proceeds from the sale of the shares.
The selling stockholders may, but are not obligated to, offer all or
part of their shares for resale from time to time through public or private
transactions including underwritten offerings, at either prevailing market
prices or at privately negotiated prices. See "Plan of Distribution" below.
Our common stock is currently quoted on the Over-the-Counter Bulletin
Board under the symbol "CBBT." On March 24, 2006, the last reported sales price
on our common stock was $9.22 per share.
Investing in our common stock involves risks. See "Risk Factors"
beginning on page 3 to read about factors you should consider before buying
shares of our common stock.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is a
criminal offense.
The date of this prospectus is April 5, 2006.
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ABOUT THIS PROSPECTUS
You should rely only on the information contained in this document or
any other document to which we refer you. Neither we nor the selling
stockholders have authorized anyone to provide you with different information.
If anyone provides you with different or inconsistent information, you should
not rely on it. Neither we nor the selling stockholders are making an offer to
sell these securities in a jurisdiction where the offer or sale is not
permitted. The information contained in this document is current only as of its
date, regardless of the time of delivery of this prospectus or of any sales of
shares of common stock. Our business, financial condition, results of operations
and prospects may have changed since that date.
TABLE OF CONTENTS
PROSPECTUS SUMMARY.............................................................1
RISK FACTORS...................................................................3
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS.............................14
MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND DIVIDEND POLICY....15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATION AND FINANCIAL
CONDITION.................................................................18
OUR BUSINESS..................................................................31
DIRECTORS AND EXECUTIVE OFFICERS..............................................42
PRINCIPAL STOCKHOLDERS........................................................45
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS..........................46
DESCRIPTION OF OUR COMMON STOCK...............................................47
SELLING STOCKHOLDERS..........................................................47
SHARES ELIGIBLE FOR FUTURE SALE...............................................52
PLAN OF DISTRIBUTION..........................................................52
INDEPENDENT PUBLIC ACCOUNTANTS................................................54
LEGAL MATTERS.................................................................54
EXPERTS.......................................................................54
INTERESTS OF NAMED EXPERTS AND COUNSEL........................................54
DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT
LIABILITIES...............................................................54
WHERE YOU CAN FIND MORE INFORMATION...........................................54
FINANCIAL STATEMENTS ........................................................F-1
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PROSPECTUS SUMMARY
This summary highlights selected information about us and the offering
that is contained elsewhere in this prospectus. You should read the entire
prospectus before making an investment decision, especially the information
presented under the heading "Risk Factors" on page 3 and the financial
statements and related notes included elsewhere in this prospectus, as well as
the other documents to which we refer you. Except as otherwise indicated by the
context, references in this prospectus to "we," "us," or "our" are to the
combined business of China BAK Battery, Inc. ("CBBI") and its wholly-owned
direct subsidiary, BAK International, Ltd. ("BAK International") and BAK
International's wholly-owned subsidiaries, Shenzhen BAK Battery Co., Ltd. ("BAK
Battery") and BAK Electronics (Shenzhen) Co., Ltd. ("BAK Electronics"), and in
each case does not include the selling stockholders. References to "China" or to
the "PRC" are references to the People's Republic of China. All references to
"dollars" or "$" refers to United States dollars.
Our Business
We are engaged in the manufacture, commercialization and distribution
of a wide variety of standard and customized lithium ion rechargeable batteries
for use in a wide array of applications. We believe that our technologies allow
us to offer batteries that are flexibly configured, lightweight and generally
achieve longer operating time than many competing batteries currently available.
We have focused on manufacturing a family of replacement lithium batteries for
cellular telephones. We also supply rechargeable lithium ion batteries for use
in various other portable electronic applications, including high-power handset
telephones, laptop computers, digital cameras, video camcorders, MP3 players and
general industrial applications.
Historically, we have manufactured three types of batteries: steel
cell, aluminum cell and cylindrical cell. We deliver our products to packing
plants operated by third parties where the bare cells are packed in accordance
with specifications established by certain manufacturers of cellular telephones
and other electronic products. The majority of our income is generated from the
sale of steel cells. However, we believe there is growth potential for aluminum
and cylindrical cells because of their wide applications. In September 2005 we
began producing a fourth type of battery, lithium polymer.
Our current growth strategy includes entering into the global original
equipment manufacture ("OEM") battery market for cellular telephone brands and
portable electronic applications. We have developed a program for producing high
power lithium ion battery cells which may allow us inroads into additional
battery markets such as those for power tools. We have begun marketing our high
power lithium ion battery cells.
We have internal research and development facilities engaged primarily
in furthering lithium ion related technologies. We operate sales and service
branches in Beijing and seven principal coastal cities in the PRC.
Our Corporate Information
We originally began operations as a Nevada corporation known as "Medina
Copy, Inc." We were incorporated in Nevada on October 4, 1999, and subsequently
changed our name to "Medina Coffee, Inc." ("Medina Coffee") on October 6, 1999.
Medina Coffee commenced operations on December 1, 2002 and was considered a
development stage company. Medina Coffee was formed originally for the purpose
of building a retail specialty coffee business that sold specialty coffee and
espresso drinks through company owned and operated espresso carts. Medina Coffee
had incurred operating losses from its inception, and therefore looked to
combine with a privately-held company that was profitable or that management
considered to have growth potential.
On January 20, 2005 we completed a stock exchange transaction with the
stockholders of BAK International, which is a Hong Kong company. The exchange
was consummated under Nevada law pursuant to the terms of a Securities Exchange
Agreement dated effective as of January 20, 2005 by and among Medina Coffee, BAK
International and the stockholders of BAK International. Pursuant to the
Securities Exchange Agreement, we issued 39,826,075 shares of our common stock,
par value $0.001 per share, to the stockholders of BAK International,
representing approximately 97.2% of our post-exchange issued and outstanding
common stock, in exchange for 100% of the outstanding capital stock of BAK
International. Effective February 14, 2005, we changed our name from Medina
Coffee, Inc. to China BAK Battery, Inc. Prior to and in connection with the
completion of
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the stock exchange with BAK International, BAK International sold 8,600,433
shares of its common stock to certain of the selling stockholders in a private
placement and agreed to register with the Securities and Exchange Commission
("SEC") the resale by the selling stockholders of the shares of our common stock
upon completion of the exchange of the shares of common stock in BAK
International held by the selling stockholders for our shares pursuant to the
Stock Exchange Agreement.
Our corporate headquarters is located at BAK Industrial Park, No. 1 BAK
Street, Kuichong Town, Longgang District, Shenzhen, People's Republic of China.
Our telephone number there is (86-755) 8977-0093.
Registration of Other Shares
We have filed with the SEC a registration statement on Form SB-2 (file
number 333-130247), as amended, registering the resale of 8,531,852 shares of
our common stock by certain selling stockholders as described therein. If and
when such registration statement is declared effective, the offers and sales of
the shares covered by such registration statement by those selling stockholders
could occur simultaneously with offers and sales of the shares to which this
prospectus relates. See "Risk Factors -- Risks Related to our Common Stock."
The Offering
Common stock outstanding prior to and to
be outstanding after this offering............48,878,396 shares
Common stock offered by us...................We are not offering any shares for
sale pursuant to this prospectus.
Common stock offered by the selling
stockholders.................................12,626,264 shares
Total shares of common stock offered
pursuant to this prospectus..................12,626,264 shares
Method of offering...........................The selling stockholders may offer
and sell their shares in one or
more types of transactions,
including in ordinary brokerage
transactions, by cross or block
trades, in negotiated transactions,
by sales "at the market," in
underwritten offerings, and in
transactions involving options,
swaps and other derivatives. See
"Plan of Distribution" below.
Dividends....................................We have not in the past paid any
dividends on our common stock and
currently have no plans to do so.
Risk Factors.................................See "Risk Factors" beginning on
page 3 and other information
included in this prospectus for a
discussion of factors you should
consider before deciding to invest
in shares of our common stock.
Trading......................................Shares of our common stock trade in
the over-the-counter market and are
quoted on the OTC Bulletin Board
under the symbol "CBBT."
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RISK FACTORS
An investment in our securities involves a high degree of risk. You
should carefully consider the following risks and the other information set
forth elsewhere in this prospectus, including our financial statements and
related notes, before you decide to purchase shares of our common stock.
Risks Related to Our Business
We have significant short-term debt obligations, which mature in less than one
year. Failure to extend those maturities of, or to refinance, that debt could
result in defaults, in certain instances, and foreclosures on our assets.
At December 31, 2005, we had $72.637 million of short-term loans and
notes payable maturing in less than one year, a substantial portion of which is
secured by the pledge of certain of our assets. That collateral includes
inventory, machinery and equipment, and cash and cash equivalents which, at
December 31, 2005, were in the aggregate amount of $42.4 million. Failure to
obtain extensions of the maturity dates of, or to refinance, these obligations
or to obtain additional equity financing to meet these debt obligations would
result in an event of default with respect to such obligations and could result
in the foreclosure on the collateral. The sale of such collateral at foreclosure
would result in a substantial disruption in our ability to produce products for
our customers in the quantities required by customer orders or deliver products
in a timely fashion, which could significantly lower our revenues and
profitability. We may be able to refinance or obtain extensions of the
maturities of all or some of such debt only on terms that significantly restrict
our ability to operate, including terms that place limitations on our ability to
incur other indebtedness, to pay dividends, to use our assets as collateral for
other financings, to sell assets or to make acquisitions or enter into other
transactions. Such restrictions may adversely affect our ability to finance our
future operations or to engage in other business activities. If we finance the
repayment of our outstanding indebtedness by issuing additional equity or
convertible debt securities, such issuances could result in substantial dilution
to our stockholders.
Our indebtedness adversely affects our ability to fund our operations and to
compete effectively.
The amount of our indebtedness to lenders, which was $72.637 million,
as of December 31, 2005, is substantial compared to our assets, stockholders'
equity and our operating cash flow. That indebtedness limits our ability to fund
our operations through our operating cash flow and to compete effectively. Among
other things, our indebtedness:
o requires us to dedicate a substantial portion of our cash flow
from operations to debt service payments, reducing our working
capital and adversely affecting our ability to fund capital
expenditures through operating cash flow;
o places us at a disadvantage compared with competitors that
have proportionately less debt; and
o limits our ability to borrow additional funds in the future,
if we need them, due to financial and restrictive covenants in
our debt agreements.
Our manufacturing facilities are not insured against damage or loss.
Our operations and financial condition are dependent on the success of
BAK Battery's operations in China. As is the case with many manufacturing
companies in the PRC, we conduct those operations in manufacturing facilities,
and using machinery and other related property, that we do not insure against
damage or loss. We do not carry business interruption insurance. If we suffer
any business interruption or material damage to, or the loss of, any of our
manufacturing facilities, due to any cause, the loss would not be offset by any
insurance proceeds, and if large enough, that loss could threaten the continued
viability of our business.
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We are and will continue to be under downward pricing pressures on our products
from our customers and competitors.
We face downward pricing pressures from our customers and competitors,
especially in the sales of replacement batteries. To retain our existing
customers and gain new ones, we must continue to keep our unit prices low. In
view of our need to maintain low prices on our products, our growth, profit
margins and net income will suffer if we cannot effectively continue to control
our manufacturing and other costs.
Our contracts with our customers are generally short-term and do not require the
purchase of a minimum amount.
Our customers generally do not provide us with firm, long-term volume
purchase commitments. Although we enter into manufacturing contracts with our
customers who have continuing demand for a certain product, these contracts
state terms such as payment method, payment period, quality standard and
inspection and similar matters rather than provide firm, long-term commitments
to purchase products from us. As a result of the absence of the long term
contracts, we could have periods during which we have no or only limited orders
for our products, but will continue to have to pay the costs to maintain our
work force and our manufacturing facilities and to service our indebtedness
without the benefit of current revenues.
We consistently face short lead times for delivery of products to customers.
Failure to meet delivery deadlines in our production agreements could result in
the loss of customers and damage to our reputation and goodwill.
We enter into production agreements with our customers prior to commencing
production, which reduces our risk of cancellations. However, these production
agreements typically contain short lead times for delivery of products, leading
to production schedules that can strain our resources and reduce our profit
margins on the products produced. Although we have increased our manufacturing
capacity, we may lack sufficient capacity at any given time to meet all of our
customers' demands if they exceed our production capacity levels. We strive for
rapid response to customer demand, which can lead to reduced purchasing
efficiency and increased material costs. If we are unable to sufficiently meet
our customers' demands, we may lose our customers. Moreover, failure to meet
customer demands may damage our reputation and goodwill.
Because of the short lead times in our production agreements, we may not be able
to accurately or effectively plan our production or supply needs.
We make significant decisions, including determining the levels of business
that we will seek and accept, production schedules, component procurement
commitments, facility requirements, personnel needs, and other resource
requirements, based on our production agreements with our customers. Short lead
times of our customers' commitments to their own customers and the possibility
of rapid changes in demand for their products reduce our ability to estimate
accurately the future requirements of those customers for our products. Because
many of our costs and operating expenses are fixed, a reduction in customer
demand can harm our gross margins and operating results. We may also
occasionally acquire raw materials without having customer orders based on a
customer's forecast or in anticipation of an order and to secure more favorable
pricing, delivery or credit terms in view of the short lead times we often have
under our customers' orders. These purchases can expose us to losses from
inventory carrying costs or inventory obsolescence.
We have not obtained the certificate of land use right for our BAK Industrial
Park.
We do not own the tract of property on which we have constructed a new
manufacturing plant and related facilities, which facilities are important to
our future operations. See "Our Business-Facilities." We have applied for, but
have not obtained, a certificate of land use right for the property and those
new facilities. We are negotiating with the PRC government to obtain such a
certificate and believe that we will obtain the certificate. If we are
unsuccessful in doing so, we could be forced to vacate our current premises,
would not be permitted to use the new manufacturing and other facilities we have
constructed and could be required to relocate to new facilities. Such an
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event would cause a severe disruption in our ability to produce our products,
resulting in the failure to fill customer orders, the loss of customer revenues
and a resulting loss of revenues.
We face intense competition from other battery manufacturers, many of whom have
significantly greater resources than do we.
We are subject to intense competition from manufacturers of traditional
rechargeable batteries, such as nickel-cadmium batteries, from manufacturers of
rechargeable batteries of more recent technologies, such as nickel-metal hydride
and liquid electrolyte, other manufacturers of lithium ion batteries, as well as
from companies engaged in the development of batteries incorporating new
technologies. Other manufacturers of lithium ion batteries currently include
Sanyo Electric Co., Sony Corp., Matsushita Electric Industrial Co., Ltd.
(Panasonic), GS Group, NEC Corporation, Hitachi Ltd., LG Chemical Ltd., Samsung
Electronics Co., Ltd., BYD Co. Ltd., Tianjin Lishen Battery Joint-Stock Co.,
Ltd., Henan Huanyu Group and Harbin Coslight Technology International Group Co.,
Ltd.
Several of these existing competitors have greater financial, personnel and
capacity resources than we do and, as a result, these competitors may be in a
stronger position to respond quickly to market opportunities, new or emerging
technologies and changes in customer requirements. Many of our competitors are
developing a variety of battery technologies, such as lithium polymer and fuel
cell batteries, which are expected to compete with our existing product line.
Other companies undertaking research and development activities of solid-polymer
lithium ion batteries have developed prototypes and are constructing commercial
scale production facilities. The introduction of new products that are perceived
as having more desirable qualities than our products and that gain market
acceptance would lead to price erosion for our products, require greater
marketing and advertising of our products or require greater research and
development costs to develop competing products. If competitors develop
manufacturing processes that are more efficient than ours, we may face downward
pressure on pricing with resulting reductions in our gross profit for our
products. Any such developments may require us to increase our research and
development and related expenditures to develop competing technology or more
efficient manufacturing processes.
We are dependent on a single line of products.
Our revenues are derived solely from the sale of our lithium ion batteries.
The market for these products is characterized by changing technology and
evolving industry standards, often resulting in product obsolescence or short
product lifecycles. Although we believe our products are based on
state-of-the-art technology, other technologies may become the standard for
manufacturers of cellular telephones and other devices that use our batteries.
In that instance, our products could be obsolete, requiring us to develop new
products that compete effectively with the other products on the market. Our
failure to identify and develop a commercially viable number of product lines
that are sought by the market could adversely affect our growth opportunities
and, ultimately, our viability. Because we do not have a diverse product
offering that would enable us to sustain our business while seeking to develop
new types of products, our business may not be able to recover if we experience
a steep decline in demand for our current product offerings.
Our operations depend highly on Mr. Xianqian Li, our President and Chief
Executive Officer and a small number of other executives.
The success of operations depends greatly on a small number of key
managers, including Mr. Li, the President, Chief Executive Officer and Chairman
of the Board of Directors of CBBI and the chief executive officer and sole
director of BAK International and BAK Battery. The loss of the services of Mr.
Li or any of the other senior executives of CBBI or BAK Battery could adversely
affect our ability to conduct our business. Although we believe we would be able
to find other managers to replace any of these managers, the search for such
managers and the integration of such managers into our business will inevitably
occur only over an extended period of time. During that time the lack of senior
leadership could affect adversely our sales and manufacturing, as well as our
7research and development efforts. Mr. Li has held his positions with BAK
Battery since the inception of its business, and our future growth and success
very much depends on his continued involvement with our company. All of our
senior managers have an employment agreement with CBBI, BAK International or BAK
Battery.
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Our operations depend on our ability to attract and retain a highly skilled
group of managers and other personnel.
Because of the highly specialized, technical nature of our business, we
must attract and retain a highly skilled group of managers and a sizeable
workforce of technically competent employees. Although we do not experience
unacceptable attrition among our technical staff and sales force, if we were to
lose a substantial portion of such persons, our ability to effectively pursue
our business strategy could be materially and negatively affected. Although we
believe the pool of managers and workers having the necessary education,
training and technical skills to fill any positions that may become open is
sufficient for our needs, the labor market for such managers and workers is
becoming more competitive and we could have to pay higher salaries and wages and
provide greater benefits in order for us to attract the necessary workers.
We may not be able to effectively respond to rapid growth in demand for our
products and of our manufacturing operations.
If we are successful in obtaining rapid market growth of our batteries, we
will be required to deliver large volumes of quality products to customers on a
timely basis at a reasonable cost to those customers. Meeting such increased
demands will require us to expand our manufacturing facilities, to increase our
ability to purchase raw materials, to increase the size of our work force,
to expand our quality control capabilities and to increase the scale upon which
we produce products. Such demands would require more capital and working capital
than we currently have available.
We extend relatively long payment terms for accounts receivable.
As is customary in the PRC, we extend relatively long payment terms and
provide liberal return policies to our customers. As a result of the size of
many of our orders, these extended terms adversely affect our cash flow and our
ability to fund our operations out of our operating cash flow. In addition,
although we attempt to establish appropriate reserves for our receivables, those
reserves may not prove to be adequate in view of actual levels of bad debts. The
failure of our customers to pay us timely would negatively affect our working
capital, which could in turn adversely affect our cash flow.
Our customers often place large orders for products, requiring fast
delivery, which impacts our working capital. If our customers do not incorporate
our products into their products and sell them in a timely fashion, for example,
due to excess inventories, sales slowdowns or other issues, they may not pay us
in a timely fashion, even on our extended terms. This failure to pay timely may
defer or delay further product orders from us, which may adversely affect our
cash flows, sales or income in subsequent periods.
We may not be able to finance the development of new products.
Our future operating results will depend to a significant extent on our
ability to continue to provide new products that compare favorably on the basis
of cost and performance with the products of our competitors, many of whom have
design and manufacturing capabilities and technologies that compete well with
our products. We are currently conducting research and development on a number
of new products, activities requiring a substantial outlay of capital. To remain
competitive, we must continue to incur significant costs in product development,
equipment, facilities and invest in research and development of new products.
These costs may increase, resulting in greater fixed costs and operating
expenses. All of these factors create pressures on our working capital and
ability to fund our current and future manufacturing activities and the
expansion of our business.
Lithium ion batteries pose certain safety risks that could affect our financial
condition and results of operations.
Due to the high energy density inherent in lithium batteries, our batteries
can pose certain safety risks, including the risk of fire. Although through our
research, design, development and manufacturing processes we attempt to minimize
safety risks related to our batteries, should an accident occur, whether at the
manufacturing facilities or from the use of the products, it could result in
significant production delays or product liability claims
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for damages resulting from injuries. As a result of limits imposed in our
product liability insurance policy, such losses might not be covered by our
insurance policy, and if large enough, could have a material and negative effect
on our financial condition and results of operations.
We depend on certain suppliers of raw materials for the production of our
products, and any disruption with those suppliers could delay product shipments
and adversely affect our relationships with customers.
Certain materials used in our products are available to us only from a
limited number of suppliers. We currently maintain volume purchase agreements
with our major suppliers. However, any interruption in deliveries from any such
supplier could delay our product shipments and adversely affect our
relationships with customers. We believe, however, that alternative suppliers
could supply raw materials that could replace the materials currently used and
that, if necessary, we would be able to redesign our products to make use of
such alternatives.
We receive a significant portion of our revenues from a small number of
customers.
Although no customer individually accounted for more than 10% of our
revenues for the fiscal year ended September 30, 2005, our five largest
customers accounted for approximately 34.51% and 38.98% of our revenues in
fiscal 2005 and 2004, respectively. Dependence on a few customers could make it
difficult to negotiate attractive prices for our products and could expose us to
the risk of substantial losses if a single dominant customer stops purchasing
our products.
Our business depends on our ability to protect our intellectual property
effectively.
The success of our business depends in substantial measure on the legal
protection of the patents and other proprietary rights in technology we hold. We
hold patents in China and have patent applications pending in China and other
countries regarding technologies important to our business. If (i) our pending
patent applications do not result in the issuance of patents, (ii) the claims
allowed under any existing patents are not sufficiently broad to protect our
technology, or (iii) any patents issued to us are challenged, invalidated or
circumvented, then the resulting ability of third parties to utilize the subject
technology will adversely affect our business. We do not hold similar patents in
other countries with respect to these technologies. Consequently, our ability to
protect against the unauthorized use of those technologies outside of China is
limited.
We claim proprietary rights in various unpatented technologies,
know-how, trade secrets and trademarks relating to products and manufacturing
processes. We protect our proprietary rights in our products and operations
through contractual obligations, including nondisclosure agreements. If these
contractual measures fail to protect our proprietary rights, any advantage those
proprietary rights provided to us would be negated.
Monitoring infringement of intellectual property rights is difficult,
and we cannot be certain that the steps we have taken will prevent unauthorized
use of our intellectual property and know-how, particularly in the PRC and other
countries in which the laws may not protect our proprietary rights as fully as
the laws of the United States. Accordingly, other parties, including
competitors, may duplicate our products using our proprietary technologies.
Pursuing legal remedies against persons infringing our patents or otherwise
improperly using our proprietary information is a costly and time consuming
process that would divert management's attention and other resources from the
conduct of our other business, could cause delays and other problems with the
marketing and sales of our products, as well as delays in deliveries. Our
business may be adversely affected by obsolete inventories as a result of
changes in demand for our products and change in life cycles of our products.
Risks Related to Doing Business in China
Our operations are located in China. Changes in the political and economic
policies of the Chinese government may adversely affect our operations.
Our business operations may be adversely affected by the political
environment in the PRC. The PRC has operated as a socialist state since 1949 and
is controlled by the Communist Party of China. In recent years, however, the
government has introduced reforms aimed at creating a "socialist market economy"
and policies have
7
been implemented to allow business enterprises greater autonomy in their
operations. Changes in the political leadership of the PRC may have a
significant effect on laws and policies related to the current economic reforms
program, other policies affecting business and the general political, economic
and social environment in the PRC, including the introduction of measures to
control inflation, changes in the rate or method of taxation, the imposition of
additional restrictions on currency conversion and remittances abroad, and
foreign investment. Moreover, economic reforms and growth in the PRC have been
more successful in certain provinces in the PRC than in others, and the
continuation or increases of such disparities could affect the political or
social stability of the PRC.
Although we believe that the economic reform and the macroeconomic
measures adopted by the Chinese government have had a positive effect on the
economic development of China, the future direction of these economic reforms is
uncertain and the uncertainty may decrease the attractiveness of our company as
an investment, which may in turn materially adversely affect the price at which
our stock trades.
The Chinese government exerts substantial influence over the manner in which we
must conduct our business activities.
The PRC only recently has permitted provincial and local economic
autonomy and private economic activities. The government of the PRC has
exercised and continues to exercise substantial control over virtually every
sector of the Chinese economy through regulation and state ownership. Our
ability to operate in China may be adversely affected by changes in Chinese laws
and regulations, including those relating to taxation, import and export
tariffs, environmental regulations, land use rights, property and other matters.
We believe that our operations in China are in compliance with all applicable
legal and regulatory requirements. However, the central or local governments of
these jurisdictions may impose new, stricter regulations or interpretations of
existing regulations that would require additional expenditures and efforts on
our part to ensure our compliance with such regulations or interpretations.
Accordingly, government actions in the future, including any decision
not to continue to support recent economic reforms and to return to a more
centrally planned economy or regional or local variations in the implementation
of economic policies or to nationalized ownership of all companies now privately
owned, could have a significant effect on economic conditions in the PRC or
particular regions thereof, and could require us to divest ourselves of any
interest we then hold in Chinese properties or joint ventures.
We currently enjoy a reduced tax rate, and the loss of this benefit may
adversely impact our net income.
Under PRC laws and regulations our PRC subsidiary BAK Battery enjoys a
reduced enterprise income tax rate as a foreign invested enterprise and a high
tech enterprise in an economic development zone. As such, under the current tax
scheme, we did not owe any tax during the first two years following the time at
which we became profitable, which tax-free period ended on December 31, 2003.
After that time and through the 2009 calendar year, we have been and will be
taxed on our enterprise income, which is equivalent to our net income before
provision for income tax, at the rate of 7.5%, which is equal to 50% of the
current 15% enterprise income tax rate currently applicable in Shenzhen. If we
fail to qualify for a reduced tax program following the end of the 2009 calendar
year, we would be required to pay tax at the full tax rate applicable in
Shenzhen at that time.
We currently benefit from favorable local tax treatment, the loss of
which would adversely affect our results of operations. The current enterprise
income tax rate in Shenzhen is 15%, which is in addition to the taxes described
above. The PRC could change the tax law to raise the enterprise income tax rate
applicable in Shenzhen to the standard statutory tax rate in the PRC, which
currently is 33%, which change would result in our incurring a substantially
increased tax liability and a consequent reduction in our net income.
Future inflation in China may inhibit economic activity in China.
In recent years, the Chinese economy has experienced periods of rapid
expansion and high rates of inflation. During the past ten years, the rate of
inflation in China has been as high as 20.7% and China has experienced deflation
as low as minus 2.2%. These factors have led to the adoption by the PRC
government, from time to time, of various corrective measures designed to
restrict the availability of credit or regulate growth and contain inflation.
8
While inflation has been more moderate since 1995, high inflation may in the
future cause the PRC government to impose controls on credit and/or prices, or
to take other action, which could inhibit economic activity in China, and
thereby adversely affect the market for our products.
Any recurrence of severe acute respiratory syndrome, or SARS, or another
widespread public health problem, in the PRC could adversely affect our
operations.
A renewed outbreak of SARS or another widespread public health problem
in China, where all of our manufacturing facilities are located and where over
71% of our sales occur and in Shenzhen, where our operations are headquartered,
could have a negative effect on our operations. Such an outbreak could have an
impact on our operations as a result of:
o quarantines or closures of some of our manufacturing
facilities offices, which would severely disrupt our
operations,
o the sickness or death of our key officers and employees, and
o a general slowdown in the Chinese economy.
Any of the foregoing events or other unforeseen consequences of public
health problems could adversely affect our operations.
Restrictions on currency exchange may limit our ability to receive and use our
revenues effectively.
Because all of our revenues are in the form of Renminbi, the Chinese
currency unit, any restrictions on currency exchanges may limit our ability to
use revenue generated in Renminbi to fund any future business activities outside
China. Although the Chinese government introduced regulations in 1996 to allow
greater convertibility of the Renminbi for current account transactions,
significant restrictions still remain, including primarily the restriction that
foreign-invested enterprises may only buy, sell or remit foreign currencies,
after providing valid commercial documents, at those banks authorized to conduct
foreign exchange business. In addition, conversion of Renminbi for capital
account items, including direct investment and loans, is subject to government
approval in China, and companies are required to open and maintain separate
foreign exchange accounts for capital account items. If the currency exchange
system prevents us from obtaining sufficient foreign currency, we may be unable
to fund business activities outside China or otherwise make payments in dollars.
Shortages in China in the availability of foreign currency may also restrict our
ability to pay dividends. We cannot be certain that the Chinese regulatory
authorities will not impose more stringent restrictions on the convertibility of
the Renminbi, especially with respect to foreign exchange transactions.
The value of our common stock will be affected by the foreign exchange rate
between Dollars and Renminbi.
To the extent that we need to convert dollars into Renminbi for our
operational needs, should the Renminbi appreciate against the U.S. dollar at
that time, our financial position and the price of our common stock may be
adversely affected. Conversely, if we decide to convert our Renminbi into
dollars for the purpose of paying dividends on our common stock or for other
business purposes and the dollar appreciates against the Renminbi, the dollar
equivalent of our earnings from our subsidiaries in China would be reduced.
Until 1994, the Renminbi experienced a gradual but significant
devaluation against most major currencies, including dollars, and there was a
significant devaluation of the Renminbi on January 1, 1994 in connection with
the replacement of the dual exchange rate system with a unified managed floating
rate foreign exchange system. Since 1994, the value of the Renminbi relative to
the U.S. Dollar has remained stable and has appreciated slightly against the
U.S. dollar. Countries, including the United States, have argued that the
Renminbi is artificially undervalued due to China's current monetary policies
and have pressured China to allow the Renminbi to float freely in world markets.
On July 21, 2005 the PRC government changed its policy of pegging the value of
the Renminbi to the dollar. Under the new policy the Renminbi is permitted to
fluctuate within a narrow and managed band against a basket of designated
foreign currencies. This change in policy has resulted in an approximate 2.0%
9
appreciation in the Renminbi against the dollar. While the international
reaction to the Renminbi revaluation has generally been positive, there remains
significant international pressure on the PRC government to adopt an even more
flexible currency policy, which could result in further and more significant
appreciation of the Renminbi against the dollar.
Any significant revaluation of the Renminbi may materially and
adversely affect our revenues, cash flow, earnings and financial position, and
the value of any dividends payable in dollars. For example, an appreciation of
the Renminbi against the dollar would make any Renminbi denominated investment
or expenditure more costly to us, to the extent that we use dollars that we must
convert into Renminbi for such purpose.
We may be unable to enforce our legal rights due to policies regarding the
regulation of foreign investments in China.
The PRC's legal system is a civil law system based on written statutes,
in which system decided legal cases have little value as precedents unlike the
common law system prevalent in the United States. The PRC does not have a
well-developed, consolidated body of laws governing foreign investment
enterprises. As a result, the administration of laws and regulations by
government agencies are subject to considerable discretion and variation on the
part of the PRC government, including its courts, and may be subject to
influence by external forces unrelated to the legal merits of a particular
matter. China's regulations and policies with respect to foreign investments are
evolving. Definitive regulations and policies with respect to such matters as
the permissible percentage of foreign investment and permissible rates of equity
returns have not yet been published. As a result, we may not be aware of any
violations of these policies and rules until some time after the violation.
Statements regarding these evolving policies have been conflicting and any such
policies, as administered, are likely to be subject to broad interpretation and
discretion and to be modified, perhaps on a case-by-case basis. The
uncertainties regarding such regulations and policies present risks that may
affect our ability to achieve our business objectives. If we are unable to
enforce any legal rights we may have under our contracts or otherwise, our
ability to compete with other companies in our industry could be materially and
negatively affected. In addition, any litigation in China may be protracted and
result in substantial cost and diversion of resources and management attention.
You may experience difficulties in effecting service of legal process, enforcing
foreign judgments or bringing original actions in China based upon U.S. laws,
including the federal securities laws or other foreign laws against us or our
management.
Almost all of our current operations are conducted in China. Moreover,
all of our current directors and officers are nationals or residents of China.
All or a substantial portion of the assets of these persons are located outside
the United States and in the PRC. As a result, it may not be possible to effect
service of process within the United States or elsewhere outside China upon
these persons. In addition, uncertainty exists as to whether the courts of China
would recognize or enforce judgments of U.S. courts obtained against us or such
officers and/or directors predicated upon the civil liability provisions of the
securities laws of the United States or any state thereof, or be competent to
hear original actions brought in China against us or such persons predicated
upon the securities laws of the United States or any state thereof.
Recent PRC regulations relating to acquisitions of PRC companies by foreign
entities may create regulatory uncertainties that could restrict or limit our
PRC subsidiary BAK Battery's ability to operate, including its ability to pay
dividends.
The PRC State Administration of Foreign Exchange, or SAFE, issued a
public notice in January 2005 concerning foreign exchange regulations on mergers
and acquisitions in China. The public notice states that if an offshore company
controlled by PRC residents intends to acquire a PRC company, such acquisition
will be subject to strict examination by the relevant foreign exchange
authorities. The public notice also states that the approval of the relevant
foreign exchange authorities is required for any sale or transfer by the PRC
residents of a PRC company's assets or equity interests to foreign entities,
such as CBBI, for equity interests or assets of the foreign entities.
In April 2005, SAFE issued another public notice further explaining the
January notice. In accordance with the April notice, if an acquisition of a PRC
company by an offshore company controlled by PRC residents has been confirmed by
a Foreign Investment Enterprise Certificate prior to the promulgation of the
January notice, the PRC
10
residents must each submit a registration form to the local SAFE branch with
respect to their respective ownership interests in the offshore company, and
must also file an amendment to such registration if the offshore company
experiences material events, such as changes in the share capital, share
transfer, mergers and acquisitions, spin-off transaction or use of assets in
China to guarantee offshore obligations. The April notice also provides that
failure to comply with the registration procedures set forth therein may result
in restrictions on our PRC resident shareholders and BAK International and BAK
Battery, including their ability to distribute profits to CBBI. Pending the
promulgation of detailed implementation rules, the relevant government
authorities are reluctant to commence processing any registration or application
for approval required under the SAFE notices.
Our business operations or future strategy could be adversely affected
by the interpretations and implementation of the SAFE notices . For example, we
may be subject to more stringent review and approval process with respect to our
foreign exchange activities, including remittance of dividends to CBBI and the
making of foreign-currency-denominated borrowings.
Risks Related to our Common Stock
The market price for our common stock may be volatile.
The market price for our common stock is likely to be highly volatile
and subject to wide fluctuations in response to factors including the following:
o the lack of depth and liquidity of the market for our common
stock,
o actual or anticipated fluctuations in our quarterly operating
results,
o announcements of new products or services by us or our
competitors,
o changes in financial estimates by securities analysts,
o conditions in the lithium ion battery market,
o changes in the economic performance or market valuations of
other companies involved in lithium ion battery production,
o our sales of common stock,
o investor perceptions of us and our business,
o changes in the estimates of the future size and growth rate of
our markets,
o announcements by our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments,
o additions or departures of key personnel, and
o potential litigation, or conditions in the mobile telephone
market.
In addition, the stock market in general, and the over-the-counter
market in particular, have experienced significant price and volume fluctuations
that have often been unrelated or disproportionate to the performance of listed
companies. These broad market and industry factors may seriously harm the market
price of our common stock, regardless of our operating performance.
11
A large portion of our common stock is controlled by a small number of
stockholders.
43.4% of our common stock is held by Xiangqian Li, our President and
Chief Executive Officer and Chairman of our Board, and 44.6% of our common stock
is held by our directors and executive officers, collectively. As a result, our
directors and executive officers are able to influence the outcome of
stockholder votes on various matters, including the election of directors and
extraordinary corporate transactions including business combinations.
Furthermore, the current ratios of ownership of our common stock reduce the
public float and liquidity of our common stock which can in turn affect the
market price of our common stock.
Only a limited trading market for our common stock exists.
Historically, we have had limited trading in our common stock, in part,
as a result of the limited public float in our stock and as a result of our
operating history. Unless a substantial number of shares are sold by the selling
shareholders and other CBBI shareholders into the open market, an active trading
market for shares of our common stock may never develop. Without an active
market in our shares, the liquidity of the stock could be limited and prices for
the common stock would be depressed.
Our common stock is traded in the over-the-counter market through the
Over-the-Counter Electronic Bulletin Board. Our common stock may never be
included for trading on any stock exchange or through any other quotation system
(including, without limitation, the NASDAQ Stock Market).
Sales of substantial amounts of our common stock in the market could cause the
price to fall.
As there is only limited trading activity in our securities, the sale
of a substantial amount of our common stock in the market over a relatively
short period of time could result in significant fluctuations in the market
price of our common stock and could cause our common stock price to fall. In
addition to this registration statement, we have filed with the Securities and
Exchange Commission a registration statement on Form SB-2 (file number
333-130247), as amended, registering the resale of 8,531,852 shares of our
common stock by certain selling stockholders as described therein. If and when
such registration statement is declared effective, the offers and sales of the
shares covered by such registration statement by those selling stockholders
could occur simultaneously with offers and sales of the shares to which this
prospectus relates. The sale of any or all of those shares in the open market
could adversely affect the liquidity of the shares being offered by this
prospectus and the price for shares of our common stock in the open market.
Our common stock could be subject to additional regulation as a "penny stock,"
which may reduce the liquidity of our common stock.
If the trading price of our common stock falls below $5.00 per share,
the open-market trading of our common stock will be subject to the "penny stock"
rules. The "penny stock" rules impose additional sales practice requirements on
broker-dealers who sell securities to persons other than established customers
and accredited investors (generally those with assets in excess of $1,000,000 or
annual income exceeding $200,000 or, together with his or her spouse, $300,000).
For transactions covered by these rules, the broker-dealer must make a special
suitability determination for the purchase of securities and have received the
purchaser's written consent to the transaction before the purchase.
Additionally, for any transaction involving a penny stock, unless
exempt, the broker-dealer must deliver, before the transaction, a disclosure
schedule prescribed by the SEC relating to the penny stock market. The
broker-dealer also must disclose the commissions payable to both the
broker-dealer and the registered representative and current quotations for the
securities. Finally, monthly statements must be sent disclosing recent price
information on the limited market in penny stocks. These additional burdens
imposed on broker-dealers may restrict the ability of broker-dealers to sell the
common stock and may affect a stockholder's ability to resell the common stock.
Stockholders should be aware that, according to SEC Release No.
34-29093, the market for penny stocks has suffered in recent years from patterns
of fraud and abuse. Such patterns include (i) control of the market for the
security by one or a few broker-dealers that are often related to the promoter
or issuer; (ii) manipulation of prices
12
through prearranged matching of purchases and sales and false and misleading
press releases; (iii) boiler room practices involving high-pressure sales
tactics and unrealistic price projections by inexperienced sales persons; (iv)
excessive and undisclosed bid-ask differential and markups by selling
broker-dealers; and (v) the wholesale dumping of the same securities by
promoters and broker-dealers after prices have been manipulated to a desired
level, along with the resulting inevitable collapse of those prices and with
consequent investor losses.
We are obligated to indemnify our officers and directors for certain losses they
suffer.
Our Bylaws provide for the indemnification of our directors, officers,
employees, and agents, under certain circumstances, against liabilities,
attorney's fees and other expenses incurred by them in any litigation to which
they become a party arising from their association with or activities on behalf
of us to the maximum extent permitted by Nevada law. If we are required to
indemnify any persons under this policy, the amounts we would have to pay could
be material, and we may be unable to recover any of these funds from any source.
We recently adopted amendments to our Bylaws that could entrench our Board of
Directors and prevent a change in control.
Effective January 20, 2005, we adopted Amended and Restated Bylaws that
(i) increased the percentage of stockholders required to call special meetings
of stockholders from 10% to 30%, (ii) eliminated a provision allowing
stockholders to fill vacancies in the Board if such vacancies were not filled by
the Board, (iii) include a new provision providing that no contract or
transaction between us and one or more of our directors or officers is void if
certain criteria are met and (iv) allow for the amendment of our Bylaws by the
Board of Directors rather than our stockholders. Collectively, these provisions
may allow our Board of Directors to entrench the current members and prevent a
change in control of our company in situations where a change in control would
be beneficial to our stockholders.
13
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains certain statements that may be deemed to be
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. In some cases, you can identify forward-looking
statements by the use in those statements of terminology such as "may," "will,"
"could," "expect," "plan," "intend," "anticipate," "believe," "estimate,"
"predict," "potential," or "continue," or the negative of such terms or other
comparable terminology. The forward-looking statements included in this
prospectus address activities, events or developments that we expect or
anticipate will or may occur in the future, including:
o our ability to maintain our gross profit on our products at
certain levels;
o our ability to increase sales in the higher profit margin OEM
market;
o our ability to continue to achieve cost savings through
vertical integration of the manufacturing process, increased
production efficiencies and low labor costs.
Although we believe the expectations expressed in the forward-looking
statements included in this prospectus are based on reasonable assumptions
within the bounds of our knowledge of our business, a number of factors outside
of our control could cause actual results to differ materially from those
expressed in any of the forward-looking statements included in this prospectus.
Any one, or a combination, of these factors could materially affect our
financial performance, business strategy, business operations, plans, goals and
objectives. These factors include:
o costs of raw materials;
o costs of energy, including electricity;
o competitive pressures, including the impact on our market of
competitive products introduced into the marketplace;
o price resistance among consumers to products using our
batteries;
o changes in the design of products that use rechargeable
batteries to require batteries different from those we
produce;
o changes in the laws and regulations applicable to us and our
operations;
o rates of taxation applicable to our Chinese operations and our
effective rate of taxation in the United States;
o cost and availability of capital and debt financing;
o product liability claims against us;
o the adequacy of our products liability insurance coverage;
o casualty losses to our manufacturing and other facilities,
which are uninsured;
o interest rate fluctuations;
o demand for our products by existing and new customers;
o inflation;
14
o currency exchange rate fluctuations;
o changes in freight rates;
o labor costs; and
o other capital market, economic and geo-political conditions.
Forward-looking statements that we make or that are made by others on
our behalf are based on a knowledge of our business and the environment in which
we operate, but because of the factors listed above, actual results may differ
from those in the forward-looking statements. Consequently, these cautionary
statements qualify all of the forward-looking statements we make herein. The
results or developments we anticipate may not be realized. Even if substantially
realized, those results or developments may not result in the expected
consequences for us or affect us, our business or our operations in the ways we
expect. We caution readers not to place undue reliance on any of these
forward-looking statements in this prospectus, which speak only as of their
dates. We assume no obligation to update any of the forward-looking statements.
MARKET FOR COMMON EQUITY,
RELATED STOCKHOLDER MATTERS AND DIVIDEND POLICY
There is no established public trading market for our common stock, and
our common stock is not listed for trading on any securities exchange or the
NASDAQ. However, over-the-counter trades in our common stock are quoted on the
Over-the-Counter Bulletin Board under the symbol "CBBT." On March 24, 2006, the
last reported sales price for our common stock was $9.22 per share.
The following table sets forth, for the quarters indicated, the range
of closing high and low bid prices of our common stock as reported by the
Over-the-Counter Bulletin Board, as adjusted for all previously effected stock
splits. These prices do not include retail markup, markdown or commission and
may not represent actual transactions.
15
Common Stock
---------------------
By Quarter Ended High Low
-------------------------------------- -------- --------
FISCAL 2004
--------------------------------------
December 31, 2003 .................... $ 1.01 $ 1.01
March 31, 2004 ....................... $ 1.01 $ 1.01
June 30, 2004 ........................ $ 1.01 $ 1.01
September 30, 2004 ................... $ 1.45 $ 1.02
FISCAL 2005
--------------------------------------
December 31, 2004 .................... $ 3.50 $ 1.25
March 31, 2005 ....................... $ 7.30 $ 2.80
June 30, 2005 ........................ $ 8.50 $ 5.00
September 30, 2005 ................... $ 7.75 $ 6.54
FISCAL 2006
--------------------------------------
December 31, 2005 .................... $ 11.10 $ 5.60
- -----------
In reviewing the foregoing table, it should be noted that the exchange
of stock by which CBBI acquired BAK International and its subsidiary BAK
Battery occurred on January 20, 2005.
As of March 1, 2006, there were 48,878,396 shares of our common stock
outstanding held by approximately 139 stockholders of record.
We have never paid any cash dividends on our common stock. We do not
anticipate paying any cash dividends or making any other cash distributions on
our common stock in the foreseeable future. Should we decide in the future to do
so, as a holding company, our ability to pay dividends and meet other
obligations depends upon the receipt of dividends or other payments from our
operating subsidiaries. Our operating subsidiaries may be subject, from time to
time, to restrictions on their ability to make distributions to us, including as
a result of restrictive covenants in loan agreements, restrictions on the
conversion of local currency into dollars or other hard currency and other
regulatory restrictions. We currently intend to retain future earnings, if any,
to finance operations and the expansion of our business.
16
Equity Compensation Plan Information
The following table provides information about the securities
authorized for issuance under our equity compensation plans. In accordance with
the rules of the SEC, the information in the table is presented as of September
30, 2005, the end of our most recently completed fiscal year.
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SECURITIES TO FUTURE ISSUANCE UNDER EQUITY
BE ISSUED UPON EXERCISE WEIGHTED-AVERAGE EXERCISE COMPENSATION PLANS
OF OUTSTANDING OPTIONS, PRICE OF OUTSTANDING OPTIONS, (EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (a))
- ----------------------------------------- ----------------------- ----------------------------- ----------------------------
(a) (b) (c)
Equity compensation plans approved by
security holders -- -- --
Equity compensation plans not approved by
security holders 2,000,000 6.25 2,000,000
Total 2,000,000 6.25 2,000,000
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATION
AND FINANCIAL CONDITION
The following management's discussion and analysis should be read in
conjunction with our consolidated financial statements and the notes thereto and
the other financial information appearing elsewhere in this item. In addition to
historical information, the following discussion contains certain
forward-looking information. See "Special Note Regarding Forward Looking
Statements" above for certain information concerning those forward looking
statements.
Our financial statements are prepared in US Dollars and in accordance
with accounting principles generally accepted ("GAAP") in the United States. See
"Exchange Rates" below for information concerning the exchange rates at which
Renminbi were converted to US Dollars at various pertinent dates and for
pertinent periods.
Overview
CBBI is a holding company whose Hong Kong-based subsidiary, BAK
International, and China-based subsidiaries, BAK Battery and BAK Electronics,
focus on the manufacture, commercialization and distribution of a wide variety
of standard and customized lithium ion rechargeable batteries for use in
cellular telephones, as well as various other portable electronic applications,
including high-power handset telephones, laptop computers, power tools, digital
cameras, video camcorders, MP3 players, electric bicycles, hybrid/electric
motors, and general industrial applications. We manufacture five types of
batteries: steel case cell, aluminum case cell, cylindrical case cell, Li-ion
polymer cells and industrial batteries, although the majority of our income is
generated from the sale of steel case cells.
CBBI acquired BAK International and, as a result, BAK International's
wholly-owned subsidiary, BAK Battery, on January 20, 2005, by means of an
exchange of 39,826,075 shares of CBBI's common stock for all of the outstanding
shares of stock of BAK International. However, we have accounted for the
transaction as a recapitalization, which resulted in the adoption of the
historical consolidated financial statements of BAK International, as prepared
in accordance with United States GAAP, as the financial statements of CBBI. See
Note 2 to our consolidated financial statements included in this filing for
additional information regarding the accounting treatment of the acquisition and
its impact on our consolidated financial statements.
On September 16, 2005, we consummated the sale of 7,899,863 shares of
our common stock to certain accredited investors (as that term is defined in
Rule 502 of Regulation D promulgated under the Securities Act of 1933, as
amended). We granted certain registration rights to such purchasers, including
our covenant to file with the Securities and Exchange Commission within ten days
of the date that the registration statement of which this prospectus is a part
is declared effective by the Securities and Exchange Commission a registration
statement covering the resale of the 7,899,863 shares of our common stock
purchased by such purchasers and to use our reasonable best efforts to cause
such registration statement to be declared effective by the Securities and
Exchange Commission. In connection with the closing of that issuance, CBBI
issued warrants to purchase an aggregate of 631,989 shares of common stock at an
exercise price of $7.92 per share exercisable for a period ending three years
after the date of issuance to certain persons as part of an agreed upon fee. The
631,989 shares of common stock purchasable upon exercise of the warrants will
also be covered by the registration statement. If and when such registration
statement is declared effective, the offers and sales of the shares covered by
such registration statement could occur simultaneously with offers and sales of
the shares to which this prospectus relates. See "Risk Factors -- Risk Related
to our Common Stock."
Certain Accounting Matters
Substantially all of our revenue is derived from the sale of battery
cells, which we recognize upon shipment or delivery depending upon the sales
order. In the event goods are returned, revenue is reduced and the returned
goods are placed back in inventory during the period the goods are received by
us. Concurrent with the recognition of revenue, we record a warranty reserve for
product returns. When determining the amount of such reserves, we estimate the
amount of claims based upon our historical experience with product returns and
warranty claims.
Cost of goods sold consists primarily of raw materials, direct labor
and manufacturing overhead. Manufacturing overhead consists primarily of an
allocation of purchasing and receiving costs, supplies, utilities, depreciation,
factory and equipment repairs and maintenance, and inspection fees.
Selling expenses consist primarily of payroll, advertising and
promotion, depreciation, share-based compensation and travel and entertainment.
Marketing or advertising costs are incurred primarily to promote ourselves and
our products through printed advertisements in trade publications and to display
our products through attendance at industry trade exhibitions. We do not pay
slotting fees, engage in cooperative advertising programs, participate in
buy-down programs or similar arrangements. No material estimates are required to
determine our marketing or advertising costs.
18
General and administrative expenses consist primarily of payroll,
share-based compensation, professional fees, insurance, payroll taxes and
benefits, general office expenses, travel and entertainment, transportation, and
depreciation.
Research and development expenses consist primarily of share-based
compensation, payroll and materials, offset by grants received.
Net income does not reflect certain annual appropriations to reserve
funds in accordance with PRC regulations. These appropriations are reflected in
the statement of retained earnings as a reduction in retained earnings.
Results of Operations
Results of operations for the three months ended December 31, 2005 as
compared to the three months ended December 31, 2004.
Revenues
Revenues increased to $26.1 million for the three months ended December
31, 2005 as compared to $25.1 million for the same period of the prior year, an
increase of $1.0 million or 3.9%. Our revenues increased during the period as a
result of increased sales volume, partially offset by a decline in unit selling
prices. Revenues relating to steel case cell batteries increased to $14.6
million from $14.1 million in the prior year period, an increase of $453,000 or
3.2%, due to increased sales volume partially offset by lower selling prices.
Revenues from sales of aluminum case cell batteries increased to $8.9 million
for the period as compared to $6.6 million in the prior year period, an increase
of $2.3 million or 35.2%, primarily due to increased sales volume. We were able
to gain market share both domestically and internationally during the period
because, in our belief, our production volume and technological advantage gives
us an advantage over our competitors with regard to supply ability and cost. We
also believe that our gain in market share was due in part to our decision to
maintain low pricing, the improved quality of our products and the improvements
we made in manufacturing efficiencies.
Gross Profit
Gross profit for the three months ended December 31, 2005 was $7.0
million or 27.0% of revenues as compared to gross profit of $4.4 million or
17.4% of revenues for the same period of the prior year. The increase in gross
profit, as a percentage of revenues, resulted primarily from decreased unit
manufacturing costs stemming from a decrease in prices for most raw materials
and an increased yield in the manufacturing process. Steel case cell battery
selling prices decreased by 3.5% during the period, while the cost of
manufacturing steel case cell units decreased by 20.3%, resulting in an overall
increase in gross profit from 16.4% to 27.2% of revenues. In the aluminum case
cell market, the average unit selling price remained consistent from last year
and unit manufacturing costs decreased by 17.6%, thereby increasing gross profit
from 13.9% to 25.7% of revenues. While we have historically sold our products
primarily into the replacement battery market with lower selling prices and,
consequently, lower gross profit margins, we are continuing to pursue a strategy
of increasing sales into the higher profit margin OEM segment.
Continued vertical integration of the manufacturing process, volume
discounts on increasing raw material purchases, increasing production
efficiencies, and low labor costs collectively served to reduce manufacturing
costs. We believe that we can continue to achieve cost savings from these
activities that will help to offset potential replacement battery market selling
price decreases during 2006.
Some entities include all costs associated with their distribution
system in cost of goods sold while other companies may record a portion of their
distribution costs in selling expense. Because of this disparity in financial
reporting, gross margins between our company and other companies may not be
comparable. With the exception of transportation and freight charges which we
include under selling expenses, we believe we include most other costs of our
distribution system in cost of goods sold.
19
Selling Expenses
Selling expenses increased to $1.2 million for the three month period
ended December 31, 2005 as compared to $808,000 for the same period of the prior
year, an increase of $416,000 or 51.4%. As a percentage of revenues, selling
expenses have increased to 4.7% this year, from 3.2% last year, as we increase
our staff and advertising to obtain orders to increase utilization of our recent
manufacturing capacity expansion.
Salaries related to selling efforts increased to $598,000 from $464,000
for the same period of the prior year, an increase of $134,000. We had 80
employees engaged in sales and marketing on December 31, 2005 as compared to 71
on December 31, 2004. Share-based compensation included in selling expenses was
$109,000 for the three months ended December 31, 2005. There was no comparable
expense in the prior year. The options were issued in May 2005. As a result of
the introduction of a formal and coordinated marketing campaign and increased
professional advertisements and exhibitions, advertising expenses increased
$37,000 from the same period in the prior year. Transportation, maintenance,
travel and entertainment and other related selling and marketing expenses also
increased due to the increased selling effort. Marketing or advertising costs
consist primarily of promoting ourselves and our products through printed
advertisements in trade publications, packaging and displaying our products
through attendance of industry trade exhibitions. We do not pay slotting fees,
engage in cooperative advertising programs, participate in buydown programs or
similar arrangements. No material estimates are required to determine our
marketing or advertising costs.
General and Administrative Expenses
General and administrative expenses increased to $1.8 million for the
three months ended December 31, 2005 as compared to $1.2 million for the same
period of the prior year, an increase of $654,000 or 56.8%. As a percentage of
revenues, general and administrative expenses were 6.9% and 4.6% as of December
31, 2005 and December 31, 2004, respectively. Despite increased general and
administrative expense, we believe that general and administrative expenses
remain manageable relative to revenues. Share-based compensation included in
general and administrative expenses was $333,000 for the three months ended
December 31, 2005. There was no comparable expense in the prior year. The
options were issued in May 2005. Professional fees and expenses increased
$306,000 from the first quarter of last year, reflecting the additional costs of
operating as a public company since January 2005. Benefits, primarily employee
pensions, increased $102,000 from the same quarter last year, while insurance
increased $76,000 to cover our equipment additions since last year. These
increases were partially offset by a $140,000 decrease in salaries due to a lump
sum payment made to new hires that completed their probationary period during
the three month period ended December 31, 2004.
Research and Development Expenses
Research and development expenses increased to $495,000 for the three
months ended December 31, 2005 as compared to $20,000 for the same period of the
prior year, an increase of $475,000 or 2,374%. Share-based compensation included
in research and development expenses was $254,000 for the three months ended
December 31, 2005. There was no comparable expense in the prior year. The
options were issued in May 2005. This increase also resulted from a $60,000
grant that partially offset the prior year's expense, with the balance of the
increase due to materials and other purchases required to support our increased
research and development effort.
Bad Debts
Bad debts expense totaled $255,000 for the three months ended December
31, 2005 as compared to $51,000 for the same period of the prior year. As a
percentage of revenues, bad debts expenses were 1.0% and 0.2% for the three
months ended December 31, 2005 and 2004, respectively. The bad debt expense
increase is primarily due to the increase in the bad debts reserve from $834,000
or 3.0% of total accounts and notes receivable of $28.2 million at December 31,
2004 to $1.8 million or 3.5% of total accounts and notes receivable of $51.8
million at December 31, 2005. Management believes that the reserve for bad debts
as of December 31, 2005 is adequate and will adjust future reserves as we gain
more experience with our customers.
Operating Income
As a result of the above, operating income totaled $3.3 million for the
three months ended December 31, 2005 as compared to operating income of $2.4
million for the same period of the prior year, an increase of $907,000 or 38.6%.
20
As a percentage of revenues, operating income was 12.5% for the three
months ended December 31, 2005 as compared to 9.4% for the same period of the
prior year. The growth in operating income as a percentage of revenues was
substantially due to the increase in gross profit.
Finance Costs
Finance costs decreased to $385,000 for the three month period ended
December 31, 2005 as compared to $390,000 for the same period of the prior year,
a decrease of $5,000 or 1.3%. The finance costs decrease is primarily due to BAK
Battery's receipt of the second science and technology development interest
subsidy from the Shenzhen Department of Finance amounting to $124,000, which has
been offset against the interest costs during the period. We had $72.6 million
in short term loans and notes payable as of December 31, 2005 as compared to
$52.6 million outstanding as of December 31, 2004. Short term loans and notes
payable are comprised of various short term bank loans and promissory notes,
with interest ranging from 5.022% to 6.138%, and maturities of generally less
than twelve months. The funds were used for working capital purposes to support
the anticipated increase in revenues in the second quarter of fiscal 2006.
Other Expenses (Income)
Other income was $309,000 for the three month period ended December 31,
2005 as compared to $16,000 of other expenses for the same period of the prior
year, an improvement of $325,000. The other income increase is primarily due to
BAK International's short term investment in financial instruments during the
period.
Net Income
Primarily as a result of decreased manufacturing costs during the
period, we increased our net income to $3.1 million as compared to $1.8 million
for the same period of the prior year, an increase of $1.3 million or 70.77%.
Inventory
Inventory totaled $36.9 million as of December 31, 2005 as compared to
$21.7 million as of September 30, 2005, an increase of $15.2 million. We built
finished goods inventory by $9.9 million in preparation for the one week plant
closing for the Chinese New Year as well as the anticipated ramp up of sales
starting in the second quarter of fiscal 2006. Management expects that the
finished goods inventory, approximating two months' sales at December 31, 2005,
will be reduced by one-third by March 31, 2006. We were also able to enjoy
volume discounts from the increased level of raw material purchases.
Notes Receivable
We have modified our policy with respect to accounts receivable by
allowing customers that have good credit ratings and business relationships with
us to transfer a portion of their accounts receivable balances to notes
receivable. As a result, notes receivable increased to $9.4 million as of
December 31, 2005 from $484,000 as of September 30, 2005, an increase of $8.9
million. All of this increase was attributed to sales made during the month of
December 2005 and the corresponding notes receivable are due by June 30, 2006.
Management believes that this policy will provide a better way to secure our
receivables as well as providing the flexibility for us to discount our notes
receivable in the future.
Results of operations for the year ended September 30, 2005 as compared
to the year ended September 30, 2004.
21
Revenues
Revenues increased to $101.9 million for the year ended September 30,
2005 as compared to $63.7 million for the prior year, an increase of $38.2
million or 59.9%. Our revenues increased during 2005 primarily as a result of an
increase in the number of units sold, with a slight improvement in average unit
selling prices. Revenues relating to steel case cells increased to $56.9 million
in 2005 from $38.0 million in 2004, an increase of $18.9 million or 49.7%,
primarily due to an increase in the number of units sold. Revenues from sales of
aluminum case cells increased to $23.7 million for 2005 as compared to $13.1
million in 2004, an increase of $10.6 million or 80.9%, primarily due to
increased sales volume. Revenues relating to industrial batteries increased to
$20.2 million in 2005 from $12.4 million in 2004, an increase of $7.8 million or
62.9%, primarily due to an increase in the number of units sold.. Although most
of our sales were made in China, we were able to gain market share both
domestically and internationally during the year because, in our belief, our
production volume and technological advantage gives us an advantage over our
competitors with regard to supply ability and cost. We also believe that our
gain in market share was due in part to our decision to maintain competitive
pricing, the improved quality of our products and the improvements we made in
production efficiencies.
Gross Profit
Gross profit for the fiscal year ended September 30, 2005 was $25.7
million or 25.2% of revenues as compared to gross profit of $13.8 million or
21.7% of revenues for the prior fiscal year.
The increase in gross profit, as a percentage of revenues, resulted
from a combination of decreased unit manufacturing costs and slightly higher
average unit selling prices. While our cost of manufacturing steel case cell
units decreased by 4.8% in fiscal 2005, selling prices decreased by less than
1.0%, resulting in an overall increase in gross profit from 23.2% to 26.5% of
revenues. In the aluminum case cell market, unit manufacturing costs increased
by 8.2% in fiscal 2005, while selling prices increased an average of only 6.5%,
thereby reducing gross profit from 21.9% to 20.7% of revenues. The 7.0% decrease
in unit selling prices for industrial batteries from fiscal 2004 to fiscal 2005,
however, was more than offset by a 14.0% improvement in unit manufacturing
costs, resulting in an improvement in gross profit from 24.1% to 29.8% of
revenues. We did gain market share during the year due to our decision to
maintain competitive pricing while improving the quality of our products.
Selling Expenses
Selling expenses increased to $4.0 million for the year ended September
30, 2005, as compared to $1.9 million for the prior year, an increase of $2.1
million or 114.2%.
Salaries related to selling efforts increased to $2.0 million in fiscal
2005 from $830,000 for the prior year, an increase of $1.2 million. An increase
in the number of employees in our sales and marketing group and higher average
salaries paid to the sales and marketing employees in fiscal 2005 were
responsible for this increase. We had 88 employees engaged in sales and
marketing as of September 30, 2005 as compared to 67 as of September 30, 2004.
In connection with the introduction of a formal and coordinated marketing
campaign, advertising expenses increased to $298,000 in fiscal 2005 from
$201,200 in 2004, an increase of $96,800. Filing fees, promotion, trademarks,
depreciation, and other related selling and marketing expenses increased to
$1,725,600 for fiscal 2005 from $476,700 for the prior fiscal year, an increase
of $1,248,900, related to increased sales and selling efforts.
General and Administrative Expenses
General and administrative expenses grew to $5.0 million for the fiscal
year ended September 30, 2005 from $3.1 million for the prior fiscal year, an
increase of $1.9 million or 61.0%. As a percentage of revenues, general and
administrative expenses were 4.9% and 4.9% in fiscal 2005 and 2004,
respectively. Despite the increase in general and administrative expenses from
fiscal 2004 to fiscal 2005, those expenses remained manageable relative to
revenues.
Salaries and benefits, including costs of training, increased to $1.4
million in fiscal 2005 from $1.2 million in the prior fiscal year, an increase
of $234,000 or 19.8%, primarily as a result of additional employees. We had 500
employees in general and administration positions as of September 30, 2005, as
compared to 451 employees as of September 30, 2004. Professional fees increased
$224,000 from fiscal 2004 to fiscal 2005, reflecting the additional costs of
operating as a public company since January 2005.
22
Research and Development Expenses
Research and development expenses increased to $542,000 for the fiscal
year ended September 30, 2005 as compared to $329,000 for the prior fiscal year,
an increase of $213,000 or 64.7%. New initiatives, such as rechargeable lithium
polymer batteries and LiNiCoO2 anode research, depreciation from research and
development equipment additions and an increase in patent applications and
maintenance contributed to the increase.
Bad Debts
Bad debt expense totaled $770,000 for the fiscal year ended September
30, 2005 as compared to $327,000 for the prior fiscal year, an increase of
$443,000 or 135.5%. As a percentage of revenues, bad debts were 0.8% and 0.5%
for fiscal 2005 and fiscal 2004, respectively. We believe that the reserve for
bad debts as of September 30, 2005 is adequate, and we will adjust future
reserves as we gain more experience with our customers.
Operating Income
As a result of the foregoing, operating income totaled $15.3 million
for the fiscal year ended September 30, 2005 as compared to operating income of
$8.1 million for the fiscal year ended September 30, 2004, an increase of $7.2
million or 88.0%, on a 59.9% increase in revenues.
As a percentage of revenues, operating income was 15.0% in fiscal 2005
as compared to 12.8% for the prior fiscal year. This increase in operating
income as a percentage of revenues was substantially due to the increase in
gross margin from fiscal 2004 to fiscal 2005.
Finance Costs
Finance costs increased to $2.4 million for the fiscal year ended
September 30, 2005 as compared to $1.0 million for the prior fiscal year, an
increase of $1.4 million or 138.1%. The increase was attributable to the
increase in the amount of our short term bank loans in fiscal 2005 compared with
that outstanding in fiscal 2004. We had $39.5 million in short-term bank loans
as of September 30, 2005, as compared to $27.3 million and $3.5 million
outstanding as of September 30, 2004 and 2003, respectively. Short-term bank
loans bear interest at annual rates ranging from 4.5% to 6.1%, and maturities
are generally less than twelve months. The funds obtained from the increased
borrowings were primarily used to fund working capital and to purchase
equipment. We expect to replace the short term debt incurred to fund these
long-term equipment acquisitions with comparable long-term debt once BAK Battery
formally acquires its certificate of land use right.
Provision for Income Taxes
We temporarily enjoy favorable tax treatment as a result of locating
our main production facilities in the Shenzhen Special Enterprise Zone. In
accordance with the relevant income tax laws applicable to enterprises operating
in the Shenzhen Special Economic Zone of the PRC, the taxable income of BAK
Battery is fully exempt from income tax for 2 years ("tax holiday"), commencing
from the first profit making year of operations, followed by a 50% exemption for
the immediate next three years ("tax preferential period"), after which the
profits of BAK Battery will be taxable at the full reduced rate for New and High
Technology Enterprises, currently 15%. In addition, BAK Battery also enjoys the
same tax holiday and tax preferential period treatments on the additional
investments that were approved during fiscal year 2005. The percentage of
taxable income enjoying a tax holiday in 2005 is 55.88%; the 44.12% balance
enjoys tax preferential period treatment. We anticipate a tax rate of 7.5% of
profits on the original investment portion through the 2006 calendar year,
before reverting to the anticipated standard corporate rate of 15% afterward.
The additional investment will enjoy the tax holiday through the 2006 calendar
year and then be taxed at 7.5% through the 2009 calendar year.
Further, on August 11, 2005, BAK Battery was recognized as a
Foreign-Invested, Advanced-Technology Enterprise by the Shenzhen government,
whereby BAK Battery will enjoy an additional three year tax preferential period
for all of its taxable income after the expiration of the original three year
tax preferential period. If BAK Battery fails to qualify for a reduced tax
program following the end of the 2009 calendar year, BAK Battery will be
required to pay tax at the full 15% tax rate of its taxable income applicable to
Shenzhen starting in 2010.
23
Income taxes increased to $527,000 for the year ended September 30,
2005, as compared to $394,000 for the previous year. We commenced paying taxes
at the annual rate of 7.5% for the final nine months of fiscal 2004, resulting
in an effective tax rate of 5.5% for fiscal 2004. Although income taxes were
paid at a 7.5% rate for all of 2005 on the original investment portion, no taxes
were due in 2005 for the additional investment due to the tax holiday, resulting
in a lower overall rate of 4.1%. We have purchased $173,000 of equipment made in
China during the year ended September 30, 2005, and will be eligible for a tax
credit, equal to 40% of theses purchases, against additional future income tax.
Net Income
Primarily as a result of increased sales during fiscal 2005, we
increased our net income to $12.4 million as compared to $6.7 million for the
prior year, an increase of $5.6 million or 83.4%.
Results of operations for the year ended September 30, 2004 as compared
to the year ended September 30, 2003
Revenues
Revenues increased to $63.75 million for the fiscal year ended
September 30, 2004 as compared to $20.05 million for the prior fiscal year ended
September 30, 2003, an increase of $43.70 million or 218%. Revenues from sales
of aluminum case cell batteries were $13.08 million, an increase of $12.8
million, as compared to $280,000 in the prior year. This increase was primarily
due to increased volume resulting from additional product offerings and our
increased production. Revenues relating to steel case cell batteries increased
to $50.41 million from $19.68 million in the prior year, an increase of $30.73
million or 156%. This increase also was due to increased volume of sales as a
result of additional product offerings and our increased production. In fiscal
year 2004, our customers continued to demand price concessions, while
simultaneously demanding greater quality and services from us. In response to
these conditions, we acted to contain costs and provided price reductions.
Despite continued pricing pressure resulting in selling price reductions during
the year in both aluminum case and steel case markets, we were able to gain
market share both domestically and internationally because, in our belief, our
production volume and technological advantage gives us an advantage over our
competitors with regard to supply ability and cost.
Gross Profit
Gross profit for the fiscal year ended September 30, 2004 was $13.82
million or 21.7% of revenues as compared to gross profit of $5.52 million or
27.5% of revenues for the prior fiscal year.
The reduction in gross profit, as a percentage of revenues, resulted
from a combination of reduced unit selling prices and increased unit
manufacturing costs stemming from an increase in prices for most raw materials
used in the manufacturing process. Steel case cell battery selling prices
decreased by 12.4% during fiscal 2004, while our cost of manufacturing steel
case cell units decreased by only about 5.5%, resulting in an overall decrease
in gross profit from 26.65% to 20.42% of revenues from the sale of steel case
cell units in fiscal 2004. In the aluminum case cell market, price reductions
averaged 21.9% and unit costs increased by 10.6%, thereby reducing gross profit
in our aluminum case products from 21.69% to 19.38% of revenues in fiscal 2004.
We did, however, gain market share due in part to our decision to maintain low
pricing, the improved quality of our products and the improvements we made in
manufacturing efficiencies.
Selling Expenses
Selling expenses increased to $1.88 million for the year ended
September 30, 2004 as compared to $445,800 for the prior year, an increase of
$1.43 million or about 321.2%.
24
Salaries related to selling efforts increased to $740,000 from $80,000
for the prior year, an increase of $660,000, primarily as a result of an
increase in the number of employees in our sales and marketing group and higher
average salaries paid to the sales and marketing employees in fiscal 2004. More
sales and marketing group efforts were required to continue gaining market share
and to grow revenues. We had 67 employees engaged in sales and marketing as of
September 30, 2004 as compared to 51 as of September 30, 2003. In connection
with the introduction of a formal and coordinated marketing campaign, marketing
expenses increased to $610,000 from $230,000 incurred in the prior year, an
increase of $380,000. Transportation, filing fees, promotion, trademarks, and
other related selling and marketing expenses increased to $520,000 for fiscal
2004 from $132,000 for the prior fiscal year, an increase of $388,000, related
to increased sales and selling efforts.
General and Administrative Expenses
General and administrative expenses grew to $3.14 million for the
fiscal year ended September 30, 2004 as compared to $804,600 for the prior
fiscal year, an increase of $2.3 million or 290.4%. As a percentage of revenues,
general and administrative expenses were 4.9% and 4.0% in fiscal 2004 and fiscal
2003, respectively. The increase in the general and administrative expenses
stemmed from an increase in our infrastructure to support the increased sales
levels during fiscal 2004 through facilities expansion and the hiring of
additional employees. Despite the increase in general and administrative
expenses from fiscal 2003 to fiscal 2004, those expenses remained manageable
relative to revenues.
Salaries and benefits, including costs of training, increased to $1.27
million in fiscal 2004 from $260,000 as compared to the prior fiscal year, an
increase of $1.01 million or 388%, primarily as a result of additional
employees. We had 99 employees in machinery and engineering positions as of
September 30, 2004, as compared to 27 employees as of September 30, 2003.
Increases in office expenses, insurance, professional fees, maintenance,
recruitment, and other administrative expenses accounted for the remainder of
the increase in this category from fiscal 2003 to fiscal 2004, increases also
related to the increased number of employees.
Research and Development Expenses
Research and development expenses increased to $329,000 for the fiscal
year ended September 30, 2004 as compared to $117,000 for the prior fiscal year,
an increase of $212,000 or 182%. The increase in our research and development
staff to 107 as of September 30, 2004 from 58 as of September 30, 2003 was the
primary factor accounting for the increase in this category. New initiatives,
such as rechargeable lithium polymer batteries research and development, and an
increase in patent applications and maintenance required incremental staff
hiring contributed to the increase.
Bad Debts
Bad debt expense totaled $327,000 for the fiscal year ended September
30, 2004 as compared to $448,000 for the prior fiscal year, a decrease of
$121,000 or 27%. As a percentage of revenues, bad debts were 0.5% and 2.2% for
fiscal 2004 and fiscal 2003, respectively. We believe that the reserve for bad
debts as of September 30, 2004 was adequate, and we will adjust future reserves
as we gain more experience with our customers.
Operating Income
As a result of the foregoing, operating income totaled $8.15 million
for the fiscal year ended September 30, 2004 as compared to operating income of
$3.70 million for the fiscal year ended September 30, 2003, an increase of $4.45
million or 120%.
As a percentage of revenues, operating income was 12.8% in fiscal 2004
as compared to 18.5% for the prior fiscal year. This reduction in operating
income as a percentage of revenues was substantially due to the reduction in
levels of gross profit from fiscal 2003 to fiscal 2004.
25
Finance Costs
Finance costs increased to $1.01 million for the fiscal year ended
September 30, 2004 as compared to $123,000 for the prior fiscal year, an
increase of $887,000 or 721%. The increase was attributable to the increase in
the amount of our outstanding debt in fiscal 2004 compared with that outstanding
in fiscal 2003. We had $49.89 million in short-term loans and notes payable as
of September 30, 2004 as compared to $9.58 million outstanding as of September
30, 2003. Short-term loans and notes payable are comprised of various short-term
bank loans and promissory notes, bearing interest at rates ranging from 4.54% to
5.84%, and maturities of generally less than twelve months. The funds obtained
from the increased borrowings were used to construct our new manufacturing
facilities and to purchase associated equipment, which resulted in $40.31
million of capital costs. The remaining proceeds of the borrowing were used for
working capital purposes.
Provision for Income Taxes
We enjoy a temporary favorable tax treatment as a result of locating
our main production facilities in the Shenzhen Special Enterprise Zone. We
anticipate a tax rate of 7.5% of profits through the 2009 calendar year before
reverting to the anticipated standard corporate rate of 15%.
Taxes increased to $394,000 for the year ended September 30, 2004 as
compared to no taxes for the previous year. We commenced paying taxes at the
annual rate of 7.5% in 2004, two years after we first had net income; however,
because these taxes are based on a calendar year we only paid taxes for the
final nine months of fiscal 2004, resulting in an effective tax rate of 5.5% for
fiscal 2004.
Net Income
Primarily as a result of increased sales during fiscal 2004, we
increased our net income to $6.75 million as compared to $3.58 million for the
prior year, an increase of $3.17 million or about 89%.
Liquidity and Capital Resources
We have historically financed our liquidity requirements from a variety
of sources, including short term borrowings under bank credit agreements,
promissory notes and issuance of capital stock. As of December 31, 2005, we had
cash and cash equivalents of $36.3 million, as compared to $52.4 million as of
September 30, 2005. Included in cash and cash equivalents are cash deposits that
are pledged to banks in the amount of $24.9 million and $19.4 million at
December 31, 2005 and September 30, 2005, respectively. Typically, banks will
require borrowers to maintain deposits of approximately 20% to 100% of the
outstanding loan balances. The individual bank loans have maturities ranging
from 5 to 12 months which coincides with the periods the cash remains pledged to
the banks.
We had a working capital surplus of $17.9 million as of December 31,
2005, as compared to $20.0 million as of September 30, 2005, a decrease of $2.1
million. This decrease was primarily attributable to the $4.0 million increase
in notes payable to finance the construction of the BAK Industrial Park and the
acquisition of equipment. We had short term borrowings maturing in less than one
year of $72.6 million as of December 31, 2005, as compared to $69.1 million as
of September 30, 2005, an increase of $3.5 million. We currently expect to be
able to extend the maturities of our short-term debt once we formally acquire
our certificate of land use right. If we are not able to do so, we will have to
refinance such short-term debt as it becomes due or to repay that debt to the
extent we have cash available from operations or from the proceeds of additional
issuances of capital stock.
As of December 31, 2005, the principal outstanding under our credit
facilities and lines of credit were as follows:
26
Maximum
Amount Amount
Available Borrowed
--------- ---------
(In thousands)
Comprehensive Credit Facilities:
Agricultural Bank of China .................. $ 30,978 $ 29,158
Shenzhen Development Bank ................... 18,587 13,630
Shenzhen Commercial Bank .................... 6,196 4,337
China Minsheng Bank ......................... 4,956 4,956
Construction Bank of China .................. 6,196 6,196
--------- ---------
Subtotal - Credit Facilities $ 66,913 58,277
========= ---------
Lines of Credit:
Agricultural Bank of China .................. 4,264
Shenzhen Development Bank ................... 212
Shenzhen Commercial Bank .................... 4,942
China Minsheng Bank ......................... 4,942
---------
Subtotal - Other Borrowings 14,360
---------
Total Principal Outstanding $ 72,637
=========
Lines of credit are outside of comprehensive credit facilities and are
therefore shown separately.
We refinanced our short-term debt during fiscal 2005 at annual interest
rates of 4.5% to 6.1%, payable monthly, and for terms of six to twelve months.
These debt arrangements are generally guaranteed by BAK International, Mr.
Xiangqian Li, our Director, Chairman of the Board, President, and Chief
Executive Officer, and Jilin Provincial Huaruan Technology Company Limited by
Shares, a PRC company ("Huaruan Technology"). Pursuant to the refinancing, we
deposited $19.4 million of restricted cash, and pledged $7.7 million of
inventory and $9.8 million of equipment and machinery as security for our
comprehensive credit facility with Shenzhen Development Bank ("Credit
Facility"). In addition, Mr. Li pledged 19,053,887 of his shares of our common
stock to guarantee our obligations under the Credit Facility. Furthermore, if at
any point during the term of the Credit Facility (i) our liabilities exceed 70%
of our assets, (ii) our sales revenue declines by 10% from their levels for the
prior calendar year or (iii) our net asset value declines by 10% compared to the
same point during the prior calendar year, all outstanding debt, including
interest and penalties due thereunder, will accelerate and become immediately
due and payable. We are currently in compliance with these financial tests. The
indebtedness to Shenzhen Commercial Bank is guaranteed by Mr. Li and by an
unaffiliated third party guarantor.
During the three months ended December 31, 2005, we refinanced two of
our credit facilities totalling $3.8 million, and entered into two new credit
facilities totalling $3.7 million with existing lenders. The four new facilities
provide for monthly interest payments at fixed annual interest rates from 5.022%
to 6.138%, with principal repayments at maturities during the second calendar
quarter of 2006. On January 11, 2006, BAK Battery repaid in full its loan from
the Agricultural Bank of China, originally entered into on July 29, 2005 for up
to $6,178,942 and maturing January 29, 2006. The principal balance at the time
of repayment was $6,178,942. On February 22, 2006, BAK Battery renewed its
outstanding loan from China Construction Bank in the amount of $3,726,847 under
an Application Letter for Drawing for Bank Loan Facility. The new loan agreement
provides for a term of six months, with interest accruing at an annual rate of
5.481%, payable monthly, and principal payable at maturity. The principal and
interest terms of the loan renewal are the same as those terms under the
original loan. In the future, we may be unable to obtain the same or similar
terms for any refinancing of our short-term indebtedness, or be unable to renew
our credit facilities on acceptable terms. If we fail to obtain debt or equity
financing to meet our debt obligations, or fail to obtain extensions of maturity
dates of these obligations as they become due, our overall liquidity and capital
resources will be adversely affected.
27
As of December 31, 2005, principal, interest and rental payments due
under our contractual obligations were as follows:
(In thousands)
Payments Due
---------------------------------------------------------
Less than More than
Total 1 Year 1-3 Years 3-5 Years 5 Years
--------- --------- --------- --------- ---------
Bank Loan, Short Term $ 39,032 $ 39,032 -- -- --
Notes Payable 33,605 33,605 -- -- --
Operating Leases 192 95 $ 97 -- --
Capital Leases -- -- -- -- --
--------- --------- --------- --------- ---------
Total Payments Due $ 72,829 $ 72,732 $ 97 -- --
--------- --------- --------- --------- ---------
On September 30, 2004, contrary to relevant PRC laws and regulations,
BAK Battery borrowed $1,812,316 from Changzhou Lihai Investment Consulting Co.,
Ltd., an unaffiliated party. BAK Battery subsequently repaid this loan on
October 11, 2004. Management believes that the risk to BAK Battery, due to this
loan arrangement, is very limited.
On January 18, 2005, BAK International completed a private offering of
8,600,433 shares of its common stock for gross offering proceeds of $17.0
million or $1.98 per share. Investors in the offering participated in the
subsequent exchange transaction with CBBI, and received 8,600,433 restricted
shares of CBBI's common stock, along with attendant registration rights. Net
proceeds from the financing of $15.7 million were used as follows: $4.3 million
to expand production facilities, $1.8 million to enhance existing products and
to research and develop new product offerings, and $9.6 million for working
capital purposes.
On September 16, 2005, CBBI sold 7,899,863 shares of its common stock
for gross offering proceeds of $43.4 million or $5.50 per share. Net proceeds
from that transaction of $40.3 million will be used to purchase equipment and
for working capital.
We have completed the construction of 174,784 square meters of new
facilities comprised of manufacturing facilities, warehousing and packaging
facilities, dormitory space and administrative offices at the BAK Industrial
Park. Of that space, 107,388 square meters are new manufacturing facilities. We
have completed construction and put into use an additional administrative area,
production facility, four manufacturing facilities, a warehouse and packaging
facility, two dormitories and one dining hall. At present, we have no
significant payment obligations related to these facilities, although we
continue to make payments regarding the construction of the facility as costs
arise. We do not own the tract of property on which we constructed the new
manufacturing plant and related facilities. We have applied for, but have not
obtained, a certificate of land use right for the property and those new
facilities. After formal receipt of our land use right, we anticipate being able
to extend the maturity of some or all of our short-term debt.
We are also seeking additional capital from other sources in order to
meet our capital requirements for expansion and ongoing liquidity needs. We may
be unable to obtain this additional capital or may be able to obtain additional
capital only on terms unfavorable to us and our existing stockholders. The
additional capital could include debt or equity financing, which could be
dilutive to existing stockholders. If we are unable to secure such financing, we
may not be able to complete all of our planned capital expansion.
Off-Balance Sheet Transactions
In the ordinary course of business practices in China, we enter into
transactions with banks or other lenders where we guarantee the debt of other
parties. These parties may be related to or unrelated to CBBI.
Conversely, CBBI's debt with lenders may also be guaranteed by other
parties which may be related or unrelated to CBBI.
Under generally accepted accounting principles, these transactions may
not be recorded on the balance sheet of CBBI or may be recorded in amounts
different than the full contract or notional amount of the transaction. Our
primary off balance sheet arrangements would result from our loan guaranties in
which BAK Battery would provide contractual assurance of the debt, or guarantee
the timely re-payment of principal and interest of the guaranteed party.
Typically, no fees are received for this service. Thus in those transactions,
BAK Battery would have a contingent obligation related to the guaranty of
payment in the event the underlying loan is in default.
28
Transactions described above require accounting treatment under FASB
Interpretation 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others ("FIN 45").
Under that standard, CBBI would be required to recognize the fair value of
guarantees issued or modified after December 31, 2002 for non-contingent
guaranty obligations, and also a liability for contingent guaranty obligations
based on the probability that the guaranteed party will not perform under the
contractual terms of the guaranty agreement.
We had contingent guaranty obligations at December 31, 2005 requiring
recognition or disclosure under FIN 45. We had guaranteed the timely re-payment
of principal and interest of two parties to a bank. The maximum amount of our
exposure for those guaranties at December 31, 2005 was $6.3 million. On January
11, 2006, we guaranteed an additional $619,000 for one of these parties to a
bank. Between January 9, 2006 and March 7, 2006, we discounted an additional
$10.8 million of notes receivable, increasing our maximum exposure for
guarantees to $17.7 million on that date. No revenue, expenses or cash flows
arose from these arrangements at anytime.
Interest Rate Risk
We are exposed to interest rate risk primarily with respect to our
short-term bank loans. Although the interest rates, based on the banks' prime
rates, are fixed for the terms of the loans, the terms are typically five to
twelve months and interest rates are subject to change upon renewal. There were
no changes in interest rates for short-term bank loans renewed during the three
months ended December 31, 2005. A hypothetical 1.0% increase in the annual
interest rates for all of our credit facilities at December 31, 2005 would
decrease net income before provision for income taxes by $98,000 or 2.5% for the
three months ended December 31, 2005. Management monitors the banks' prime rates
in conjunction with our cash requirements to determine the appropriate level of
debt balances relative to other sources of funds. We have not entered into any
hedging transactions in an effort to reduce our exposure to interest rate risk.
Foreign Exchange Risk
While our reporting currency is the U.S. Dollar, approximately 75% of
our consolidated revenues and 90% of consolidated costs and expenses are
denominated in Renminbi ("RMB"), with the balance denominated in U.S. Dollars.
Substantially all of our assets are denominated in RMB except for cash, of which
34% is denominated in U.S. Dollars. As a result, we are exposed to foreign
exchange risk as our revenues and results of operations may be affected by
fluctuations in the exchange rate between U.S. Dollars and RMB. If the RMB
depreciates against the U.S. Dollar, the value of our RMB revenues, earnings and
assets as expressed in our U.S. Dollar financial statements will decline. We
have not entered into any hedging transactions in an effort to reduce our
exposure to foreign exchange risk.
Critical Accounting Policies
In preparing our consolidated financial statements in conformity with
accounting principles generally accepted in the United States, we use
statistical analysis, estimates and projections that affect the reported amounts
and related disclosures and may vary from actual results. We consider the
following accounting policies to be both those that are most important to the
portrayal of our financial condition and require the most subjective judgment.
If actual results differ significantly from management's estimates and
projections, there could be an effect on our financial statements.
Revenue Recognition, Returns and Warranties. Revenue from sales of our
products is recognized upon shipment or delivery, depending on the terms of the
sales order, provided that persuasive evidence of a sales arrangement exists,
title and risk of loss have transferred to the customer, the sales amount is
fixed and determinable, sales and value-added tax laws have been complied with,
and collection of the revenue is reasonably assured.
29
We reduce revenue based upon estimates of future credits to be granted
to customers. Credits are granted for reasons such as product returns due to
quality issues, including product warranties claims, volume-based incentives,
and other special pricing arrangements. Management utilizes its historical
experience to estimate the allowance for product returns and warranty claims and
revises those estimates periodically based on changes in actual experience,
market conditions and contract terms.
In addition, management monitors collectability of accounts receivable
primarily through review of the accounts receivable aging. When facts and
circumstances indicate the collection of specific amounts from specific
customers is at risk, we assess the impact on amounts recorded for bad debts
and, if necessary, record a charge in the period such determination is made.
Inventory Valuation Allowances. Inventory is valued net of allowances
for unsalable or obsolete raw materials, work-in-process and finished goods.
Allowances are determined by comparing inventory levels of individual materials
and parts to historical usage rates, current backlog and estimated future sales,
and by analyzing the age of inventory, in order to identify specific components
of inventory that are judged unlikely to be sold. In addition to this specific
identification process, statistical allowances are calculated for remaining
inventory based on historical write-offs of inventory for salability and
obsolescence reasons. Inventory is written-off in the period in which the
disposal occurs. Actual future write-offs of inventory for salability and
obsolescence reasons may differ from estimates and calculations used to
determine valuation allowances due to changes in customer demand, customer
negotiations, technology shifts and other factors.
Changes in Accounting Standards
In December 2004, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123R, "Share-Based Payment"
("SFAS 123R"), which became effective for us on October 1, 2005. SFAS 123R
revises FASB Statement No. 123 "Accounting for Stock-Based Compensation" and
supersedes APB Opinion No. 25 "Accounting for Stock Issued to Employees". SFAS
123R requires all public and non-public companies to measure and recognize
compensation expense for all stock-based payments for services received at the
grant-date fair value, with the cost recognized over the vesting period (or the
requisite service period). The impact of the adoption of SFAS 123R upon the
Company's consolidated financial statements is consistent with the fair value
disclosures included in the notes to the Company's September 30, 2005
consolidated financial statements.
In December 2004, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4," ("SFAS 151") which became effective for us
on October 1, 2005. This standard clarifies that abnormal amounts of idle
facility expense, freight, handling costs and wasted material should be expensed
as incurred and not included in inventory. In addition, this standard requires
that the allocation of fixed production overhead costs to inventory be based on
the normal capacity of the production facilities. The impact of the adoption of
SFAS 151 has not been material.
Exchange Rates
The financial records of BAK International, BAK Battery and BAK
Electronics are maintained in Renminbi. In order to prepare our financial
statements and to state other amounts set forth in this Management's Discussion
and Analysis ("MD&A"), we have translated amounts in Renminbi into amounts in US
Dollars. The amounts of our assets and liabilities on our balance sheets are
translated using the closing exchange rate as of the date of the balance sheet.
Revenues, expenses, gains and losses are translated using the average exchange
rate prevailing during the period covered by such financial statements.
Adjustments resulting from the translation, if any, are included in our
cumulative other comprehensive income (loss) in our stockholders' equity section
of our balance sheet. All other amounts stated in this MD&A, that were
originally booked in Renminbi and translated into US Dollars, were translated
using the closing exchange rate on the date of recognition. Year to year
comparative amounts included in this MD&A are based on the amounts for the years
or date compared included in the financial statements for the years discussed.
Consequently, the exchange rates at which the amounts in those comparisons were
computed varied from year to year.
30
The exchange rates used to translate amounts in Renminbi into US
Dollars in connection with the preparation of our financial statements or
otherwise stated in this MD&A were as follows:
RMB per US Dollar
-----------------
2005 2004
-----------------
Balance sheet items as of December 31 8.0702 8.2765
Amounts included in the statement of operations, statement of
changes in stockholders' equity and statement of cash flows for the
three months ended December 31 8.0827 8.2765
Balance sheet items as of September 30 8.0920 8.2767
Amounts included in the statement of operations, statement of
changes in stockholders' equity and statement of cash flows for the
years ended September 30 8.2413 8.26688
Renminbi are not readily convertible into US Dollars in the foreign
exchange markets. The foreign exchange rate between the RMB and the US Dollar
had been stable at approximately RMB 8.28 to US$1.00 for the last few years. On
July 21, 2005, the Central Bank of China announced that it would allow the RMB
to move to a flexible exchange rate with a maximum daily variance against the US
Dollar of 0.3%. No provision has been made in the accompanying financial
statements for the change in currency policy, nor has any determination been
made, as to the potential impact, this may have on our future operations. As a
result, the stated exchange rates may not accurately reflect the amount in US
Dollars into which Renminbi could be actually converted at the date or during
the periods reflected in the foregoing table.
OUR BUSINESS
Overview
CBBI conducts its operations through its China-based indirect
subsidiaries, BAK Battery and BAK Electronics. Both CBBI and BAK International
are holding companies and do not conduct any revenue generating activities
except through BAK Battery and BAK Electronics. We focus on the manufacture,
commercialization and distribution of a wide variety of standard and customized
lithium ion rechargeable batteries for use in a wide array of applications. We
also have internal research and development facilities engaged primarily in
furthering lithium ion related technologies. We believe that our technologies
allow us to offer batteries that are flexibly configured, lightweight and
generally achieve longer operating time than many competing batteries currently
available. We have focused on manufacturing a family of replacement lithium
batteries for cellular telephones. We also supply rechargeable lithium ion
batteries for use in various other portable electronic applications, including
high-power handset telephones, laptop computers, digital cameras, video
camcorders, MP3 players and general industrial applications.
Historically, we have manufactured three types of batteries: steel
cell, aluminum cell and cylindrical cell. We deliver our products to packing
plants operated by third parties where the bare cells are packed in accordance
with specifications established by certain manufacturers of cellular telephones
and other electronic products. The majority of our income is generated from the
sale of steel cells. However, we believe there is growth potential for aluminum
and cylindrical cells because of their wide applications. In September 2005 we
began producing a fourth type of battery, lithium polymer. Our current growth
strategy includes entering into the global original equipment manufacture
battery market for mobile phone and portable electronic applications. We have
developed a program for producing high power lithium ion battery cells which
will allow us inroads into additional battery markets such as those for power
tools. We have begun marketing our high power lithium ion battery cells.
We operate sales and service branches in Beijing, Shanghai, Qingdao,
Xiamen, Quanzhou, Zhuhai, Fuzhou and Guangzhou in the PRC.
31
History
We originally began operations as a Nevada corporation known as "Medina
Copy, Inc." We were incorporated in Nevada on October 4, 1999 and subsequently
changed our name to "Medina Coffee, Inc." ("Medina Coffee") on October 6, 1999.
Medina Coffee commenced operations on December 1, 2002 and was considered a
development stage company. Medina Coffee was formed originally for the purpose
of building a retail specialty coffee business that sold specialty coffee and
espresso drinks through company owned and operated espresso carts. Medina Coffee
had incurred operating losses from its inception and therefore looked to combine
with a privately-held company that was profitable or that management considered
to have growth potential.
On January 20, 2005, we completed a stock exchange transaction with the
stockholders of BAK International. The exchange was consummated under Nevada law
pursuant to the terms of a Securities Exchange Agreement dated effective as of
January 20, 2005 by and among Medina Coffee, BAK International and the
stockholders of BAK International. Pursuant to the Securities Exchange
Agreement, we issued 39,826,075 shares of our common stock, par value $0.001 per
share, to the stockholders of BAK International, representing approximately
97.2% of our post-exchange issued and outstanding common stock, in exchange for
100% of the outstanding capital stock of BAK International. Effective February
14, 2005, we changed our name from "Medina Coffee, Inc." to "China BAK Battery,
Inc."
BAK Battery was formed in August, 2001 to manufacture and sell a
variety of standard and customized lithium ion rechargeable batteries for use in
a number of applications, although primarily in cellular telephones. It
commenced revenue producing operations in June 2002. BAK International was
incorporated in Hong Kong on December 29, 2003 under the Companies Ordinance at
BATCO International Limited (and subsequently changed its name to BAK
International Limited on November 3, 2004) for the purpose of acquiring all of
the equity ownership interests in BAK Battery, a transaction which it completed
in January 18, 2005. Our recent business activities include:
o In June 2002, BAK Battery began operations with initial
monthly output of approximately 220,000 units.
o BAK Battery received government authorization in October 2002
to establish a Postdoctoral Workstation, the establishment of
which serves as recognition by the PRC government of the
strong capabilities of our in-house research team. With our
research and development facilities we are focusing our
research efforts on liquid lithium ion batteries, high power
lithium ion batteries, solid-polymer lithium ion batteries,
and cylindrical and rectangular lithium ion batteries.
o In March 2003, monthly output of the BAK Battery steel case
battery cell reached approximately 2.4 million units.
o In September 2003, BAK Battery was granted International
Organization for Standardization 14001: 1996, an environmental
management system certification, as well as International
Organization for Standardization 9001: 2000, a quality
management system certification, by Beijing Zhonjing Quality
Certification Co., Ltd, an independent third party which
issues such standardization certifications in the PRC.
o As of September 2004, BAK Battery established a sales and
service network to cover six principal coastal cities and
Beijing in the PRC.
o Following the completion of the new steel case cell production
facility located in Shenzhen, PRC in May 2005, BAK Battery's
total monthly capacity for all battery types rose to 22
million units. As of September 2005, our total monthly output
for all battery types was approximately 18 million units. The
opening of our new steel case cell production facility also
allowed us to increase the production of aluminum case cells
by making available a production line previously dedicated to
steel cell production. Our ability to continue to grow our
manufacturing capacity will depend upon the development and
expansion of semi-automated manufacturing lines requiring less
manual labor efforts when compared to previous more labor
intensive manufacturing processes.
32
Our Business Strategy
We seek to maintain and strengthen our position as a provider of
lithium ion batteries and related services while increasing the breadth of our
product line and improving the quality of our products. In order to achieve our
objective, we plan to pursue the key strategies described below.
o Continuing to be a cost leader in an increasingly competitive
market. We believe we can ensure competitive pricing by
integrating a labor intensive production process with
high-tech, proprietary manufacturing equipment. We believe our
experience in designing and updating key manufacturing
equipment and operating such equipment at a low cost gives us
a cost advantage over our competitors.
o Taking advantage of our ready production capacity and allowing
for increased production capacity. We believe our production
capacity makes us more reliable, flexible and responsive in
terms of fulfilling our customers' requirements than other
providers. As such, existing and potential competitors may
find it more difficult to compete with our production
capabilities. The completion of our new manufacturing facility
should only enhance our production capacity.
o Enhanced R & D activities. With the completion of our new
facility, we will have the space to enhance our existing R&D
capabilities through the addition of state of the art
equipment and experienced personnel.
o Developing our OEM business. We believe that by entering the
global OEM market for lithium ion batteries, we will be able
to significantly increase revenues. In order to do so, we are
currently undergoing certification by a global OEM in the
mobile phone industry. To date, most of the certification
process is complete, and we anticipate that we will receive
certification.
o Expanding our product lines to capture new market
opportunities. We have developed high power lithium ion
battery cells that can be used in power tools. Our product
offering is currently undergoing testing by a potential
customer. We have begun sales of our high power lithium
battery during our fourth quarter of calendar year 2005. In
addition, we are beginning to produce lithium polymer battery
cells that can be used for various cellular telephones,
portable electronic applications, Bluetooth technology, and
similar types of technology. Lithium polymer batteries are
used for applications similar to those that utilize lithium
ion aluminum cell batteries. However, lithium polymer battery
cells weigh less and are easier to shape. By entering these
markets, we believe we can achieve future revenue growth and
improved profit margins. In September 2005 we began production
of lithium polymer batteries.
Principal Products and Services
Lithium Batteries
A battery is an electrochemical apparatus used to store and release
energy in the form of electricity. The main components of a conventional battery
are the anode, cathode, separator and an electrolyte, which can be either a
liquid or a solid. The separator acts as an electrical insulator, preventing
electrical contact between the anode and cathode inside the battery. During
discharge of the battery, the anode supplies a flow of electrons, known as
current, to a load or device outside of the battery. After powering the load,
the electron flow reenters the battery at the cathode. As electrons flow from
the anode to the device being powered by the battery, ions are released from the
cathode, cross through the electrolyte and react at the anode.
33
All of the cells that we build are rechargeable through the systems in
the devices in which our batteries are used. Several important parameters for
describing the performance characteristics of a rechargeable battery are design
flexibility, energy density, discharge rate, internal resistance and cycle life.
Design flexibility refers to the ability of rechargeable batteries to be
designed to fit a variety of shapes and sizes of battery compartments. Thin
profile batteries with prismatic geometry provide the design flexibility to fit
the battery compartments of today's electronic devices. Energy density refers to
the total electrical energy per unit volume stored in a battery. High energy
density batteries generally are longer lasting power sources providing longer
operating time and necessitating fewer battery recharges. Lithium batteries, by
the nature of their electrochemical properties, are capable of providing higher
energy density than comparably sized batteries that utilize other chemistries
such as Nickel Cadmium (NiCd) and Nickel Metal Hydride (Ni-MH) and, therefore,
tend to consume less volume and weight for a given energy content. Long cycle
life is a preferred feature of a rechargeable battery because it allows the user
to charge and recharge many times before noticing a difference in the
performance of the battery. A lithium ion battery with lower internal resistance
will provide higher electrical current with less energy consumption, as well as
lower internal heat energy as a result of the lower internal resistance. The
lower internal heat also makes the battery safer because it is less subject to
explosion. A higher discharge rate means a higher electrical current, which in
cellular telephones means a longer talking time.
In addition to the higher energy density of lithium ion batteries
compared to other rechargeable chemistry batteries such as NiCd and Ni-MH,
lithium ion batters also provide higher discharge rate and shorter recharge
time. Lithium batteries also can be manufactured using lithium sulfur dioxide or
lithium thionyl chloride although those other chemistries have not been as
widely used. Generally, rechargeable batteries have been replacing
non-rechargeable batteries in many of the uses of which our batteries are
intended.
We manufacture a variety of lithium ion rechargeable batteries. We
believe our range of lithium ion rechargeable batteries offer substantial
benefits including the ability to design and produce lightweight cells in a
variety of custom sizes, shapes and thickness. We produce the following types of
rechargeable lithium batteries.
o Prismatic lithium ion batteries. These batteries are used in
cellular telephones, MP3 players, digital cameras and other
portable electronic devices. These batteries can be composed
of steel case cells or aluminum case cells. Aluminum case
cells are lighter than steel case cells and safer. However,
aluminum case cells generally are more expensive to
manufacture and therefore have a higher cost. We manufacture a
wide variety of steel case cell and aluminum case cell lithium
ion prismatic batteries in various sizes and voltage
configurations to satisfy customer requirements.
o Cylindrical lithium ion batteries. These batteries are
primarily used in laptop computers, digital cameras and
electric razors. These batteries are flexible in design like
prismatic batteries, but have a greater energy density.
Cylindrical batteries offer better uniformity, which permits
them to be used in parallel circuits which increases the
electrical current and the resulting working time. However,
cylindrical batteries are more expensive to manufacture and
therefore have a higher sales price than comparable
non-cylindrical batteries. We manufacture 3 types of models
ranging in size and voltage requirements to satisfy customer
requirements.
o Lithium polymer batteries. These batteries are used in
cellular telephones, Bluetooth headsets, laptop computers,
integrated circuit cards and personal digital assistant
devices. Lithium polymer batteries have a polymer electrolyte
rather than a liquid electrolyte, which reduces the battery's
overall weight and volume. This allows for lighter, more
compact batteries and more flexibility in design than
prismatic or cylindrical lithium ion batteries. However, they
are more expensive to manufacture. In September 2005, we began
production of lithium polymer batteries in a variety of sizes
and voltage configurations. We are continuing to increase our
offerings of lithium polymer batteries in order to gain the
market's acceptance of these products from BAK Battery.
During fiscal 2005, our product mix was 55.89% steel case battery
cells, 23.27% aluminum case battery cells, 1.03% cylindrical case battery cells,
0.02% polymer battery cells and 19.79% industrial batteries.
34
Services
We have built a sales and service network covering the cities of
Shanghai, Qingdao, Xiamen, Quanzhou, Zhuhai, Fuzhou, Guangzhou and Beijing in
the PRC. We provided services to support sales to our customers who currently
are primarily battery pack manufacturers. Our service motto is "cooperative
spirit, rapid reaction". We provide presale, sales and post sale services. Our
presale service is designed to determine our customers' order requirements,
including, size, quantity, voltage and delivery date, and plan for the
production of batteries to meet these order requirements. We solicit this
information through face-to-face meetings and through a written client survey.
The information we collect is used to schedule raw materials purchases and
production. Our sales service includes the actual order processing, materials
purchases, production scheduling and shipment of product. Depending upon our
customers' location, we may ship directly using our own transportation
facilities, primarily delivery by truck, or we may ship using a third party
carrier. We support our sales with post-sales customer support. Our service
capabilities include a 24-hour customer response. Our other services include
providing battery testing and test reporting; providing training courses
regarding quality control and battery usage; gathering customer opinions on our
products and services; evaluating customer requirements and fulfilling
appropriate requests.
We have two strategic policies for sales and service:
o We built a sales and service network to cover Beijing,
Shanghai, Qingdao, Xiamen, Quanzhou, Zhuhai, Fuzhou and
Guangzhou in China.
o Our service capabilities include 24-hour customer response.
Features
Performance standards. Our lithium ion batteries have high capacity,
low internal resistance, and a safety guarantee. Certificates or approvals we
have received include: EU's CE attestation; Underwriters' Laboratory
authentication in the United States; and certificates from the major cellular
telephone manufacturers of China, including China Saibao (the CEPREI
certification body); Amoi Electronics Co., Ltd.; China Datang (Group)
Corporation; Konka Group Co., Ltd.; Tianyu Communication Technology (Kunshan)
Co., Ltd.; and Shenzhen Telsda Mobile Communication Industry Development Co.,
Ltd.
Longer usage time and higher discharge rates. We believe our battery
has a higher discharge voltage so it can provide a longer talking time for
mobile phone users. Our products have a higher discharge capacity than the
battery products of certain competitors. Therefore, with the same capacity, our
battery can therefore provide a longer talking time. The higher discharge
capacity is especially useful for cellular telephones with color screens, which
have a high demand on the battery's continuous discharge voltage.
Performance at lower temperatures. Our lithium ion batteries perform
well from -20 Celsius to +60 Celsius. At a temperature as low as -20 Celsius the
batteries release 95% of the battery energy at an 0.2C rate (i.e. discharge all
the energy in 5 hours); and over 90% of the battery energy can be discharged at
an 1.0C rate. This feature allows improved cell phone battery duration,
particularly in northern areas of the PRC.
Manufacturing
We manufacture all of products from raw materials at our facilities in
Shenzhen in the PRC. The battery cells we produce are typically shipped to third
parties for final packaging prior to delivery to our customers. The cost of such
packaging is not included in our sales price to our customers. We maintain
separate production lines for steel case cells, aluminum case cells, cylindrical
cells and lithium polymer batteries. Such production lines can be adapted to
produce other types of batteries if the demand for a particular type of battery
increases or decreases. Our current monthly output capacity is 22 million units.
Certain of the materials we utilize may pose safety problems if
improperly used. We have designed our batteries to minimize safety hazards both
in manufacturing and in use.
35
Depending upon the customer's location, we generally deliver our
product to our customers by truck or by shipment from the Port of Hong Kong. We
deliver our product to packing plants operated by third parties where cells are
packed in accordance with our customer's specifications.
We primarily utilize electrical supply from the local utility company
for heat, light and power to our facilities. As part of our production
efficiency, we may enter into a supply agreement with an electrical supplier in
order to assure the supply of electrical power to our manufacturing facilities.
We have received International Organization for Standardization 9001:
2000, a quality management system certification, and International Organization
for Standardization 14001: 1996, an environmental management system
certification for all our manufacturing facilities.
Suppliers
We have built a complete supply chain, putting together a group of
material and equipment suppliers, primarily Chinese, except for ENTEK (a
separator supplier in the US), from whom we buy on a purchase order basis.
During the sales process, our purchasing department prepares a schedule of
materials needs for the planned production. The purchasing department then
solicits from the suppliers with whom we have established relationships and may
have entered into a long-term supply contract. We then enter an order with the
selected supplier(s). The order will specify price, settlement date, quantity
and the other requirements. We also specify quality standards for the purchase.
We have established standards for our suppliers relating to quality, service and
various other aspects of supply. We may enter into volume purchase agreements
with our major suppliers under which we purchase materials and equipment on a
purchase order basis. We have entered into such an agreement with Beijing CITIC
Guoan Mengguli Electric Supply Ltd. Co., from whom we purchase the cathode
material, Lithium Cobalt Dioxide (LiCoO2). These volume purchase agreements
generally only specify nonmaterial terms; the material terms of each purchase
are separately determined at the time of purchase order. We believe that
alternative suppliers are available to supply materials and equipment if
purchases were not available under any volume purchase agreement we may enter
into.
Cathode material in a lithium ion battery is primarily LiCoO2; LiMnO4
and LiCo1-xNixO2 are also used as cathode materials. Anode material mainly
consists of carbon materials such as graphite, sourced primarily in China. The
separator material is imported from Japan and the US. There are sufficient
supplies of electrolytes in China, and we believe the quality to be very good.
The table below describes the key sources of our key materials.
As of December 31, 2005, our key material suppliers and key equipment
suppliers were as follows:
Key Material Suppliers
- ------ ------------------ ------------------------------------------------------
Item Materials Main Suppliers
- ------ ------------------ ------------------------------------------------------
1 Case and caps Roofer Group Company, Yijinli technology company
Shenzhen Tongli Precision Stamping Products Co., Ltd.
- ------ ------------------ ------------------------------------------------------
2 Cathode materials CITIC Guoan
- ------ ------------------ ------------------------------------------------------
3 Anode materials Shanghai Shan Shan, Changsha graphite
- ------ ------------------ ------------------------------------------------------
4 Aluminum foil Aluminum Corporation of America, Shanghai
- ------ ------------------ ------------------------------------------------------
5 Copper foil Huizhou United Copper Foil
- ------ ------------------ ------------------------------------------------------
6 Electrolyte Zhangjiagang Guotai-Huarong New Chemical Materials
Co., Ltd.
- ------ ------------------ ------------------------------------------------------
7 Separator Ube Industries, ENTEK, CELGARD
- ------ ------------------ ------------------------------------------------------
36
Key Equipment Suppliers
- ------ -------------------------------- ----------------------------------------
Item Instruments Suppliers
- ------ -------------------------------- ----------------------------------------
1 Coating machine Beijing 706 Factory
- ------ -------------------------------- ----------------------------------------
2 Mixer Guangzhou Hongyun Machine
- ------ -------------------------------- ----------------------------------------
3 Press machine SevenStar Huachuang
- ------ -------------------------------- ----------------------------------------
4 Ultrasonic spot welding machine Zhenjiang Tianhua Machinery and
Electrical Co., Ltd.
- ------ -------------------------------- ----------------------------------------
5 Laser seam welder Wuhan Chutian Laser Group
- ------ -------------------------------- ----------------------------------------
6 Vacuum oven Jiangshu Wujiang Songling
- ------ -------------------------------- ----------------------------------------
7 Electrolyte filling machine BAK (internally developed)
- ------ -------------------------------- ----------------------------------------
8 Aging equipment Guangzhou Qingtian Industrial Co., Ltd.
- ------ -------------------------------- ----------------------------------------
9 Testing and sorting equipment Guangzhou Qingtian Industrial Co., Ltd.;
Wuhan Kingnuo Electronics Co., Ltd.
- ------ -------------------------------- ----------------------------------------
Sales and Marketing
Marketing Strategies. We have two key marketing strategies. Our first
strategy is to be a leader in the worldwide replacement battery market. We
believe we can secure and enhance our market share because of the quality of our
products and our ability to maintain high production volume with low production
cost. Our second marketing strategy is to enter the global OEM market. To enter
into this market we will be required to gain certification from a global OEM,
which we are currently seeking and anticipate that we will receive. We believe
that our entry into the global OEM market is important to our continued growth
because the market for replacement batteries is becoming saturated.
Our Current Market. We have developed a sales and service network of
our own employees based in the cities of Qingdao, Xiamen, Quanzhou, Zhuhai,
Fuzhou, Shanghai, Guangzhou and Beijing in the PRC. We also export our products
to the United States, Canada, South Africa, Japan, Singapore, Taiwan, and Hong
Kong. From 2001, our annual sales have grown from $3 million to $101.9 million
for the year ended September 30, 2005. For the year ended September 30, 2005,
71% of our sales were domestic, while 29% were made internationally. We believe
that our share of the domestic replacement battery market for cell phones for
2004 was 60%.
Competition
Our rechargeable lithium ion batteries compete against other
manufacturers of lithium ion batteries. We compete on the basis of the prices at
which we sell our products, our ability to supply the quantities of batteries
our customers need in accordance with our customers' schedules and the quality
of our products. We face competition in the production of rechargeable lithium
ion batteries, not only within China, but also from other parts of the world,
particularly Japan and Korea. Sony Corp. first commercialized rechargeable
lithium ion batteries in 1992. However, Japan's market share of lithium ion
battery production has decreased since 2000. We believe we are currently one of
the largest lithium ion battery manufacturers in the world, with a monthly
output of 22 million units (our current monthly production has reached the
monthly output capacity). We also believe we are the second largest manufacturer
in the Chinese market.
We believe the following are the leading global manufacturers of
lithium batteries:
o Japan - Sanyo Electric Co., Sony Corp., Matsushita Electric
Industrial Co., Ltd. (Panasonic), GS Group, NEC Corporation
and Hitachi Ltd.;
o Korea - LG Chemical Ltd. and Samsung Electronics Co., Ltd.;
and
o China - BYD Co. Ltd., Shenzhen BAK Battery Co., Ltd., Tianjin
Lishen Battery Joint-Stock Co., Ltd., Henan Huanyu Group and
Harbin Coslight Technology International Group Co., Ltd.
37
We compete with these companies by striving to provide a higher quality
product at a lower cost. We believe that by doing business in China we enjoy
competitive advantages over similar companies doing business in Japan and Korea,
including abundant labor resources, low cost raw materials and better access to
China's extensive mobile phone market. We also believe that our production
efficiencies as well as our labor costs give us a competitive advantage over
other manufacturers in China. Historically, although other entities may attempt
to take advantage of the growth of the lithium battery market, the lithium
battery industry has certain technological and economic barriers to entry. The
development of technology, equipment and manufacturing techniques and the
operation of a facility for the automated production of lithium batteries
require large capital expenditures, which may deter new entrants from commencing
production.
Customers
We have targeted sales of our lithium ion rechargeable batteries to
OEM's and replacement battery pack manufacturers, who resell our batteries in
packaging to end users. Due to the demand for replacement cell phone batteries
in China, and our proximity to that market, we targeted our domestic market
through replacement battery pack manufacturers. Over the past three years, we
have developed relationships with key battery pack customers, including SCUD
(Fujian) Electronics Co., Ltd., Desay Power Tech. Co., Ltd. and Shenzhen Ya
Litong Electronic Co., Ltd. We are also targeting sales of lithium ion batteries
to global OEM's. A key to the OEM market is obtaining approval of our products
from the OEM's, which we are currently seeking from a global OEM in the mobile
phone industry. Our sales are generated primarily from purchase orders. We
generally do not have long-term contracts with customers, although we may enter
into a letter of intent to express our long term cooperative relationship with
the customer. Our ten largest customers, who predominantly are in China,
accounted for 53.31% of our sales during the fiscal year ended September 30,
2005. Our 30 largest customers accounted for 78.45% of our sales during the
fiscal year ended September 30, 2005, predominantly in China. We do not believe
our sales are materially seasonal.
Research and Development
We operate a state of the art research and development center
performing proprietary research that has resulted in 25 issued patents in the
PRC, 164 applications for patents filed in the PRC and 4 applications for
patents filed outside the PRC as of December 31, 2005. We have not had any
patents awarded in any country other than the PRC. We also outsource certain of
our research and development matters to ChangChun Applied Chemistry Research
Institute of the China Scientific Institute, Tstinghua University, JiLin
University, the Electrochemistry Department of XiaMen University and Shenzhen
University. In our in-house facility we employ over 100 staff members, led by
three government recognized specialists. Upon the approval of the National
Ministry of Personnel in October 2002, a Postdoctoral Workstation was
established. The establishment of the Workstation serves as recognition by the
PRC government of the strong capabilities of our in-house research team. The
research and development center focuses research on projects relating to liquid
lithium ion batteries, high power lithium ion batteries, solid lithium polymer
ion batteries, and cylindrical and rectangular lithium ion batteries.
During fiscal 2005 and 2004, we expended $541,735 and $328,779,
respectively, on our research and development efforts. We have also invested
$930,000 on research and development equipment during fiscal 2005, bringing the
total research and development expenditures during fiscal 2005 to $1.5 million.
During 2004, our research was aimed at developing new or improved anode raw
material and new products. Our research in 2005 was targeted at new or improved
cathode raw material and product safety research.
Employees
The following table summarizes the functional distribution of our
employees as of September 30, 2004, September 30, 2005 and December 31, 2005:
38
Department September 30, 2004 September 30, 2005 December 31, 2005
---------------------------------- ------------------ ------------------ ------------------
Officers 10 11 19
Comprehensive Management 197 146 133
Human Resources 19 18 21
Sales and Marketing 67 88 80
PMS Department 21 13 12
Process Department 46 29 15
Research & Development 107 108 108
Purchasing Department 29 24 25
Financial Department 18 25 31
PMC Department 45 74 87
After Sales Department 33 35 23
Quality Control Department 242 125 125
Investment Banking Department 1 5 5
Information Technology Department 0 10 12
Intellectual Property Department 0 12 9
Mechanical and Electronic
Engineering 99 165 165
Law Affairs Department 0 0 8
Packing Department 420 578 595
Manufacturing Department 5,008 5,504 6,777
---------------------------------- ------------------ ------------------ ------------------
TOTALS 6,362 6,970 8,250
39
None of our personnel are represented under collective bargaining
agreements. We consider our relations with our employees to be good.
Facilities
We currently lease 8,486 square meters in the aggregate for office
space, manufacturing facilities, and dormitory space. We lease 3,000 square
meters for office space and manufacturing operations pursuant to a lease which
runs from June 1, 2003 to June 1, 2008. Our current rent due under that lease is
$2,781 a month. We also lease 2,500 square meters for office space and
manufacturing facilities pursuant to a lease with a term beginning December 16,
2001 and ending December 15, 2006. We owe lease payments of $2,329 a month
during the term of this second lease. We also lease an additional 2,986 square
meters for dormitory space pursuant to a lease with a term beginning July 1,
2005, and ending June 30, 2008. We owe lease payments of $2,583 per month under
this lease.
In addition, currently we have completed construction of 174,784 square
meters of new facilities comprised of manufacturing facilities, warehousing and
packaging facilities, dormitory space and administrative offices at the BAK
Industrial Park. Of that space, 107,388 square meters will be new manufacturing
facilities. We have completed construction and put into use an additional
administrative area, production facility, four manufacturing facilities, a
warehouse and packaging facility, two dormitories and one dining hall. At
present, we have no payment obligations related to these facilities, although we
continue to make payments relating to the completion of construction of the
facility. We do not own the tract of property on which we have constructed the
new manufacturing plant and related facilities. We have applied for, but have
not obtained, a certificate of land use right for the property and those new
facilities.
Legal Proceedings
We are not a party to any legal proceedings, nor are we aware of any
threatened or contemplated proceedings which are expected to result in a
material adverse effect on our consolidated financial position or results of
operation.
40
Intellectual Property and Proprietary Rights
We rely primarily on a combination of copyright laws and contractual
restrictions to establish and protect our intellectual property rights. As of
December 31, 2005 we had obtained 25 issued patents in the PRC and 164 are in
the application process in the PRC, and 4 are in the application process outside
the PRC. We require our management and key technical personnel to enter into
agreements requiring them to keep confidential all information relating to our
customers, methods, business and trade secrets during and after their employment
with us.
We have very strict control over the core technologies for which we can
not apply for patents. Every employee who is related to these proprietary
technologies must sign a "special technology non-disclosure agreement". We have
also established an internal department to protect property rights. In this
department, there are professionals including attorneys, engineers, information
managers and archives managers responsible for the application and protection of
proprietary rights. We have also developed a series of rules regarding "property
right non-disclosure", "property right archives management", "information
collection and analysis" and "innovation encouragement". While we actively take
steps to protect our proprietary rights, such steps may not be adequate to
prevent the infringement or misappropriation of our intellectual property. This
is particularly the case in China where the laws may not protect our proprietary
rights as fully as in the United States. Infringement or misappropriation of our
intellectual property could materially harm our business. BAK Battery has
registered the following Internet and WAP domain name www.bak.com.cn (the
English version of our website can be found at www.bak.com.cn.en).
41
DIRECTORS AND EXECUTIVE OFFICERS
The following table provides information about our executive officers
and directors and their respective ages and positions as of December 31, 2005.
The directors listed below will serve until our next annual or special meeting
of stockholders at which directors are elected:
NAME AGE POSITION HELD
---- --- -------------
Xiangqian Li 37 Director, Chairman of the Board, President and
Chief Executive Officer
Yongbin Han 36 Chief Financial Officer, Secretary and Treasurer
Huanyu Mao 54 Chief Operating Officer and Chief Technical Officer
Xiangqian Li has served as our Director, Chairman of the Board,
President and Chief Executive Officer since January 20, 2005. Mr. Li has been
Chairman of the Board of Directors and General Manager of BAK Battery since
April 2001 and has also served as BAK Battery's general manager since December
2003. Previously, Mr. Li served as (i) Chairman of the Board of Directors and
General Manager of Shenzhen BAK Li-ion Battery Co., Ltd. from December 2000
until March 2001; (ii) as Chairman of the Board of Directors and General Manager
of Jilin Province Huaruan Technology Company Limited by Stocks ("Huaruan
Technology") from March 2001 until June 2001; and (iii) as Chairman of the Board
of Directors of Huaruan Technology from January 2001 until June 2003. Prior to
2001 Mr. Li was self employed. Mr. Li graduated from Lanzhou Railway Institute
and holds a Bachelors degree in gas engineering. He is pursuing a Doctorate of
quantity economics from Jilin University.
Yongbin Han has served as our Chief Financial Officer and Secretary
since January 20, 2005. Mr. Han is a Chinese certified public accountant and
certified tax agent. Mr. Han has been Deputy General Manager of BAK Battery
since April 2003. In that capacity he oversees the finance and accounting
department. Previously, Mr. Han served as (i) Deputy General Manager of Huaruan
Technology from January 2002 until April 2003 and (ii) Department Manager of
Zhonghongxin Jianyuan Accounting Firm from July 1995 until July 2001. Mr. Han
graduated from Changchun Tax Institute with a Bachelors degree in accounting.
Huanyu Mao has served as our Chief Technical Officer since January 20,
2005 and as our Chief Operating Officer since June 30, 2005. Dr. Mao has been
Chief Scientist of BAK Battery since September 2004. From 1997 until September
2004 Dr. Mao served as Chief Engineer of Tianjin Lishen Company. Dr. Mao
received a Doctorate degree in electrochemistry in conducting polymers from
Memorial University of Newfoundland, Canada.
By the written consent of holders of a majority of the shares of our
common stock, Dr. Huanyu Mao, Mr. Richard Goodner, Mr. Joseph R. Mannes and Mr.
Jay J. Shi have been chosen to become directors of CBBI, although their
elections will not be effective until the end of the twentieth calendar day
after an Information Statement under Section 14(c) of the Securities Exchange
Act of 1934, as amended, which includes information relating to the choice of
those individuals to become directors, is sent to the stockholders of CBBI. An
Information Statement has not been sent to stockholders of CBBI and accordingly,
Dr. Mao and Messrs. Goodner, Mannes and Preston are not yet directors of CBBI.
Richard Goodner, 59, currently serves as Vice President - Legal Affairs
and General Counsel for U.S. Home Systems, Inc., a Nasdaq National Market System
publicly traded company and has held that position since June 2003. Prior to
working with U.S. Home Systems, Inc., Mr. Goodner was a partner in the law firm
of Jackson Walker L.L.P. from 1997 to 2003. Mr. Goodner holds a Bachelor of Arts
degree in Economics from Eastern New Mexico University and a law degree from
Southern Methodist University.
Joseph R. Mannes, 47, currently serves as the Managing Director -
Corporate Finance of SAMCO Capital Markets, a division of Penson Financial
Services, Inc. and has held this position since 2001. Prior to working with
SAMCO Capital Markets, Mr. Mannes served as Vice President, Chief Financial
Officer and Secretary of Clearwire Technologies, Inc. from 1998 to 2001. Mr.
Mannes holds a Bachelor of Arts degree. in Philosophy and French from Dartmouth
College and an M.B.A. in Finance and Accounting from the Wharton School Graduate
Division of the University of Pennsylvania.
42
Jay J. Shi, 46, currently serves as Chairman and Chief Technology
Officer of SoBright Technology, Co., Ltd. Mr. Shi has served in this capacity
since October 2005. Mr. Shi also currently serves as President of Big Wave
Consulting Co. Mr. Shi has served in this capacity since March 2005. From April
2002 to February 2005, Mr. Shi served as Senior Manager/Associate Principal of
TIAX, LLC. Mr. Shi holds a Ph.d in Physical Chemistry from St. Andrews
University, and an M.S. in Polymer Sciences and a B.S. in Chemistry from Zhejian
University.
Board Composition and Committees
The board of directors is currently composed of one member, Xiangqian
Li. After the election of the four individuals describe above becomes effective,
the board of directors will consist of five members. All Board action requires
the approval of a majority of the directors in attendance at a meeting at which
a quorum is present. We have purchased officers and directors liability
insurance.
We currently do not have standing audit, nominating or compensation
committees. We intend, however, to establish an audit committee and a
compensation committee of the board of directors as soon as practicable. We
envision that the audit committee will be primarily responsible for reviewing
the services performed by our independent auditors, evaluating our accounting
policies and evaluating and administering our system of internal controls over
financial reporting. The compensation committee will be primarily responsible
for reviewing and approving our salary and benefits policies (including stock
options), including compensation of executive officers.
Director Compensation
At present we do not pay our directors a fee for attending scheduled
and special meetings of our board of directors. We intend to reimburse each
director for reasonable travel expenses related to such director's attendance at
board of directors and committee meetings. As noted above, we intend to expand
our board to include "independent" directors. It is anticipated that the
appointment of independent members of our board will require us to pay fees
comparable to those paid by other public companies in our peer group.
Indebtedness of Directors and Executive Officers
None of our directors or officers or their respective associates or
affiliates is indebted to us.
Involvement in Certain Legal Proceedings
In the normal course of business, various claims are made against us.
At this time, in the opinion of management, there are no pending claims the
outcome of which are expected to result in a material adverse effect on our
consolidated financial position or results of operations.
Family Relationships
There are no family relationships among our directors or officers.
Executive Compensation
The following Summary Compensation Table sets forth all cash
compensation paid to our chief executive officer for services rendered in all
capacities to us during the noted periods. No executive officers received total
annual salary and bonus compensation in excess of $100,000.
43
Summary Compensation Table
Name and Restricted Securities
Principal Stock Underlying All Other
Position Year Salary Bonus Awards Options Compensation
- --------------------------------- -------- -------- -------- ----------- ------------ ------------
Xiangqian Li 2005 $ 8,736 -0- N/A N/A $ 45,730(1)
Chairman of the Board, 2004 $ 8,709 -0- N/A N/A N/A
President, and Chief Executive
Officer 2003 $ 8,699 -0- N/A N/A N/A
- ----------
(1) For use of a company-owned vehicle.
Mr. Timothy P. Halter served as our Chief Executive Officer without
compensation for nineteen days at the beginning of fiscal 2005, from January 1,
2005 to January 19, 2005.
Stock Option Plan
In May 2005, our board of directors adopted the China BAK Battery, Inc.
2005 stock option plan. We plan to submit the plan to a stockholder vote within
12 months of its adoption. The plan will be void if it is not approved by our
stockholders.
Our 2005 stock option plan provides for the grant of "nonqualified"
stock options. These nonqualified stock options may be granted to our employees,
non-employee directors and advisors and those of any of our subsidiaries or
affiliates. However, advisors are only eligible to receive awards if they render
bona fide services for us or any of our subsidiaries or affiliates. The exercise
price of options granted pursuant to the plan must be at least equal to the fair
market value of our common stock on the date of the grant. The plan authorizes
the issuance of up to 4,000,000 shares of our common stock. We granted options
to purchase 2,000,000 shares to approximately 55 individuals at fair market
value on May 16, 2005, including options to purchase 200,000 shares granted to
each of Yongbin Han, our Chief Financial Officer, Secretary and Treasurer, and
Huanyu Mao, our Chief Operating Officer and Chief Technical Officer. We have
2,000,000 shares of our common stock remaining available for issuance under this
plan.
The plan will generally terminate on May 16, 2055. Generally, stock
options granted under this plan may not be transferred in any manner other than
by will or by the laws of descent and distribution and may be exercised during
the lifetime of the optionee only by the optionee. However, exceptions can be
made to this restriction. Options granted under our 2005 stock option plan
expire immediately upon the termination of the optionee's service to us or to a
subsidiary or affiliate of ours for misconduct, thirty-one days following
termination if the termination is for reasons other than death, disability or
cause, or 12 months following termination if the termination is due to death or
disability. Upon a change in control, all outstanding stock options under our
2005 stock option plan either may be assumed or substituted for by the successor
entity. If the successor entity determines not to assume or substitute for these
stock options, the vesting provisions of such stock options will be accelerated,
and the stock options will terminate upon the change of control if not
previously exercised.
Employment, Change of Control and Severance Arrangements
BAK Battery has an employment agreement with Mr. Li for a term
extending until August 3, 2006. BAK Battery pays Mr. Li a salary in accordance
with its principle's; his annual salary for fiscal year 2005 was US$8,736. This
employment agreement also provides that we will pay social insurance benefits
for Mr. Li, which we also provide to our other management employees. We or Mr.
Li may terminate this employment agreement upon thirty days prior written
notice.
44
PRINCIPAL STOCKHOLDERS
The following table sets forth, as of March 1, 2006, certain
information with respect to the beneficial ownership of our common stock by (i)
each director and officer of CBBI, (ii) each person known to CBBI to be the
beneficial owner of five percent or more of the outstanding shares of common
stock of CBBI, and (iii) all directors and officers of CBBI as a group. Unless
otherwise indicated, the person or entity listed in the table is the beneficial
owner of, and has sole voting and investment power with respect to, the shares
indicated. Some of the principal stockholders are selling stockholders in this
offering.
Amount and Nature of Beneficial Ownership(1)
--------------------------------------------
Number Percent of
Name of Beneficial Owner of Shares(2) Voting Stock(3)
- ------------------------ ------------ ---------------
Xiangqian Li 21,233,437(4) 43.4%
BAK Industrial Park, No. 1 BAK Street
Kuichong Town
Longgang District, Shenzhen
People's Republic of China
Jinghui Wang 3,600,035 7.4%
BAK Industrial Park, No. 1 BAK Street
Kuichong Town
Longgang District, Shenzhen
People's Republic of China
The Pinnacle Fund, L.P.(5) 2,609,636 5.3%
4965 Preston Park Blvd., Suite 240
Plano, TX 75093
Fenghua Li 2,498,051 5.1%
BAK Industrial Park, No. 1 BAK Street
Kuichong Town
Longgang District, Shenzhen
People's Republic of China
Huanyu Mao 249,805 *
BAK Industrial Park, No. 1 BAK Street
Kuichong Town
Longgang District, Shenzhen
People's Republic of China
Yongbin Han 312,256 *
BAK Industrial Park, No. 1 BAK Street
Kuichong Town
Longgang District, Shenzhen
People's Republic of China
Directors and executive officers
as a group (3 persons) 21,795,498 44.6%
- --------------------
*Denotes less than 1% of the outstanding shares of common stock.
(1) On March 1, 2006, there were 48,878,396 shares of common stock
outstanding and no issued and outstanding preferred stock. Each person
named above has the sole investment and voting power with respect to
all shares of common stock shown as beneficially owned by the person,
except as otherwise indicated below.
(2) Under applicable SEC rules, a person is deemed to be the "beneficial
owner" of a security with regard to which the person directly or
indirectly, has or shares (a) the voting power, which includes the
power to vote or direct the voting of the security, or (b) the
investment power, which includes the power to dispose, or direct the
disposition, of the security, in each case irrespective of the person's
economic interest in the security. Under these SEC rules, a person is
deemed to beneficially own securities which the person has the right to
acquire within 60 days through the exercise of any option or warrant or
through the conversion of another security.
(3) In determining the percent of voting stock owned by a person on March
1, 2006, (a) the numerator is the number of shares of common stock
beneficially owned by the person, including shares the beneficial
ownership of which may be acquired within 60 days upon the exercise of
options or warrants or conversion of convertible securities, and (b)
the denominator is the total of (i) the 48,878,396 shares in the
aggregate of common stock outstanding on March 1, 2006, and (ii) any
shares of common stock which the person has the right to acquire within
60 days upon the exercise of options or warrants or conversion of
convertible securities. Neither the numerator nor the denominator
includes shares which may be issued upon the exercise of any other
options or warrants or the conversion of any other convertible
securities.
45
(4) Mr. Li is a party to an Escrow Agreement pursuant to which he agreed to
place 2,179,550 shares of his common stock into escrow for the benefit
of certain stockholders in the event we fail to satisfy certain
"performance thresholds", as defined in the Escrow Agreement, which
Escrow Agreement is incorporated by reference as a material exhibit to
the registration statement of which this prospectus is a part and is on
file with the SEC. CBBI's net income for the fiscal year ended
September 30, 2005 exceeded the "performance threshold" for such
period; accordingly, 1,089,775 of the shares placed in escrow by Mr. Li
will be released to Mr. Li. Mr. Li is also a party to a Lock-up
Agreement pursuant to which he has agreed, except for distributions of
his shares of common stock required under the Escrow Agreement, not to
transfer his common stock for a period commencing January 20, 2005 and
ending 12 months after the date our common stock is listed on either
the Nasdaq Stock Market or another national stock exchange or quotation
medium. The Lock-up Agreement is incorporated by reference as a
material exhibit to the registration statement of which this prospectus
is a part and is on file with the SEC. Mr. Li is also a party to a
Pledge Agreement pursuant to which he has agreed to pledge 19,053,887
shares of his common stock to Shenzhen Development Bank (Longgang
Branch) as security for a comprehensive credit facility of BAK Battery.
(5) Barry Kitt has sole voting and investment control over the securities
held by The Pinnacle Fund, L.P.
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
BAK Battery has several outstanding short term bank notes payable to
(i) Agricultural Bank of China (Longgang Branch), (ii) Shenzhen Commercial Bank
(Shuibei Branch), (iii) Shenzhen Development Bank (Longgang Branch), (iv) China
Minsheng Bank (Binhai/Shenzhen Branches) and (v) Construction Bank of China
(Shenzhen Branch), respectively, the proceeds of which were used primarily to
fund the operations of our manufacturing facility located at the BAK Industrial
Park and for general working capital requirements. At December 31, 2005, we had
aggregate amounts due and payable under these debt arrangements of $72.637
million. The debt arrangements bear interest at rates ranging from 5.022% to
6.138% and have maturity dates ranging from six to twelve months. This
indebtedness is generally guaranteed by BAK International, by Xiangqian Li, our
director, Chairman of the Board, President and Chief Executive Officer, and by
Jilin Provincial Huaruan Technology Company Limited by Shares, a PRC company
("Huaruan Technology"). Mr. Li has also pledged 19,053,887 of his 21,233,437
shares of our common stock to secure certain of our indebtedness. Mr. Li is the
controlling shareholder and an executive officer of Huaruan Technology. The
indebtedness to Shenzhen Commercial Bank is guaranteed by Mr. Li and by an
unaffiliated third party guarantor. None of Mr. Li, Huaruan Technology or the
third party guarantor received or is entitled to receive any consideration for
the above referenced guarantees, and we are not independently obligated to
indemnify any of those guarantors for any amounts paid by them pursuant to any
guarantee.
On October 18, 2003, we acquired intangible assets, including a patent
and other patent rights, from Huaruan Technology, an entity controlled by
Xiangqian Li, our President and Chief Executive Officer. The total consideration
paid to Huaruan Technology was $3.86 million. The consideration paid to Huaruan
Technology was recorded at fair market value.
On September 30, 2004, BAK Battery entered into a Financial Advisory
Agreement with HFG International, Ltd., a Hong Kong corporation, pursuant to
which HFG International agreed to provide BAK Battery with consulting help in
implementing an organizational structure that would facilitate accessing the
capital markets of the United States. In consideration for these services, HFG
International was paid a fee of $400,000 in conjunction with the consummation of
BAK Battery's private placement on January 20, 2005. Timothy P. Halter, our
former Chief Executive Officer, is the principal shareholder and an executive
officer of HFG International. We believe the agreement was on terms at least as
favorable to BAK Battery as those that could have been negotiated with an
unaffiliated party providing similar services.
On June 10, 2004, we issued 99,858 shares of our $ 0.001 par value
common stock to Harry Miller, our former President and Chief Executive Officer,
in full settlement of a debt in the amount of $49,929 that we owed to Mr.
Miller. The price of the transaction was $0.50 per share. The last reported sale
price for shares of our common stock prior to that issuance was $0.50 per share.
46
DESCRIPTION OF OUR COMMON STOCK
Our authorized capital stock consists of 100,000,000 shares of our
common stock, having a par value of $0.001 per share. Each outstanding share of
common stock entitles the holder thereof to one vote per share on all matters
coming before the stockholders for a vote. Our Articles of Incorporation do not
permit cumulative voting for the election of directors, which means that the
holders of more than 50% of such outstanding shares voting for the election of
directors can elect all of the directors to be elected, if they so choose; in
such event, the holders of the remaining shares will not be able to elect any of
our directors. Likewise, our Articles of Incorporation do not vary the size of
the vote necessary for the stockholders to act on various matters from the size
of the vote required by Nevada law, which requires an action by the stockholders
on a matter other than the election of directors to be approved if the number of
votes cast in favor of the action exceeds the number of votes cast in opposition
to the action. The directors of a Nevada corporation are elected at the annual
meeting of the stockholders by a plurality of the votes cast at the election.
Stockholders do not have preemptive rights to purchase shares in any future
issuance of our common stock.
The holders of shares of our common stock are entitled to dividends out
of funds legally available when and as declared by our board of directors. Our
board of directors has never declared a dividend or otherwise authorized any
cash or other distribution with respect to the shares of our common stock and
does not anticipate declaring a dividend in the foreseeable future. Should we
decide in the future to pay dividends, as a holding company, our ability to do
so and meet other obligations depends upon the receipt of dividends or other
payments from our operating subsidiaries and other holdings and investments. In
addition, our operating subsidiaries, from time to time, may be subject to
restrictions on their ability to make distributions to us, including as a result
of restrictive covenants in loan agreements, restrictions on the conversion of
local currency into dollars or other hard currency and other regulatory
restrictions. In the event of our liquidation, dissolution or winding up,
holders of our common stock are entitled to receive, ratably, the net assets
available to stockholders after payment of all creditors. PRC regulations
currently permit the payment of dividends only out of accumulated profits as
determined in accordance with PRC accounting standards and regulations. Each of
BAK International and BAK Battery is also required to set aside a portion of its
after-tax profits according to PRC accounting standards and regulations to fund
certain reserve funds. Currently, BAK Battery, through BAK International, is the
only source of revenues or investment holdings for the payment of dividends. If
it does not accumulate sufficient profits under PRC accounting standards and
regulations to first fund certain reserve funds as required by PRC accounting
standards, we will be unable to pay any dividends. In addition, if future
dividends are paid to us by BAK International in Renminbi, fluctuations in the
exchange rate for the conversion of Renminbi into dollars may adversely affect
the amount of the dividends that are received by the holders of shares of our
common stock. Furthermore, any restrictions imposed on the expatriation of
Renminbi or other currencies out of the PRC by PRC-based companies would
adversely affect our ability to pay dividends.
All of the issued and outstanding shares of our common stock are duly
authorized, validly issued, fully paid and non-assessable. To the extent that
additional shares of our common stock are issued, the relative interests of
existing stockholders will be diluted.
Our transfer agent is Securities Transfer Corporation, 2591 Dallas
Parkway, Suite 102, Frisco, Texas 75034.
SELLING STOCKHOLDERS
The following table sets forth the names of the selling stockholders
and for each selling stockholder the number of shares of common stock
beneficially owned as of March 1, 2006, and the number of shares being
registered. Except as otherwise indicated in the footnotes to the below table,
each selling stockholder acquired its securities in CBBI's stock exchange
transaction on January 20, 2005. Furthermore, except as set forth in the
footnotes below, none of the selling stockholders has held a position as an
officer or director of CBBI, nor has any selling stockholder had a material
relationship of any kind with CBBI. All information with respect to share
ownership has been furnished by the selling stockholders. The shares being
offered are being registered to permit public secondary trading of the shares
and each selling stockholder may offer all or part of the shares owned for
resale from time to time. A selling stockholder is under no obligation, however,
to sell any shares immediately pursuant to this prospectus, nor is a selling
stockholder obligated to sell all or any portion of the shares at any time.
Therefore, no estimate can be given as to the number of shares of common stock
that will be sold pursuant to this prospectus or the number of shares that will
be owned by the selling stockholders upon termination of the offering made
hereby. We will file a supplement to this prospectus to name successors to any
named selling stockholders who are able to use this prospectus to resell the
securities registered hereby.
47
PERCENT OF
SHARES OF COMMON STOCK
SHARES OF COMMON STOCK AFTER
COMMON STOCK PERCENT OF TO BE COMPLETION OF
SELLING STOCKHOLDERS(2) OWNED(1) COMMON STOCK(3) REGISTERED OFFERING(3)
- ---------------------------------------------- ------------ --------------- --------------- -------------
Jinghui Wang 3,600,035 7.4% 1,800,000 3.68%
Fenghua Li 2,498,051 5.1% 500,000 4.09%
The Pinnacle Fund (4) 2,609,636 5.3% 2,109,636 1.02%
Yunfei Li 1,405,153 2.9% 1,405,153 0%
Ying Wang 911,545 1.9% 911,545 0%
Gary Evans 758,862 1.6% 758,862 0%
Halter Financial Group, Inc.(5) 587,754 1.2% 587,754 0%
Chinamerica Fund, LP(6) 193,608 * 193,608 0%
Westpark Capital L.P.(7) 805,908 1.0% 505,908 *
Lake Street Fund, LP(8) 478,083 1.0% 478,083 0%
Xuechun Zhang 379,673 * 379,673 0%
Xin An 288,367 * 288,367 0%
Wanpei Chen 252,954 * 252,954 0%
Jayhawk China Fund(9) 427,954 * 252,954 *
Xiaohui Wang 224,825 * 224,825 0%
Leong Sing Lye 15,177 * 15,177 0%
Fred Astman 164,420 * 164,420 0%
MidSouth Investor Fund, L.P.(10) 164,420 * 164,420 0%
Steve Kircher 68,067 * 68,067 0%
Kevin Halter, Jr. 134,062 * 134,062 0%
Bellfield Capital Partners LP(11) 101,182 * 101,182 0%
Southwell Partners, L.P.(12) 641,182 * 101,182 1.1%
David Moy 80,945 * 80,945 0%
Yuxin Zhang 74,942 * 74,942 0%
Feng Li 67,135 * 67,135 0%
Chongying Gong 64,857 * 64,857 0%
Ray Chapman 50,591 * 50,591 0%
Lighthouse Capital Insurance Company(13) 50,591 * 50,591 0%
David Ofman 25,591 * 25,591 0%
David A. Spinney 50,591 * 50,591 0%
Si Zhang 50,591 * 50,591 0%
Scott Hood 37,943 * 37,943 0%
Bob Schiesser(14) 37,943 * 37,943 0%
48
PERCENT OF
SHARES OF COMMON STOCK
SHARES OF COMMON STOCK AFTER
COMMON STOCK PERCENT OF TO BE COMPLETION OF
SELLING STOCKHOLDERS(2) OWNED(1) COMMON STOCK(3) REGISTERED OFFERING(3)
- ---------------------------------------------- ------------ --------------- --------------- -------------
Mark DeSalvo 32,884 * 32,884 0%
BOT Holdings, Inc.(15) 25,295 * 25,295 0%
Michael Columbos 25,295 * 25,295 0%
David L. Ebershoff 25,295 * 25,295 0%
Harold E. Gear 25,295 * 25,295 0%
Robert O. McDonald(16) 25,295 * 25,295 0%
William Rosen 15,295 * 15,295 0%
Stephen S. Taylor, Sr. 11,795 * 11,795 0%
Harry Gabel 22,766 * 22,766 0%
264646 Alberta Ltd.(17) 17,707 * 17,707 0%
Yarek Bartos 17,707 * 17,707 0%
Earl Fawcett 17,707 * 17,707 0%
Kelly Fraser 17,707 * 17,707 0%
Andrew Goodacre 17,707 * 17,707 0%
Richard Macdermott 15,177 * 15,177 0%
783036 Alberta Ltd.(18) 12,648 * 12,648 0%
Dennis B. Bleackley 12,648 * 12,648 0%
Chapel Rock Holdings Ltd.(19) 12,648 * 12,648 0%
Stephen Sun Chiao 12,648 * 12,648 0%
Donna H. Dodson 12,648 * 12,648 0%
James Gilkison 12,648 * 12,648 0%
Terral D. Hagman 12,648 * 12,648 0%
J.M.C. Investments Ltd.(20) 12,648 * 12,648 0%
John Mackay 12,648 * 12,648 0%
Steven Perry 12,648 * 12,648 0%
Paul Plowman 12,648 * 12,648 0%
John B. Trescot 12,648 * 12,648 0%
John H. Trescot, Jr. 12,648 * 12,648 0%
Jack Coldwell 10,118 * 10,118 0%
Richard Dahl 10,118 * 10,118 0%
Danich Investments Ltd.(21) 10,118 * 10,118 0%
Fabmar Investments Ltd.(22) 10,118 * 10,118 0%
Robert Geddes 10,118 * 10,118 0%
Dwight L. McLennan 10,118 * 10,118 0%
Sandeep G. Aggarwal/Prof. Corp.(23) 10,118 * 10,118 0%
Ken Bell 7,589 * 7,589 0%
Imtiaz Bhiman 7,589 * 7,589 0%
Adam Carpenter 7,589 * 7,589 0%
Gary Allard 5,059 * 5,059 0%
A. J. Charbonneau 5,059 * 5,059 0%
G-Mac Welding Ltd.(24) 5,059 * 5,059 0%
Calvin Gabel 5,059 * 5,059 0%
Steve Horth 5,059 * 5,059 0%
Don A. Leeb 5,059 * 5,059 0%
Eric Pedersen 5,059 * 5,059 0%
Robert G. & Judith T. Rader(25) 5,059 * 5,059 0%
Doug Riopelle and Linda Benham-Riopelle 5,059 * 5,059 0%
Gerald Slamko 5,059 * 5,059 0%
Steve Tobias 5,059 * 5,059 0%
William Tobman 5,059 * 5,059 0%
Ann T. Garrett 2,530 * 2,530 0%
James B. & Pauline Lisle 2,530 * 2,530 0%
Total 17,939,350 36.70% 12,626,264 10.87%
- ----------
* Denotes less than 1% of the outstanding shares of common stock.
(1) On March 1, 2006, there were 48,878,396 shares of common stock
outstanding and no issued and outstanding preferred stock. All of the
shares of common stock being registered pursuant to this registration
statement are being registered on behalf of the selling stockholders
and were outstanding prior to the filing of this registration
statement. Following the offering, there will be 48,878,396 shares of
common stock outstanding and no issued and outstanding preferred stock.
(2) Each person named in the selling stockholder table above has the sole
investment and voting power with respect to all shares of common stock
shown as beneficially owned by the person, except as otherwise
indicated below. Under applicable SEC rules, a person is deemed to be
the "beneficial owner" of a security with regard to which the person
directly or indirectly, has or shares (a) the voting power, which
includes the power to vote or direct the voting of the security, or (b)
the investment power, which includes the power to dispose, or direct
the disposition, of the security, in each case irrespective of the
person's economic interest in the security. Under these SEC rules, a
person is deemed to beneficially own securities which the person has
the right to acquire within 60 days through the exercise of any option
or warrant or through the conversion of another security. None of the
selling stockholders who are not natural persons are reporting
companies under the Securities Exchange Act of 1934.
(3) Assumes that each selling stockholder sells all of the shares of stock,
the offer and sale of which is registered pursuant to the registration
statement of which this prospectus is a part. In determining the
percent of common stock owned by a person on March 1, 2006, (a) the
numerator is the number of shares of common stock beneficially owned by
the person, including shares the beneficial ownership of which may be
acquired within 60 days upon the exercise of options or warrants or
conversion of convertible securities, and (b) the denominator is the
total of (i) the 48,878,396 shares in the aggregate of common stock
outstanding on March 1, 2006, and (ii) any shares of common stock which
the person has the right to acquire within 60 days upon the exercise of
options or warrants or conversion of convertible securities. Neither
the numerator nor the denominator includes shares which may be issued
upon the exercise of any other options or warrants or the conversion of
any other convertible securities. For purposes of this selling
stockholders table, the calculation for determining the percent of
common stock owned by a person after completion of the offering is the
same, and assumes that no new shares of common stock will be issued by
us prior to the completion of the offering.
49
(4) Represents (a) 2,109,636 shares of common stock issued to The Pinnacle
Fund, L.P. pursuant to CBBI's stock exchange transaction on January 20,
2005, prior to the consummation of the private placement on September
16, 2005 and (b) 500,000 shares of common stock acquired by The
Pinnacle Fund, L.P. in the private placement consummated on September
16, 2005. Barry M. Kitt has sole voting and investment control over the
securities held by The Pinnacle Fund, L.P.
(5) The shares hereby Halter Financial Group, Inc. were acquired in June
2004 in a private purchase transaction with Harry Miller, the former
controlling stockholder of the company. Timothy P. Halter, the sole
officer and director of Halter Financial Group, Inc., served as our
sole officer and director from June 2004 through January 20, 2005. Mr.
Halter also exercises sole investment and voting control over the
securities held by Halter Financial Group.
(6) Beau Johnson and Christopher Efird have shared voting and investment
control over the securities held by Chinamerica Fund, LP.
(7) Represents (a) 505,908 shares of common stock issued to Westpark
Capital, L.P. pursuant to CBBI's stock exchange transaction on January
20, 2005, prior to the consummation of the private placement on
September 16, 2005 and (b) 300,000 shares of common stock acquired by
Westpark Capital, L.P. in the private placement consummated on
September 16, 2005. Patrick J. Brosnahan has sole voting and investment
control over the securities held by Westpark Capital, L.P.
(8) Scott Hood and Fred Astman have shared voting and investment control
over the securities held by Lake Street Fund, LP.
(9) Represents (a) 252,954 shares of common stock issued to Jayhawk China
Fund (Cayman), Ltd. pursuant to CBBI's stock exchange transaction on
January 20, 2005, prior to the consummation of the private placement on
September 16, 2005 and (b) 175,000 shares of common stock acquired by
Jayhawk China Fund (Cayman), Ltd. in the private placement consummated
on September 16, 2005. Kent McCarthy has sole voting and investment
control over the securities held by Jayhawk China Fund (Cayman), Ltd.
(10) Buzz Heidtke has sole voting and investment control over the securities
held by MidSouth Investor Fund, L.P.
(11) Dave Brigante has sole voting and investment control over the
securities held by Bellfield Capital Partners LP.
(12) Wilson Jaeggli has sole voting and investment control over the
securities held by Southwell Partners, L.P.
50
(13) David E. Richardson has sole voting and investment control over the
securities held by Lighthouse Capital Insurance Company.
(14) Mr. Schiesser is an affiliate of Canaccord Capital Corporation, a
licensed broker/dealer in Canada. Mr. Schiesser purchased the
securities to be registered in the ordinary course of business and had
no agreements or understandings, directly or indirectly, with any
person to distribute his securities at the time of purchase.
(15) Tom Brinkerhoff has sole voting and investment control over the
securities held by BOT Holdings, Inc.
(16) Mr. McDonald is an affiliate of Capital West Securities, a licensed
broker/dealer. Mr. McDonald purchased the securities to be registered
in the ordinary course of business and had no agreements or
understandings, directly or indirectly, with any person to distribute
his securities at the time of purchase.
(17) Victor Walls has sole voting and investment control over the securities
held by 264646 Alberta Ltd.
(18) Ralph Miller has sole voting and investment control over the securities
held by 783036 Alberta Ltd.
(19) Wayne Hucik and Susan Hucik have shared voting and investment control
over the securities held by Chapel Rock Holdings Ltd.
(20) Brian Carpenter and Jeanne Carpenter have shared voting and investment
control over the securities held by JMC Investments Ltd.
(21) Dan Remenda has sole voting and investment control over the securities
held by Danich Investments Ltd.
(22) Eugene Fabro and Adrienne Fabro have shared voting and investment
control over the securities held by Fabmar Investments Ltd.
(23) Sandeep G. Aggarwal has sole voting and investment control over the
securities held by Sandeep G. Aggarwal/Prof. Corp.
(24) Grant McNaughton and Donna McNaughton have shared voting and investment
control over the securities held by G-Mac Welding Ltd.
(25) Hold as trustees for the Rader Living Trust.
51
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the offering, we will have 48,878,396 shares of
common stock outstanding. A current stockholder who is our "affiliate," defined
in Rule 144 as a person who directly, or indirectly through one or more
intermediaries, controls, or is controlled by, or is under common control with,
us, will be required to comply with the resale limitations of Rule 144.
Purchasers acquiring shares from the selling shareholders in one or
more transactions to which this prospectus relates, other than persons who are
our affiliates, may resell their shares immediately. Sales by affiliates will be
subject to the volume and other limitations of Rule 144, including certain
restrictions regarding the manner of sale, notice requirements, and the
availability of current public information about us. The volume limitations
generally permit an affiliate to sell, within any three-month period, a number
of shares that does not exceed the greater of one percent of the outstanding
shares of common stock or the average weekly trading volume during the four
calendar weeks preceding his sale. A person who ceases to be an affiliate at
least three months before the sale of restricted securities beneficially owned
for at least two years may sell the restricted securities under Rule 144 without
regard to any of the Rule 144 limitations.
PLAN OF DISTRIBUTION
The 12,626,264 shares being offered by the selling stockholders may be
sold or distributed from time to time by the selling stockholders or their
transferees directly to one or more purchasers or through brokers, dealers, or
underwriters who may act solely as agents or may acquire shares as principals.
Such sales or distributions may be made at prevailing market prices, at prices
related to such prevailing market prices, or at variable prices negotiated
between the sellers and purchasers that may vary. The distribution of the shares
may be effected in one or more of the following methods:
o ordinary brokerage transactions, including long or short
sales,
o transactions involving cross or block trades, or otherwise in
the over-the-counter market,
o purchases by brokers, dealers, or underwriters as principals
and subsequent resale by the purchasers for their own accounts
pursuant to this prospectus in the open market or in
underwritten offerings of those shares,
o sales "at the market" to, or through, market makers or into an
existing market for the shares,
o sales not involving market makers or established trading
markets, including direct sales to purchasers or sales
effected through agents,
o transactions involving options, swaps, or other derivatives,
whether exchange-listed or otherwise, or
o transactions involving any combination of the foregoing or any
other legally available means.
52
In addition, a selling stockholder may enter into hedging transactions
with one or more broker-dealers who may engage in short sales of shares in the
course of hedging the positions they assume with the selling stockholder. A
selling stockholder may also enter into options or other transactions with one
or more broker-dealers requiring the delivery of the shares by such
broker-dealers with the possibility that such shares may be resold thereafter
pursuant to this prospectus.
A broker, dealer, underwriter, or agent participating in the
distribution of the shares may receive compensation in the form of discounts,
concessions, or commissions from the selling stockholders and/or purchasers of
the shares for whom such person may act as an agent, to whom such person may
sell as principal, or both; and such compensation as to a particular person may
be in excess of customary commissions. The selling stockholders and any
broker-dealers acting in connection with the sale of the shares being registered
may be deemed to be underwriters within the meaning of Section 2(11) of the
Securities Act of 1933, as amended, or the Securities Act, and any profit
realized by them on the resale of shares as principals may be deemed
underwriting compensation under the Securities Act. We know of no existing
arrangements between any of the selling stockholders and any other stockholder,
broker, dealer, underwriter, or agent relating to the sale or distribution of
the shares, nor can we presently estimate the amount, if any, of such
compensation.
Although we will receive no proceeds from the sale of shares pursuant
to this prospectus, we have agreed to bear the costs and expenses of the
registration of the shares, including legal and accounting fees, and such costs
and expenses are estimated to be approximately $213,000.
We have informed the selling stockholders that while they are engaged
in a distribution of the shares included in this prospectus they will be
required to comply with certain anti-manipulative rules contained in Regulation
M under the Exchange Act. With certain exceptions, Regulation M prohibits any
selling stockholder, any affiliated purchaser, and any broker-dealer or other
person who participates in such distribution from bidding for or purchasing, or
attempting to induce any person to bid for or purchase, any security that is the
subject of the distribution until the entire distribution is complete.
Regulation M also prohibits any bids or purchases made in order to stabilize the
price of a security in connection with the distribution of that security.
53
INDEPENDENT PUBLIC ACCOUNTANTS
There have been no changes in and/or disagreements with Schwartz
Levitsky Feldman L.L.P., independent registered public accounting firm, on
accounting and financial disclosure matters.
LEGAL MATTERS
Certain legal matters in this offering, including the legality of the
common stock offered pursuant to this prospectus, will be passed upon for us and
the selling stockholders by Schreck Brignone, 300 South Fourth Street, Suite
1200, Las Vegas, NV 89101.
EXPERTS
Our financial statements included in this prospectus have been audited
by Schwartz Levitsky Feldman L.L.P., independent registered public accounting
firm, as stated in the opinion, which has been rendered upon the authority of
said firm as experts in accounting and auditing.
INTERESTS OF NAMED EXPERTS AND COUNSEL
No "Expert" or "Counsel" as defined by Item 509 of Regulation S-B
promulgated pursuant to the Securities Act, whose services were used in the
preparation of this Form SB-2, was hired on a contingent basis or will receive a
direct or indirect interest in us.
DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION
FOR SECURITIES ACT LIABILITIES
Our Amended and Restated Bylaws, filed as Exhibit 3.3 hereto, provide
that we must indemnify our directors to the fullest extent permitted under
Nevada law and may indemnify, if so authorized by our board of directors, our
officers and any other person whom we have the power to indemnify against
liability, reasonable expense or other matter whatsoever. The effect of these
provisions is potentially to indemnify our directors and officers from all costs
and expenses of liability incurred by them in connection with any action, suit
or proceeding in which they are involved by reason of their affiliation with us.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 (the "Act") may be permitted to directors, officers and controlling
persons of the small business issuer pursuant to the foregoing provisions, or
otherwise, we have been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable.
Our Amended and Restated Bylaws also permit us to maintain insurance on
behalf of our company and any person whom we have the power to indemnify.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form SB-2 with the Securities
and Exchange Commission under the Securities Act of 1933 with respect to the
shares of common stock being offered by means of this prospectus. This
prospectus, which is a part of the registration statement, does not contain all
of the information set forth in the registration statement, or the exhibits
which are part of the registration statement. You should refer to the
registration statement and its exhibits for additional information that is not
contained in this prospectus. Whenever we make reference in this prospectus to
any of our contracts, agreements or other documents, you should refer to the
exhibits attached to the registration statement for copies of the actual
contract, agreement or other document.
54
We are subject to the informational requirements of the Securities
Exchange Act of 1934, as amended, and we are required to file reports, any proxy
statements and other information with the Securities and Exchange Commission.
You can read our Securities and Exchange Commission files, including this
registration statement, over the Internet at the Securities and Exchange
Commission's web site at http://www.sec.gov. You may also read and copy any
documents we file with the Securities and Exchange Commission at its public
reference facility at 100 F Street, N.E., Room 1580, Washington, D.C. 20549 and
at the Securities and Exchange Commission's regional offices. You may also
obtain copies of the documents at prescribed rates by writing to the Public
Reference Section of the Securities and Exchange Commission. Please call the
Securities and Exchange Commission at 1-800-SEC-0330 for further information on
the operation of the public reference facilities.
55
CHINA BAK BATTERY, INC.
CONSOLIDATED FINANCIAL STATEMENTS
TABLE OF CONTENTS
December 31, 2005 Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets as of December 31, 2005 and September 30, 2005 F-1
Consolidated Statements of Operations for The Three Months Ended
December 31, 2005 and 2004 F-2
Consolidated Statements of Cash Flows for The Three Months Ended
December 31, 2005 and 2004 F-3
Notes to Consolidated Financial Statements F-4 - F-8
September 30, 2005 and 2004 Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm F-9
Consolidated Balance Sheets as of September 30, 2005 and 2004 F-10
Consolidated Statements of Operations for the Years Ended
September 30, 2005 and 2004 F-11
Consolidated Statements of Changes in Stockholders' Equity for the Years
Ended September 30, 2005 and 2004 F-12
Consolidated Statements of Cash Flows for the Years Ended
September 30, 2005 and 2004 F-13
Notes to Consolidated Financial Statements F-14 - F-40
F-i
CHINA BAK BATTERY, INC.
Consolidated Balance Sheets
As of December 31, 2005 and September 30, 2005
(Amounts expressed in US Dollars, except number of shares)
December 31, 2005 September 30, 2005
------------------ ------------------
$ $
Restated
Unaudited
Assets
-------
Current Assets
Cash 11,368,998 33,055,784
Cash -Restricted 24,891,394 19,392,280
Accounts Receivable, Net 40,650,896 43,379,754
Inventories 36,885,868 21,696,226
Prepaid Expenses 1,748,264 1,448,119
Notes Receivable 9,365,328 484,028
Accounts Receivable - Related Party 21,588 271,873
------------------ ------------------
Total Current Assets 124,932,336 119,728,064
------------------ ------------------
Long-Term Assets
Property, Plant, & Equipment 72,067,498 52,160,610
Construction in Progress 5,198,860 17,804,181
Land Use Rights 3,255,562 3,246,791
Less Accumulated Depreciation (7,085,873) (5,873,954)
------------------ ------------------
Long-term Assets, Net 73,436,047 67,337,628
------------------ ------------------
Other Assets
Other Assets 546,585 566,703
Intangible Assets, Net 52,325 53,379
------------------ ------------------
Total Other Assets 598,910 620,082
------------------ ------------------
Total Assets 198,967,293 187,685,774
================== ==================
Liabilities and Stockholders' Equity
------------------------------------
Current Liabilities
Accounts Payable 22,159,947 17,836,561
Bank Loans, Short Term 39,032,490 39,545,230
Notes Payable 33,605,163 29,577,308
Land Use Rights Payable 2,970,563 2,962,560
Construction Costs Payable 3,899,249 5,241,883
Customer Deposits 1,329,579 655,065
Accrued Expenses 3,494,288 3,196,594
Other Liabilities 512,718 712,506
------------------ ------------------
Total Current Liabilities 107,003,997 99,727,707
------------------ ------------------
CONTINGENCIES AND COMMITMENTS (NOTE 5)
Stockholders' Equity
Capital Stock-$.001 Par Value; 100,000,000 Shares
Authorized; 48,878,396 Shares Issued and Outstanding 48,878 48,878
Additional Paid In Capital 68,724,320 68,012,808
Accumulated Comprehensive Income 579,854 362,728
Reserves 4,274,047 3,688,989
Retained Earnings 18,336,197 15,844,664
------------------ ------------------
Total Stockholders' Equity 91,963,296 87,958,067
------------------ ------------------
Total Liabilities and Stockholders' Equity 198,967,293 187,685,774
================== ==================
The accompanying notes are an integral part of these financial statements.
F-1
CHINA BAK BATTERY, INC.
Consolidated Statements of Operations
For The Three Months Ended December 31, 2005 and 2004
(Amounts expressed in US Dollars, except number of shares)
(Unaudited)
2005 2004
------------------ ------------------
$ $
Restated
Revenues, Net of Returns 26,103,750 25,126,265
Cost of Goods Sold 19,064,500 20,743,021
------------------ ------------------
Gross Profit 7,039,250 4,383,244
------------------ ------------------
Expenses:
Selling 1,223,837 808,276
General and Administrative 1,805,408 1,151,756
Research and Development 495,205 20,020
Bad Debts 255,488 51,235
------------------ ------------------
Total Expenses 3,779,938 2,031,287
------------------ ------------------
Operating Income 3,259,312 2,351,957
Other Expenses (Income):
Finance Costs 384,889 389,650
Other Expenses (Income) (308,822) 16,120
------------------ ------------------
Net Income Before Provision for Income Taxes 3,183,245 1,946,187
Provision for Income Tax 106,654 144,067
------------------ ------------------
Net Income 3,076,591 1,802,120
================== ==================
Net Income Per Common and Common Equivalent Share:
Basic 0.06 0.06
================== ==================
Diluted 0.06 0.06
================== ==================
Weighted Average Shares Outstanding:
Basic 48,878,396 31,225,642
================== ==================
Diluted 49,242,404 31,225,642
================== ==================
The accompanying notes are an integral part of these financial statements.
F-2
CHINA BAK BATTERY, INC.
Consolidated Statements of Cash Flows
For The Three Months Ended December 31, 2005 and 2004
(Amounts expressed in US Dollars)
(Unaudited)
2005 2004
------------------ ------------------
$ $
Restated
Cash Flows from (used for) Operating Activities
Net Income 3,076,591 1,802,120
Adjustments to Reconcile Net Income to Net Cash from
Operating Activities:
Bad Debts Expense 255,488 51,235
Depreciation and Amortization 1,213,116 754,727
Writedown of Inventory 460,275 -
Share-Based Compensation 711,512 -
Changes in Assets and Liabilities:
Accounts Receivable 2,512,194 (5,947,411)
Inventories (15,592,023) 10,235,226
Prepaid Expenses (300,145) 921,473
Notes Receivable (8,881,301) (437,523)
Accounts Receivable - Related Party 250,286 378,413
Other Assets 20,118 (67,767)
Accounts Payable 4,323,386 (2,786,974)
Land Use Rights Payable (768) 272
Construction Costs Payable (1,342,634) 746,559
Customer Deposits 674,514 (137,346)
Accrued Expenses 297,695 (2,664,062)
Other Liabilities (199,788) 271
------------------ ------------------
Net Cash Flows from (used for) Operating Activities (12,521,484) 2,849,213
------------------ ------------------
Cash Flows from (used for) Investing Activities
Acquisition of Property, Plant and Equipment (19,906,888) (1,300,986)
Construction in Progress 12,605,321 (3,370,433)
------------------ ------------------
Net Cash Flows used for Investing Activities (7,301,567) (4,671,419)
------------------ ------------------
Cash Flows from (used for) Financing Activities
Proceeds from Borrowings 27,529,782 21,519,898
Repayment of Borrowings (24,014,667) (18,844,328)
Cash Pledged To Bank (5,499,114) (806,951)
------------------ ------------------
Net Cash Flows from (used for) Financing Activities (1,983,999) 1,868,619
------------------ ------------------
Effect of Exchange Rate Changes on Cash 120,264 (1,525)
------------------ ------------------
Net Increase (Decrease) in Cash (21,686,786) 44,888
Cash - Beginning of Period 33,055,784 3,212,176
------------------ ------------------
Cash - End of Period 11,368,998 3,257,064
================== ==================
Supplemental Cash Flow Disclosures:
Interest Paid 425,214 313,195
================== ==================
Income Taxes Paid 195,491 94,858
================== ==================
The accompanying notes are an integral part of these financial statements.
F-3
CHINA BAK BATTERY, INC.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
(Amounts expressed in US Dollars)
(Unaudited)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements of China BAK Battery,
Inc. and Subsidiaries (the "Company") included herein have been
prepared by the Company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission (the "SEC").
Certain information and footnote disclosures normally included in
financial statements prepared in conjunction with generally accepted
accounting principles have been condensed or omitted pursuant to such
rules and regulations, although the Company believes that the
disclosures are adequate to make the information presented not
misleading. These condensed consolidated financial statements should be
read in conjunction with the annual audited consolidated financial
statements and the notes thereto included in the Company's annual
report on Form 10-KSB, and other reports filed with the SEC.
The accompanying unaudited interim consolidated financial statements
reflect all adjustments of a normal and recurring nature which are, in
the opinion of management, necessary to present fairly the financial
position, results of operations and cash flows of the Company for the
interim periods presented. The results of operations for these periods
are not necessarily comparable to, or indicative of, results of any
other interim period or for the fiscal year taken as a whole. Factors
that affect the comparability of financial data from year to year and
for comparable interim periods include non-recurring expenses
associated with the Company's registration with the SEC, costs incurred
to raise capital and stock awards.
The condensed consolidated financial statements are prepared in
accordance with generally accepted accounting principles used in the
United States of America and include the accounts of BAK International
Limited ("BAK International"), Shenzhen BAK Battery Co, Ltd. ("BAK")
and BAK Electronics (Shenzhen) Co., Ltd. for all periods presented. All
significant intercompany balances and transactions have been eliminated
on consolidation.
On January 10, 2006, BAK International completed the formation of a new
wholly owned China-based subsidiary, BAK Electronic (Shenzhen) Co.,
Ltd., focused on the manufacture, research, development and
distribution of polymer lithium ion rechargeable batteries for use in
cellular telephones as well as various other portable electronic
devices, including high-power handset telephone, laptop computers,
digital cameras, video camcorders, MP3 players, MP4 players and general
industrial applications.
F-4
CHINA BAK BATTERY, INC.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
(Amounts expressed in US Dollars)
(Unaudited)
2. CASH - RESTRICTED
The Company's cash - restricted at December 31, 2005 is summarized as
follows:
$
Time deposits pledged as collateral for letter of credit facilities 5,978,762
Cash pledged as a guarantee for notes payable 18,912,632
----------
Total cash - restricted 24,891,394
==========
3. INVENTORIES
The Company's inventories at December 31, 2005 and September 30, 2005
are summarized as follows:
December 31 September 30
2005 2005
----------- ------------
$ $
Raw materials 13,283,872 9,284,299
Work in progress 4,058,111 2,738,069
Finished goods 19,543,885 9,673,858
----------- ------------
Total inventories 36,885,868 21,696,226
=========== ============
4. BANK DEBTS
As of December 31, 2005, the Company had several short-term loans,
notes payable and letter of credit facilities with banks with a total
outstanding balance of $72,637,653. The loans were used primarily to
support operating activities, carried interest rates ranging from
5.022% to 6.138%, and have maturity dates ranging from 5 to 12 months.
The Company is required to pledge cash, inventories and equipment in
order to secure these short-term bank loans and notes payable,
summarized as follows at December 31, 2005:
$
Cash-restricted 24,891,394
Inventories 7,682,585
Equipment 9,846,100
----------
Total assets pledged 42,420,079
==========
F-5
CHINA BAK BATTERY, INC.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
(Amounts expressed in US Dollars)
(Unaudited)
5. CONTINGENCIES AND COMMITMENTS
A. Contingent Liabilities
1. Land Use and Ownership Certificate:
According to relevant PRC laws and regulations, a
land use right certificate, along with government
approvals for land planning, project planning, and
construction need to be obtained before construction
of building is commenced. An ownership certificate
shall be granted by the government upon application
under the condition that the aforementioned
certificate and government approvals are obtained.
BAK has not yet obtained the land use right
certificate and government approvals relating to the
construction of BAK Industrial Park (the Company's
operating premises). However, BAK has applied to
obtain the land use right certificate of approval.
The local government of Kuichong Township of Longgang
District of Shenzhen has, however, granted permission
for BAK to commence the construction of the new
production plant pending a decision from the bureau
of city planning. The Company anticipates that it
will receive the approval from the bureau of city
planning in 2006.
Management believes, under the condition that BAK is
granted a land use right certificate and related
approvals, there should be no legal barriers for BAK
to obtain an ownership certificate for the premises
presently under construction in BAK Industrial Park.
However, in the event that BAK fails to obtain the
land use right certificate relating to BAK Industrial
Park and/or the government approvals required for the
construction of BAK Industrial Park, there is the
risk that the buildings constructed need to be
vacated as illegitimate constructions. However,
management believes that this possibility while
present is very remote. As a result, no provision has
been made in the financial statements for this
potential occurrence.
The Company does not currently insure its
manufacturing facilities since it has not yet
received its land use right certificate. The Company
intends to procure such insurance once it has
received the certificate.
2. Guarantees
The Company's guarantees at December 31, 2005 are
summarized as follows:
$
Guaranteed for Shenzhen Tongli,
a non-related party 3,618,250
Guaranteed for Shenzhen Zhengda,
a non-related party 1,239,127
Notes receivable discounted 1,397,308
---------
Total guarantees 6,254,685
=========
F-6
CHINA BAK BATTERY, INC.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
(Amounts expressed in US Dollars)
(Unaudited)
5. CONTINGENCIES AND COMMITMENTS (cont'd)
A. Contingent Liabilities (cont'd)
2. Guarantees (cont'd)
The Company discounts notes and accounts receivable
from time to time with banks. At the time of the
discounting, all rights and privileges of holding the
note are transferred to the banks. The Company
removes the asset from its books and records a
corresponding expense for the amount of the discount.
The Company remains contingently liable on a portion
of the amount outstanding in the event the note maker
defaults.
No provision has been made in the consolidated
financial statements for these contingencies.
B. Capital Commitments
BAK has commitments under construction contracts for
the construction of factory, office, and employee
residence buildings, amounting to $1,209,726 at
December 31, 2005.
6. SUBSEQUENT EVENTS
A. On January 11, 2006, the Company repaid in full one of its
loans with a principal balance of $6.2 million at December 31,
2005.
B. On January 11, 2006, the Company guaranteed an additional
$619,563 to a bank for Shenzhen Tongli, a non-related party.
C. On February 22, 2006, the Company renewed its $3,717,380 loan
with China Construction Bank for a term of six months, with
interest accruing at an annual rate of 5.481%, payable
monthly, and principal payable at maturity.
D. Between January 9, 2006 and March 7, 2006, the Company
discounted an additional $10,800,766 of notes receivable,
increasing the Company's maximum exposure for guarantees to
$17.7 million on that date.
F-7
7. SHARE-BASED COMPENSATION RESTATEMENT
In December 2004, the FASB issued SFAS No. 123R, which requires
compensation costs related to share-based transactions, including
employee share options, to be recognized in the financial statements
based on fair value. SFAS 123R revises SFAS No. 123, as amended,
"Accounting for Stock-Based Compensation," and supersedes APB No. 25,
"Accounting for Stock Issued to Employees."
Effective October 1, 2005, the Company adopted the provisions of SFAS
No. 123R using the modified prospective transition method. Under this
transition method, the compensation cost recognized beginning October
1, 2005 is attributable to the options granted on May 16, 2005 based on
the grant-date fair value estimated in accordance with the original
provisions of SFAS No. 123. Compensation cost is recognized ratably
over the related vesting period of the options.
As a result of the adoption of SFAS No. 123R, the Company's results for
the quarter ended December 31, 2005 include incremental share-based
compensation expense of $711,512, included as follows in the
consolidated statement of operations:
Cost of goods sold $ 40,473
Selling expenses 108,540
General and administrative expenses 332,977
Research and development expenses 253,872
Provision for income taxes benefit (24,350)
------------
Net share-based compensation expense $ 711,512
============
Consequently, the effect of the restatement of the Company's financial
statements for the three months ended December 31, 2005 to reflect the
adoption of SFAS No. 123R was as follows:
As previously
As restated reported
------------- -------------
Gross profit $ 7,039,250 $ 7,079,723
Operating income 3,259,312 3,995,174
Income before provision for income taxes 3,183,245 3,919,107
Net income 3,076,591 3,788,103
Net income per share, basic and diluted .06 .08
Additional paid in capital 68,724,320 68,012,808
Retained earnings 18,336,197 19,047,709
Net cash flows used for operating
activities 12,521,484 12,521,484
Net cash flows used for financing
activities $ 1,983,999 $ 1,983,999
Since all of the options outstanding on December 31, 2005 were issued
on May 16, 2005, there would have been no effect on the financial
results for the three months ended December 31, 2004 had the fair value
method as prescribed by SFAS No. 123 been applied by the Company.
F-8
Schwartz Levitsky Feldman llp
CHARTERED ACCOUNTANTS
TORONTO, MONTREAL, OTTAWA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders of
China BAK Battery, Inc.
(Formerly known as Medina Coffee, Inc.)
and Subsidiaries
We have audited the accompanying consolidated balance sheet of China BAK
Battery, Inc. as of September 30, 2005 and 2004 and the related consolidated
statements of changes in stockholders' equity, operations and cash flows for
each of the two years ended September 30, 2005 and 2004 (all expressed in United
States dollars). These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with the Standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of China BAK Battery,
Inc. as of September 30, 2005 and 2004 and the results of its operations and its
cash flows for each of the two years ended September 30, 2005 and 2004, in
conformity with accounting principles generally accepted in the United States of
America.
As described in Notes 7 and 14 the Company has not yet obtained final approval
from the relevant authorities for the acquisition of land use rights to the
property which it occupies. However, the Company has commenced construction of
its facilities on the property and has reflected the costs incurred to date as
long-term assets on the balance sheet described as "property and equipment -
building", "construction in process" and "land use rights", with the expectation
that approval will be obtained within the next fiscal year. The Company may be
at risk as more fully set out in the notes mentioned above should the
application be rejected. The accompanying consolidated financial statements do
not include any adjustments that might result should its application not be
approved.
The comparative figures for the year ended September 30, 2004 have been restated
as more fully described in notes 7 and 21 to the consolidated financial
statements.
/s/ Schwartz Levitsky Feldman llp
"SCHWARTZ LEVITSKY FELDMAN LLP"
Toronto, Ontario, Canada
December 28, 2005, except for notes 20 a), b) and c) and 21 as to which the date
is January 12, 2006, note 20 d) as to which the date is January 30, 2006, and
notes 20 e) and f) as to which the date is March 14, 2006
Chartered Accountants
1167 Caledonia Road
Toronto, Ontario M6A 2X1
Tel: 416 785 5353
Fax: 416 785 5663
F-9
CHINA BAK BATTERY, INC.
Consolidated Balance Sheets
As of September 30, 2005 and 2004
(Amounts expressed in US Dollars, except number of shares)
September 30, September 30,
2005 2004
$ $
Restated
Assets
------
Current Assets
Cash 33,055,784 3,212,176
Cash - Restricted 19,392,280 7,120,069
Accounts Receivable, Net 43,379,754 20,999,561
Inventories 21,696,226 29,535,985
Prepaid Expenses 1,448,119 1,330,645
Notes Receivable 484,028 18,122
Accounts Receivable - Related Party 271,873 911,093
------------- -------------
Total Current Assets 119,728,064 63,127,651
------------- -------------
Long-Term Assets
Property, Plant and Equipment 52,160,610 19,875,583
Construction in Progress 17,804,181 23,656,190
Land Use Rights 3,246,791 4,029,038
Less Accumulated Depreciation (5,873,954) (2,370,774)
------------- -------------
Long-Term Assets, Net 67,337,628 45,190,037
------------- -------------
Other Assets
Other Assets 566,703 225,972
Intangible Assets, Net 53,379 58,362
------------- -------------
Total Other Assets 620,082 284,334
------------- -------------
Total Assets 187,685,774 108,602,022
============= =============
Liabilities and Stockholders' Equity
------------------------------------
Current Liabilities
Accounts Payable 17,836,561 23,570,087
Bank Loans, Short Term 39,545,230 27,304,162
Short-Term Loans -- 1,812,316
Notes Payable 29,577,308 20,772,559
Land Use Rights Payable 2,962,560 3,750,756
Construction Costs Payable 5,241,883 6,347,846
Customer Deposits 655,065 369,390
Accrued Expenses 3,196,594 5,247,656
Other Liabilities 712,506 181,223
------------- -------------
Total Current Liabilities 99,727,707 89,355,995
------------- -------------
CONTINGENCIES AND COMMITMENTS (NOTE 14)
Stockholders' Equity
Common Stock - $.001 Par Value; 100,000,000 Shares Authorized;
48,878,396 and 31,225,642 shares issued and outstanding at
September 30, 2005 and 2004, respectively 48,878 31,226
Additional Paid In Capital 68,012,808 12,052,845
Accumulated Comprehensive Income (Loss) 362,728 (144)
Reserves 3,688,989 1,724,246
Retained Earnings 15,844,664 5,437,854
------------- -------------
Total Stockholders' Equity 87,958,067 19,246,027
------------- -------------
Total Liabilities and Stockholders' Equity 187,685,774 108,602,022
============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
F-10
CHINA BAK BATTERY, INC.
Consolidated Statements of Operations
For the Years Ended September 30, 2005 and 2004
(Amounts expressed in US Dollars, except number of shares)
2005 2004
$ $
Restated
Revenues, Net of Returns 101,921,583 63,746,202
Cost of Goods Sold 76,234,834 49,921,818
----------- -----------
Gross Profit 25,686,749 13,824,384
----------- -----------
Expenses:
Selling 4,023,582 1,877,878
General and Administrative 5,027,154 3,141,125
Research and Development 541,735 328,779
Bad Debts Expense 769,807 326,990
----------- -----------
Total Expenses 10,362,278 5,674,772
----------- -----------
Operating Income 15,324,471 8,149,612
Other Expenses
Finance Costs 2,395,137 1,006,056
Other Expenses 28,117 2,916
----------- -----------
Net Income Before Provision for
Income Tax 12,901,217 7,140,640
----------- -----------
Provision for Income Tax 526,840 394,333
----------- -----------
Net Income 12,374,377 6,746,307
=========== ===========
Net Income Per Common and Common
Equivalent Share:
Basic 0.32 0.22
=========== ===========
Diluted 0.32 0.22
=========== ===========
Weighted Average Shares Outstanding:
Basic 38,288,874 31,225,642
=========== ===========
Diluted 38,405,401 31,225,642
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
F-11
CHINA BAK BATTERY, INC.
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended September 30, 2005 and 2004
(Amounts expressed in US Dollars, except number of shares)
Accumulated
Other
Additional Comprehensive
Number of Common Paid In Income Retained Stockholders'
Shares Stock Capital (Loss) Reserves Earnings Equity
- -----------------------------------------------------------------------------------------------------------------------------------
$ $ $ $ $ $
Restated Restated Restated
Balance -
September 30, 2003 31,225,642 31,226 1,176,927 (49) 651,583 3,630,298 5,489,985
- -----------------------------------------------------------------------------------------------------------------------------------
Net Income -- -- -- -- -- 6,746,307 6,746,307
Foreign Currency
Translation -- -- -- (95) -- -- (95)
- -----------------------------------------------------------------------------------------------------------------------------------
Total Comprehensive
Income -- -- -- -- -- -- 6,746,212
- -----------------------------------------------------------------------------------------------------------------------------------
Contribution of Cash by
Stockholders -- -- 10,875,918 -- -- -- 10,875,918
Transfer to Reserves -- -- -- -- 1,072,663 (1,072,663) --
Deemed Distribution to
Shareholder -
Intangible Assets -- -- -- -- -- (3,866,088) (3,866,088)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance -
September 30, 2004 31,225,642 31,226 12,052,845 (144) 1,724,246 5,437,854 19,246,027
- -----------------------------------------------------------------------------------------------------------------------------------
Net Income -- -- -- -- -- 12,374,377 12,374,377
Foreign Currency
Translation -- -- -- 362,872 -- -- 362,872
- -----------------------------------------------------------------------------------------------------------------------------------
Total Comprehensive
Income -- -- -- -- -- -- 12,737,249
- -----------------------------------------------------------------------------------------------------------------------------------
Recapitalization 1,152,458 1,152 -- -- -- (2,824) (1,672)
Shares Issued for Proceeds
of $17.0 Million 8,600,433 8,600 16,991,400 -- -- -- 17,000,000
Shares Issued for Proceeds
of $43.4 Million 7,899,863 7,900 43,441,347 -- -- -- 43,449,247
Contribution of Cash by
Stockholders Acquiring Shares
of BAK International Limited -- -- 11,500,000 -- -- -- 11,500,000
Distribution of Cash to
Stockholders in Connection
with Acquisition of Shares
of China BAK Battery, Inc. -- -- (11,500,000) -- -- -- (11,500,000)
Cost of Raising Capital -- -- (4,472,784) -- -- -- (4,472,784)
Transfer to Reserves -- -- -- -- 1,964,743 (1,964,743) --
- -----------------------------------------------------------------------------------------------------------------------------------
Balance -
September 30, 2005 48,878,396 48,878 68,012,808 362,728 3,688,989 15,844,664 87,958,067
===================================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
F-12
CHINA BAK BATTERY, INC.
Consolidated Statements of Cash Flows
For the Years Ended September 30, 2005 and 2004
(Amounts expressed in US Dollars)
2005 2004
$ $
Restated
Cash Flows from (used for) Operating Activities
Net Income 12,374,377 6,746,307
Adjustments to Reconcile Net Income to Net Cash
from Operating Activities:
Bad Debt Expense 769,807 326,990
Depreciation and Amortization 3,511,079 1,732,707
Changes in Assets and Liabilities:
Accounts Receivable (22,380,193) (14,543,660)
Inventories 7,309,304 (21,542,204)
Prepaid Expenses (117,474) (605,800)
Notes Receivable (465,906) (18,122)
Account Receivable - Related Party 639,220 --
Other Assets (340,731) --
Accounts Payable (5,733,526) 18,405,499
Land Use Rights Payable (5,949) --
Construction Costs Payable (1,105,963) 6,347,846
Customer Deposits 285,675 (286,001)
Accrued Expenses (2,051,063) 3,464,904
Other Liabilities 531,283 60,408
------------ ------------
Net Cash Flows from (used for) Operating Activities (6,780,060) 88,874
------------ ------------
Cash Flows from (used for) Investing Activities
Acquisition of Property, Plant and Equipment (32,285,027) (14,906,846)
Construction in Progress 5,852,009 (23,379,077)
Intangible Assets (1,584) (47,285)
------------ ------------
Net Cash Flows used for Investing Activities (26,434,602) (38,333,208)
------------ ------------
Cash Flows from (used for) Financing Activities
Proceeds from Borrowings 120,005,439 57,740,719
Repayment of Borrowings (100,771,939) (17,429,652)
Cash Pledged To Bank (12,272,211) (6,299,377)
Loans to Related Parties -- (235,840)
Deemed Distribution to Shareholder - Intangible Assets -- (3,866,088)
Proceeds from Issuance of Capital Stock 55,976,464 10,875,918
Contribution of Cash from Stockholders Acquiring Shares of
BAK International Limited 11,500,000 --
Distribution of Cash to Stockholders in Connection with
Acquisition of Shares of China BAK Battery, Inc. (11,500,000) --
------------ ------------
Net Cash Flows from Financing Activities 62,937,753 40,785,680
------------ ------------
Effect of Exchange Rate Changes on Cash 120,517 (95)
Net Increase in Cash 29,843,608 2,541,251
Cash - Beginning of Period 3,212,176 670,925
------------ ------------
Cash - End of Period 33,055,784 3,212,176
============ ============
Supplemental Cash Flow Disclosures:
Interest Paid 1,932,257 1,007,287
============ ============
Income Taxes Paid 487,808 --
============ ============
Recapitalization 1,152 --
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-13
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
1. PRINCIPAL ACTIVITIES AND ORGANIZATION
China BAK Battery, Inc. (the "Company" or "China BAK") is a holding company
whose Hong Kong-based subsidiary, BAK International Limited ("BAK
International") and China-based subsidiary, Shenzhen BAK Battery Co., Ltd.
("BAK" or "Shenzhen BAK") focus on the manufacture, commercialization and
distribution of a wide variety of standard and customized lithium ion
(known as "Li-ion" or "Li-ion cell") rechargeable batteries for use in
cellular telephones, as well as various other portable electronic
applications, including high-power handset telephones, laptop computers,
power tools, digital cameras, video camcorders, MP3 players, electric
bicycles, hybrid/electric motors, and general industrial applications.
BAK was founded on August 3, 2001 as a China-based company whose products
primarily target the cell phone market in the Peoples Republic of China
(PRC).
BAK International was incorporated in Hong Kong on December 29, 2003 under
the Companies Ordinance as BATCO International Limited, and subsequently
changed its name to BAK International Limited on November 3, 2004. On
November 6, 2004, the stockholders of BAK agreed to purchase, for a total
of $11.5 million in cash, 96.8% of the outstanding shares of capital stock
of BAK International, in the same proportion as their ownership interest in
BAK, and BAK International agreed to purchase, for a total of $11.5 million
in cash, all of the 31,225,642 outstanding shares of capital stock of BAK.
Five stockholders of BAK, with ownership interests of approximately 1.85%
of the 31,225,642 total outstanding shares of BAK, elected not to acquire
shares in BAK International. The five nonparticipating stockholders of BAK
sold their right to acquire their proportional ownership interest in BAK
International to other BAK stockholders as well as seven persons who were
not previously stockholders of BAK for cash, and the proportionate
interests in BAK International to which the five nonparticipating
stockholders were entitled were acquired by their transferees. After the
share purchase transactions between BAK International and the stockholders
of BAK were complete, there were 31,225,642 shares of BAK International
stock outstanding, exactly the same as the number of shares of capital
stock of BAK outstanding immediately prior to the share purchases, and the
stockholders of BAK International were substantially the same as the
stockholders of BAK prior to the share purchases. Consequently, the share
purchases between BAK International and the stockholders of BAK have been
accounted for as a recapitalization of BAK with no adjustment to the
historical basis of the assets and liabilities of BAK, and the operations
were consolidated as though the transactions occurred as of the beginning
of the first accounting period presented in these consolidated financial
statements.
As more fully described in Note 2, on January 20, 2005, the Company
completed a stock exchange transaction with the stockholders of BAK
International, whereby 100% of the stock of BAK International was exchanged
for 97.2% of the post-exchange stock of the Company.
F-14
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
1. PRINCIPAL ACTIVITIES AND ORGANIZATION (cont'd)
Also on January 20, 2005, BAK International closed a private placement of
its securities with unrelated investors whereby it issued an aggregate of
8,600,433 shares of common stock for gross proceeds of $17,000,000. In
conjunction with this financing, the Chairman and major stockholder of the
Company agreed to place 2,179,550 shares of the Company's common stock
owned by him into an escrow account, of which 50% are to be released to the
investors in the private placement if audited net income for the fiscal
year ended September 30, 2005 is not at least $12,000,000, and the
remaining 50% are to be released to investors in the private placement if
audited net income for the fiscal year ending September 30, 2006 is not at
least $27,000,000.
China BAK was originally incorporated as Medina Coffee, Inc. on October 4,
1999. The Company changed its name from Medina Coffee, Inc. to China BAK
Battery, Inc. on February 14, 2005.
The Company changed its year-end from December 31 to September 30 effective
from September 30, 2004.
The Company is subject to the consideration and risks of operating in the
PRC. These include risks associated with the political and economic
environment, foreign currency exchange and the legal system in the PRC.
The economy of PRC differs significantly from the economies of the
"western" industrialized nations in such respects as structure, level of
development, gross national product, growth rate, capital reinvestment,
resource allocation, self-sufficiency, rate of inflation and balance of
payments position, among others. Only recently has the PRC government
encouraged substantial private economic activities. The Chinese economy has
experienced significant growth in the past several years, but such growth
has been uneven among various sectors of the economy and geographic
regions. Actions by the PRC government to control inflation have
significantly restrained economic expansion in the recent past. Similar
actions by the PRC government in the future could have a significant
adverse effect on economic conditions in the PRC.
Many laws and regulations dealing with economic matters in general, and
foreign investment in particular, have been enacted in the PRC. However,
the PRC still does not have a comprehensive system of laws, and enforcement
of existing laws may be uncertain and sporadic.
The Company's operating assets and primary sources of income and cash flows
are from interests in the PRC. The PRC economy has, for many years, been a
centrally-planned economy, operating on the basis of annual, five-year and
ten-year state plans adopted by central PRC governmental authorities, which
set out national production and development targets. The PRC government has
been pursuing economic reforms since it first adopted its "open-door"
policy in 1978. There is no assurance that the PRC government will continue
to pursue economic reforms or that there will not be any significant change
in its economic or other policies, particularly in the event of any change
in the political leadership of, or the political, economic or social
conditions in, the PRC. There is also no assurance that the Company will
not be adversely affected by any such change in governmental policies or
any unfavorable change in the political, economic or social conditions, the
laws or regulations, or the rate or method of taxation in the PRC.
F-15
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
1. PRINCIPAL ACTIVITIES AND ORGANIZATION (cont'd)
As many of the economic reforms which have been or are being implemented by
the PRC government are unprecedented or experimental, they may be subject
to adjustment or refinement, which may have adverse effects on the Company.
Further, through state plans and other economic and fiscal measures, it
remains possible for the PRC government to exert significant influence on
the PRC economy.
The Company's financial instruments that are exposed to concentration of
credit risk consist primarily of cash and cash equivalents, and accounts
receivable from customers. Cash and cash equivalents are maintained with
major banks in the PRC. The Company's business activity is primarily with
customers in the PRC. The Company periodically performs credit analyses and
monitors the financial condition of its customers in order to minimize
credit risk.
Any devaluation of the Renminbi (RMB) against the United States dollar
would consequently have adverse effects on the Company's financial
performance and asset values when measured in terms of the United States
dollar. Should the RMB significantly devalue against the United States
dollar, such devaluation could have a material adverse effect on the
Company's earnings and the foreign currency equivalent of such earnings.
The Company does not hedge its RMB - United States dollar exchange rate
exposure.
On January 1, 1994, the PRC government introduced a single rate of exchange
as quoted daily by the People's Bank of China (the "Unified Exchange
Rate"). On July 21, 2005, the PRC government reformed the exchange rate
system into a managed floating exchange rate system based on market supply
and demand with reference to a basket of currencies. No representation is
made that the RMB amounts have been, or could be, converted into US dollars
at that or any rate. This quotation of exchange rates does not imply free
convertibility of RMB to other foreign currencies. All foreign exchange
transactions continue to take place either through the Bank of China or
other banks authorized to buy and sell foreign currencies at the exchange
rate quoted by the People's Bank of China. Approval of foreign currency
payments by the People's Bank of China or other institutions requires
submitting a payment application form together with suppliers' invoices,
shipping documents and signed contracts.
2. RECAPITALIZATION TRANSACTION
On January 20, 2005, the Company completed a stock exchange transaction
with the stockholders of BAK International. The exchange was consummated
under Nevada law pursuant to the terms of a Securities Exchange Agreement
by and among China BAK, BAK International and the stockholders of BAK
International. Pursuant to the Securities Exchange Agreement, the Company
issued 39,826,075 shares of common stock, par value $0.001 per share, to
the stockholders of BAK International (31,225,642 shares to original
stockholders of China BAK and 8,600,433 shares to new investors),
F-16
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
2. RECAPITALIZATION TRANSACTION (cont'd)
representing approximately 97.2% of the China BAK post-exchange issued and
outstanding common stock, in exchange for 100% of the outstanding capital
stock of BAK International. The Company presently carries on the business
of BAK, a Chinese corporation and BAK International's wholly-owned
subsidiary.
The stock exchange transaction has been accounted for as a recapitalization
of the Company whereby the historical financial statements and operations
of BAK become the historical financial statements of the Company, with no
adjustment to the carrying value of the assets and liabilities. The
1,152,458 shares of China BAK outstanding prior to the stock exchange are
accounted for at the $(1,672) net book value at the time of the
transaction. The accompanying consolidated financial statements reflect the
recapitalization of the stockholders equity as if the transaction occurred
as of the beginning of the first period presented.
3. BASIS OF PRESENTATION
The consolidated financial statements are prepared in accordance with
generally accepted accounting principles used in the United States of
America and include the accounts of China BAK Battery, Inc., BAK
International Limited and Shenzhen BAK Battery Co, Ltd. for all periods
presented. All significant intercompany balances and transactions have been
eliminated in consolidation.
4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES
A. Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and any other highly
liquid investments purchased with an original maturity of three months
or less. The carrying amounts approximate fair value because of the
short-term maturity of those instruments. As stated in the following
Note 10, a portion of the Company's cash is restricted cash, which has
been pledged to a bank to secure short-term bank loans and notes
payable. This restricted cash is not as liquid as other cash, and has
been separately stated in the attached consolidated financial
statements.
B. Accounts Receivable
In order to determine the fair value of the Company's accounts
receivable, the Company records a provision for doubtful accounts to
cover estimated credit losses. Management reviews and adjusts this
allowance periodically based on historical experience and its
evaluation of the collectability of outstanding accounts receivable.
The Company evaluates the credit risk of its customers utilizing
historical data and estimates of future performance.
F-17
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
C. Inventories
Inventories are stated at the lower of cost or net realizable value.
Cost is calculated on the moving average basis and includes all costs
to acquire and other costs incurred in bringing the inventories to
their present location and condition. The Company evaluates the net
realizable value of its inventories on a regular basis and records a
provision for loss to reduce the computed moving average cost if it
exceeds the net realizable value.
D. Property, Plant and Equipment
Property, plant and equipment are carried at cost. The cost of repairs
and maintenance is expensed as incurred; major replacements and
improvements are capitalized. When assets are retired or disposed, the
cost and accumulated depreciation are removed from the accounts, and
any resulting gains or losses are included in income in the year of
disposition. The Company recognizes a scrap value of 5% of the cost
basis and depreciation is calculated on a straight-line basis over the
estimated useful lives of the assets. The estimated useful lives are
as follows:
Buildings 30 - 40 years
Plant and machinery 5 - 12 years
Motor vehicles 8 years
Office equipment and furnishings 5 years
Leasehold improvements 2 - 5 years
E. Intangible Assets
Trademarks are carried at cost and are amortized using the
straight-line method over the estimated useful lives of 5 years from
the date the Company acquired the trademark. Management is of the
opinion that no impairment loss is considered necessary at year-end.
F. Fair Value of Financial Instruments
The carrying value of financial instruments, including cash,
receivables, accounts payable, accrued expenses and debt, approximates
their fair value at September 30, 2005 and 2004 due to the relatively
short-term nature of these instruments.
G. Construction in Progress
Construction in progress, which represents buildings, machinery and
other long-term assets under construction or installation, is stated
at cost less any impairment losses, and is not depreciated. Cost
consists of the direct costs of purchase, construction and
installation. Construction in progress is reclassified to the
appropriate category of long-term assets when completed and ready for
use. Management is of the opinion that no impairment loss is
considered necessary at year-end.
F-18
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
H. Income Taxes
The Company accounts for income tax under the provisions of Statement
of Financial Accounting Standards No. 109, which requires recognition
of deferred tax assets and liabilities for the expected future tax
consequences of events that have been included in the consolidated
financial statements or tax returns. Deferred income taxes are
provided using the liability method. Under the liability method,
deferred income taxes are recognized for all significant temporary
differences between the tax and financial statement bases of assets
and liabilities. In addition, the Company is required to record all
deferred tax assets, including future tax benefits of capital losses
carried forward, and to record a "valuation allowance" for any
deferred tax assets where it is more likely than not that the asset
will not be realized.
In accordance with the relevant income tax laws applicable to
enterprises operating in the Shenzhen Special Economic Zone of the
PRC, the profits of BAK are fully exempt from income tax for 2 years
("tax holiday"), commencing from the first profit making year of
operations, followed by a 50% exemption for the immediate next three
years ("tax preferential period"), after which the profits of BAK will
be taxable at the full reduced rate for New and High Technology
Enterprises, currently 15%. In addition, due to the additional capital
invested in BAK in 2005, BAK was granted a full tax exemption on
55.88% of its taxable income for calendar years 2005 and 2006, and a
50% tax exemption on 55.88% of its taxable income for calendar years
2007 to 2009.
Further, on August 11, 2005, BAK was recognized as a Foreign-Invested,
Advanced-Technology Enterprise by the Shenzhen government, whereby BAK
will enjoy an additional three year tax preferential period for all of
its taxable income after the expiration of the original three year tax
preferential period, with a 7.5% tax rate on the remaining 44.12% of
its taxable income from 2007 to 2009. If the Company fails to qualify
for a reduced tax program following the end of the 2009 calendar year,
the Company will be required to pay tax at the full 15% tax rate of
its taxable income applicable to Shenzhen starting in 2010.
The Company has purchased $173,000 of equipment made in China during
the year ended September 30, 2005, and will be eligible for a tax
credit, equal to 40% of theses purchases, against additional future
income tax generated through the purchase of this new equipment.
Had this tax holiday, tax preferential period and tax credit not been
available, income tax expense would have increased by $1,408,343 for
the year ended September 30, 2005 and $691,763 for the year ended
September 30, 2004.
I. Government Subsidies
Subsidies from the government are recognized at their fair values when
received, or when there is reasonable assurance that they will be
received, and all required conditions have been complied with.
F-19
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
I. Government Subsidies (cont'd)
Revenue from government sponsored grants or subsidies is recognized as
research activities are performed or as development milestones are
completed under the terms of the agreement. Costs incurred in
connection with the performance of activities under these agreements
are expensed as incurred. The Company defers revenue recognition
related to payments received during the current year for research
activities to be performed in the following year.
The Company received subsidies from the Long Gang Technology and
Science Bureau of $123,500 and $181,000 during the years ended
September 30, 2005 and September 30, 2004, respectively. The $123,500
grant, which does not need to be repaid, was awarded to purchase
equipment, and was accounted for by reducing equipment cost in the
accompanying consolidated financial statements. The $181,000 subsidy
was awarded to further the research of LiNiCoO2, an advanced anode
material in the Li-on battery cell. This subsidy requires repayment of
principal and interest, at the rate of 3% per annum, at the end of its
two year term on December 26, 2005. This subsidy was recorded as a
liability in the accompanying consolidated financial statements.
J. Related Parties
Parties are considered to be related if one party has the ability,
directly or indirectly, to control the other party, or exercise
significant influence over the other party, in making financial and
operational decisions. Parties are also considered to be related if
they are subject to common control or common significant influence.
Related parties may be individuals or corporate entities.
K. Impairment of Long-Term Assets
In accordance with the provisions of SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", the Company's policy is
to record an impairment loss against the balance of a long-lived asset
in the period when it is determined that the carrying amount of the
asset may not be recoverable. This determination is based on an
evaluation of such factors as the occurrence of a significant event, a
significant change in the environment in which the business assets
operate, or if the expected future non-discounted cash flows of the
business are determined to be less than the carrying value of the
assets. If impairment is deemed to exist, the assets are written down
to fair value. Management also evaluates events and circumstances to
determine whether revised estimates of useful lives are warranted. As
of September 30, 2005, management expects its long-lived assets to be
fully recoverable.
F-20
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
L. Foreign Currency Translation
The Company maintains its books and accounting records in Renminbi
("RMB"), the PRC's currency and the Company's functional currency.
Translation of amounts from RMB into United States dollars ("US$") has
been made at the following exchange rates for the respective years:
September 30, 2005:
Balance sheet RMB 8.0920 to US$ 1.00
Operating statements RMB 8.2413 to US$ 1.00
September 30, 2004:
Balance sheet RMB 8.27670 to US$ 1.00
Operating statements RMB 8.26688 to US$ 1.00
In translating the consolidated financial statements of the Company
from its functional currency, in RMB, into its reporting currency, in
United States dollars, balance sheet accounts are translated using the
closing exchange rate in effect at the balance sheet date and income
and expense accounts are translated using the average exchange rate
prevailing during the reporting period. Adjustments resulting from the
translation, if any, are included in accumulated comprehensive income
(loss) in stockholder's equity in the Company's financial statements.
RMB is not readily convertible into United States dollars or other
foreign currencies. Prior to July 21, 2005, the foreign exchange rate
between the United States dollar and the RMB had been stable at
approximately RMB 8.28 to US$1.00 for the last several years. On July
21, 2005, the Central Bank of China announced that it would allow the
Yuan (Renminbi) to move to a flexible exchange rate with a maximum
daily variance against the US dollar of 0.3%. No provision has been
made in the accompanying financial statements for the change in
currency policy, nor has any determination been made as to the
potential impact this may have on the Company's future operations. No
representation is made that RMB amounts could have been, or could be,
converted into United States dollars or any other currency at that
rate or any other rate.
M. Use of Estimates
The preparation of consolidated financial statements, in conformity
with generally accepted accounting principles, requires management to
make estimates and assumptions that affect certain reported amounts of
assets and liabilities, and disclosures of contingent assets and
liabilities, at the date of the financial statements, and reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
F-21
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
N. Revenue Recognition, Returns and Warranties
The Company recognizes revenue when the significant risks and rewards
of ownership have transferred pursuant to PRC law, including factors
such as when persuasive evidence of an arrangement exists, shipment or
delivery, depending upon the sales order, has occurred, the sales
price is fixed and determinable, sales and value-added tax laws have
been complied with, and collectability is reasonably assured. In the
event goods are returned from a customer, revenue is reduced, and the
returned goods are placed back into inventory during the period that
the returned goods are received by the Company. Concurrent with the
recognition of revenue, the Company records a warranty reserve for
product returns as a percentage of sales based upon historical
experience.
O. Employees' Benefits and Pension Obligations
Mandatory contributions, based on gross salary payments, are made to
the PRC government's health, retirement benefit and unemployment
programs at the statutory rates in effect during each period These
payments are charged to expense in the same period as the related
salary cost. See Note 14.
P. Comprehensive Income or Loss
The Company has adopted the provisions of Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
No. 130"). SFAS No. 130 establishes standards for the reporting and
display of comprehensive income, its components and accumulated
balances in a full set of general purpose consolidated financial
statements. SFAS No. 130 defines comprehensive income or loss to
include all changes in equity, except those resulting from investments
by owners and distributions to owners, including adjustments to
minimum pension liabilities, accumulated foreign currency translation,
and unrealized gains or losses on marketable securities.
Q. Concentrations of Credit Risk
Financial instruments that potentially subject the Company to
significant concentrations of credit risk consist primarily of trade
accounts receivable. The Company performs ongoing credit evaluations
with respect to the financial condition of its creditors, but does not
require collateral. In order to determine the value of the Company's
accounts receivable, the Company records a provision for doubtful
accounts to cover probable credit losses. Management reviews and
adjusts this allowance periodically based on historical experience and
its evaluation of the collectability of outstanding accounts
receivable.
R. Research and Development Costs
Research and development costs are charged to operating expenses when
incurred. The amounts charged in 2005 and 2004 were $541,735 and
$328,779 respectively.
F-22
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
S. Advertising Costs
Advertising costs consist primarily of promoting the Company and the
Company's products through printed advertisements in trade
publications and displaying the Company's products at industry trade
exhibitions. The Company does not pay slotting fees or engage in
cooperative advertising programs, buydown programs or similar
arrangements. Advertising costs are charged to operations when
incurred. Advertising costs included in selling expenses in the
accompanying consolidated financial statements were $297,998 and
$201,200 in 2005 and 2004, respectively.
T. Shipping And Handling Costs
Shipping and handling costs represent costs incurred by the Company to
ship its products to customers using its own delivery vehicles or
under contract with professional carriers For the majority of
products, which are sold to customers in the Zhujiang Delta, the
Company uses its own delivery vehicles. For sales made to customers
overseas, the Company incurs transportation charges for delivery to
the Port of Hong Kong. All other transportation charges are paid by
the customer. Transportation and freight expenses were $150,937 and
$83,981 for 2005 and 2004, respectively, and are included in selling
expenses in the accompanying consolidated financial statements.
U. Net Income Per Common and Common Equivalent Share
Basic and diluted net income per common and common equivalent share
are computed by dividing net income by the weighted average number of
common shares outstanding for the period, including common share
equivalents for the Company's dilutive stock options and warrants. The
weighted average common shares outstanding reflect the effects of the
share exchange transaction described in Note 2.
V. Share-Based Payments
The Company accounts for stock options using the intrinsic value
method as prescribed by Accounting Principles Board Opinion (APB 25).
Pro forma disclosures required under Statement of Financial Accounting
Standards (SFAS) 123, "Accounting for Stock-Based Compensation," as if
the Company had adopted the fair value-based method of accounting for
stock options, are presented below. See Note 19.
W. Classification of Operating Costs and Expenses
The Company records its operating costs and expenses generally with
the following classifications:
F-23
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
W. Classification of Operating Costs and Expenses (cont'd)
Cost of Goods Sold
------------------
Cost of goods sold consists primarily of raw materials, direct labor
and manufacturing overhead. Manufacturing overhead consists primarily
of an allocation of purchasing and receiving costs, supplies,
utilities, depreciation, factory and equipment repairs and maintenance
and inspection fees.
Selling Expenses
----------------
Selling expenses consist primarily of payroll, advertising and
promotion, shipping and handling, depreciation and travel and
entertainment.
General and Administrative Expenses
-----------------------------------
General and administrative expenses consist primarily of payroll,
professional fees, insurance, payroll taxes and benefits, general
office expenses, travel and entertainment, transportation, and
depreciation.
X. Recently Issued Accounting Standards
In November 2004, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard ("SFAS") No. 151
"Inventory Costs - an amendment of ARB No. 43, Chapter 4" ("SFAS
151"). This statement amends the guidance in ARB No. 43, Chapter 4,
"Inventory Pricing," to clarify the accounting for abnormal amounts of
idle facility expense, freight, handling costs, and wasted material
(spoilage). SFAS 151 requires that those items be recognized as
current-period charges. In addition, this Statement requires that
allocation of fixed production overheads to costs of conversion be
based upon the normal capacity of the production facilities. The
provisions of SFAS 151 are effective for fiscal years beginning after
June 15, 2005. As such, the Company is required to adopt these
provisions at the beginning of the fiscal year ended September 30,
2006. The Company is currently evaluating the impact of SFAS 151 on
its consolidated financial statements.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of
Nonmonetary Assets - an amendment of APB Opinion No.29" ("SFAS 153").
SFAS 153 replaces the exception from fair value measurement in APB
Opinion No. 29 for nonmonetary exchanges of similar productive assets
with a general exception from fair value measurement for exchanges of
nonmonetary assets that do not have commercial substance. A
nonmonetary exchange has commercial substance if the future cash flows
of the entity are expected to change significantly as a result of the
exchange. SFAS 153 is effective for all interim periods beginning
after June 15, 2005. The adoption of SFAS 153 did not have a material
impact on the Company's financial statements or results of operations.
In December 2004, the FASB issued SFAS No.123R, "Share-Based Payment"
("SFAS 123R"). SFAS 123R revises FASB Statement No. 123 "Accounting
for Stock-Based Compensation" and supersedes APB Opinion No. 25
"Accounting for Stock Issued to Employees". SFAS 123R requires all
public and non-public companies to measure and recognize compensation
expense for all stock-based payments for services received at the
F-24
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
X. Recently Issued Accounting Standards (cont'd)
grant-date fair value, with the cost recognized over the vesting
period (or the requisite service period). SFAS 123R is effective for
small business issuers for all interim periods beginning after
December 15, 2005. As such, the Company is required to adopt these
provisions at the beginning of the fiscal quarter ended March 31,
2006. The Company expects the impact on its consolidated financial
statements to be consistent with the fair value disclosures included
in Note 19 to the consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections - a replacement of APB Opinion No. 20 and FASB
Statement No. 3" ("SFAS 154"). SFAS 154 changes the requirements for
the accounting for and reporting of a change in accounting principle.
These requirements apply to all voluntary changes and changes required
by an accounting pronouncement in the unusual instance that the
pronouncement does not include specific transition provisions. SFAS
154 is effective for fiscal years beginning after December 15, 2005.
As such, the Company is required to adopt these provisions at the
beginning of the fiscal year ended September 30, 2006. The Company is
currently evaluating the impact of SFAS 154 on its consolidated
financial statements.
5. ACCOUNTS RECEIVABLE
The Company's accounts receivable at September 30, 2005 and 2004 are
summarized as follows:
2005 2004
$ $
Accounts receivable 44,973,292 21,763,923
Less: allowance for doubtful accounts 1,593,538 764,362
---------- ----------
Accounts receivable, net 43,379,754 20,999,561
========== ==========
Accounts receivable reserve activity for the years ended September 30, 2005
and 2004 is summarized as follows:
2005 2004
$ $
Balance, beginning of year 764,362 461,982
Bad debts expense 805,479 302,380
Foreign exchange adjustment 23,697 --
---------- ----------
Balance, end of year 1,593,538 764,362
========== ==========
F-25
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
6. INVENTORIES
The Company's inventories at September 30, 2005 and 2004 are summarized as
follows:
2005 2004
$ $
Raw materials 9,284,299 9,934,263
Work in progress 2,738,069 1,872,465
Finished goods 9,673,858 17,729,257
---------- ----------
Total inventories 21,696,226 29,535,985
========== ==========
F-26
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
7. LONG-TERM ASSETS
The Company's long-term assets at September 30, 2005 and 2004 are
summarized as follows:
2005 2004
$ $
Building 30,763,727 4,535,876
Machinery 19,920,180 14,242,696
Vehicles 671,177 486,480
Office equipment 459,408 304,773
Leasehold improvements 346,118 305,758
---------- ----------
Total cost 52,160,610 19,875,583
---------- ----------
2005 2004
$ $
Building 427,568 19,024
Machinery 4,838,119 2,006,717
Vehicles 147,061 79,097
Office equipment 119,627 53,402
Leasehold improvements 341,579 212,534
---------- ----------
Total accumulated depreciation 5,873,954 2,370,774
---------- ----------
Net book value 46,286,656 17,504,809
Construction in progress 17,804,181 23,656,190
Land use rights 3,246,791 4,029,038
---------- ----------
Long-term assets, net 67,337,628 45,190,037
========== ==========
Depreciation expense is included in the statements of operations as
follows:
2005 2004
$ $
Cost of goods sold 2,901,262 1,635,971
Selling expenses 416,701 8,603
General and administrative expenses 185,217 82,584
---------- ----------
Total depreciation expenses 3,503,180 1,727,158
========== ==========
F-27
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
7. LONG-TERM ASSETS (cont'd)
The Company's construction in progress consisted of the following at
September 30, 2005 and 2004:
2005 2004
$ $
Land use fees 1,135,763 1,109,976
Construction costs 11,735,920 18,258,222
Land excavation 2,580,449 2,401,050
Construction materials 2,352,049 790,864
Capitalized research and design -- 143,403
Other indirect costs -- 952,675
---------- ----------
Total construction in progress 17,804,181 23,656,190
========== ==========
Other indirect costs include road repairs, water and sewer fees, temporary
electric fees, environmental fees, equipment rental and other
administrative costs.
The Company has funded the construction costs with cash flow from
operations and proceeds from its share issuances, and as such, no interest
expense has been capitalized. The Company anticipates that the construction
of their facilities will be completed and placed into service by January
2006. The Company has not yet obtained their certificate of land use right.
The bureau of city planning and land resource of Shenzhen have not yet
approved the Company's application since the original zoning for the use of
the land conflicted with both the city planning for education and biology
and its current designation as industrial use. According to the agreement
with the local government of Kuichong Township of Longgang District of
Shenzhen, the Company has paid $285,000 for the down payment on the land
use right and the balance of $2,962,000 is still outstanding. It is
anticipated that the outstanding balance will be paid within the next
twelve months. The local government of Kuichong Township of Longgang
District of Shenzhen had, however, granted permission to the Company to
commence the construction of the new production plant pending a decision
from the Bureau of City Planning. The Company anticipates that it will
receive the approval from the Bureau of City Planning in 2006. See Note 14.
F-28
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
8. OTHER ASSETS
The Company's other assets at September 30, 2005 and 2004 are summarized as
follows:
2005 2004
$ $
Other receivables 160,626 283,937
Long term prepayment 437,683 --
Less: allowance for doubtful accounts (31,606) (57,965)
---------- ----------
Other assets 566,703 225,972
========== ==========
Other receivables reserve activity for the years ended September 30, 2005
and 2004 is summarized as follows:
2005 2004
$ $
Balance, beginning of year 57,965 33,355
Bad debts expense (reversal) (35,672) 24,610
Foreign exchange rate adjustment 9,313 --
---------- ----------
Balance, end of year 31,606 57,965
========== ==========
9. INTANGIBLE ASSETS
The Company's intangible assets at September 30, 2005 and 2004 are
summarized as follows:
2005 2004
$ $
Trademarks, technology and software 65,919 63,904
Less: accumulated amortization (12,540) (5,542)
---------- ----------
Intangible assets, net 53,379 58,362
========== ==========
Amortization expense for the years ended September 30, 2005 and 2004 was
$7,899 and $5,549, respectively.
F-29
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
10. BANK INDEBTEDNESS AND NOTES PAYABLE
As of September 30, 2005 and 2004, the Company had several short-term bank
loans with outstanding balances of $39,545,230 and $27,304,162,
respectively. The loans were used primarily to support operating
activities, carried interest rates ranging from 4.536% to 6.138%, and have
maturity dates ranging from 5 to 12 months. Each loan is guaranteed by
Jilin Province Huaruan Technology Company, Ltd. ("Huaruan", a corporation
owned by Xiangqian Li, BAK's Chairman), Xiangqian Li, BAK International,
related parties, and others who are not related. Neither Huaruan, Mr. Li,
nor other non-related parties receive any compensation for acting as
guarantors.
The Company is required to pledge cash, inventories and equipment in order
to secure these short-term bank loans and notes payable, summarized as
follows at September 30, 2005:
Cash-restricted $19,392,280
Inventories 7,661,888
Equipment 9,819,574
-----------
Total assets pledged $36,873,742
-----------
Certain shares of the Company were pledged by Mr. Xiangqian Li in order to
secure these short-term bank loans.
Notes payable represents customer commitments in the ordinary course of
business. The notes can generally be exchanged at a discount for cash with
financial institutions.
On September 30, 2004, contrary to relevant PRC laws and regulations, the
Company borrowed $1,812,316 from Changzhou Lihai Investment Consulting Co.,
Ltd. The Company subsequently repaid this loan on October 11, 2004.
Management believes that the risk to the Company, due to this loan
arrangement, is very limited.
11. RESERVES
Pursuant to the accounting systems for business enterprises as promulgated
by the PRC, the profits of BAK, which are based on their PRC statutory
financial statements, are available for distribution in the form of cash
dividends only after they have satisfied all PRC tax liabilities, provided
for losses in previous years, and made appropriations to reserve funds (as
discussed below), as determined at the discretion of the Board of Directors
in accordance with the PRC accounting standards and regulations. With the
exception of the restriction on distributions and dividends, the Company is
not limited or otherwise restricted in making distributions by any other
agencies or indentures.
As stipulated by the relevant laws and regulations for enterprises
operating in the PRC, companies are required to make annual appropriations
to two reserve funds, consisting of the statutory surplus and public
welfare funds. In accordance with relevant PRC regulations and the articles
of association of the respective companies, companies are required to
allocate a certain percentage of their profits after taxation, as
determined in accordance with the PRC accounting standards applicable to
the companies, to the statutory surplus reserve, until such reserve reaches
50% of the registered capital of the companies.
F-30
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
11. RESERVES (cont'd)
Net income reported in the US GAAP consolidated financial statements
differs from that reported in the PRC statutory consolidated financial
statements. In accordance with relevant laws and regulations in the PRC,
profits available for distribution are based on the statutory consolidated
financial statements. If BAK has foreign currency available after meeting
its operational needs, BAK may make its profit distributions in foreign
currency to the extent foreign currency is available. Otherwise, it is
necessary to obtain approval and convert such distributions at an
authorized bank.
12. SIGNIFICANT CONCENTRATION
The Company grants credit to its customers, generally on an open account
basis. The Company's five largest customers accounted for 34.51% of
revenues in fiscal 2005, with no customer individually exceeded 10% of
consolidated revenues. In fiscal 2004, the five largest customers comprised
38.98% of revenues, with only one customer exceeding 10% of consolidated
revenues.
13. RELATED PARTY TRANSACTIONS
In October 2003, the Company acquired intangible assets from entities
controlled by its Chairman and controlling shareholder for $3,866,088,
effectively paid in cash. The consideration paid by the Company in excess
of the Chairman's carrying cost of the intangible assets was charged to
retained earnings, as a distribution to the Chairman, resulting in the
acquired intangible asset being recorded by the Company at the Chairman's
original cost basis.
Accounts receivable - related party in the consolidated balance sheets
consists of short term advances made by the Company to a former
shareholder. The advances bore no interest, had no formal repayment terms
and were repaid on December 14, 2005.
On September 30, 2004, BAK entered into an agreement with HFG International
Ltd. ("HFG"), in which HFG provided financial consulting services to the
Company, as described below, for a period of one year for a fee of
$400,000.
Under the agreement, HFG provided the Company with, among other things,
advice on the development and implementation of a restructuring plan,
resulting in an organizational structure that would facilitate the
registration of the Company's securities, assist the Company in engaging
qualified professionals to assist in facilitating the Company's plan,
assist the Company in identifying potential merger candidates, supervise
and train management in preparation for the registration of its securities,
assist in the preparation of the necessary documentation and assist the
Company with solicitation of equity financing.
The fee was paid from the proceeds of the equity capital raised by HFG on
behalf of the Company. In January 2005, the Company raised $17,000,000 from
qualified investors in a private placement offering. In addition, in
September 2005, the Company raised $43,449,247 from qualified investors in
F-31
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
13. RELATED PARTY TRANSACTIONS (cont'd)
a private placement offering. The fee to HFG was offset against the
proceeds from the offerings as a cost of raising capital in 2005. The
principal stockholder in HFG was also the former Chief Executive Officer of
Medina Coffee, Inc. The fee charged to the Company for the services of HFG
was on essentially the same terms as those charged by HFG for financial
consulting services performed for HFG's other clients.
14. CONTINGENCIES AND COMMITMENTS
A Contingent liabilities
1. Land Use and Ownership Certificate:
According to relevant PRC laws and regulations, a land use right
certificate, along with government approvals for land planning,
project planning, and construction, needs to be obtained before
construction of a building is commenced. An ownership certificate
shall be granted by the government upon application under the
condition that the aforementioned certificate and government
approvals are obtained.
The Company has not yet obtained the land use right certificate
and government approvals relating to the construction of the
Company's operating premises, BAK Industrial Park. However, the
Company is in the process of applying to obtain the land use
right certificate of approval. The local government of Kuichong
Township of Longgang District of Shenzhen has, however, granted
permission for BAK to commence the construction of the new
production plant pending a decision from the Bureau of City
Planning. The Company anticipates that it will receive the
approval from the Bureau of City Planning in 2006.
Management believes, under the condition that the Company is
granted a land use right certificate and related approvals, that
there should be no legal barriers for the Company to obtain an
ownership certificate for the premises presently under
construction in BAK Industrial Park. However, in the event that
the Company fails to obtain the land use right certificate
relating to BAK Industrial Park and the government approvals
required for the construction of BAK Industrial Park, there is
the risk that the buildings constructed will need to be vacated
as illegitimate constructions. However, management believes that
this possibility, while present, is very remote. As a result, no
provision has been made in the consolidated financial statements
for this potential occurrence.
The Company does not currently insure its manufacturing
facilities since it has not yet received its land use right
certificate. The Company intends to procure such insurance once
it has received the certificate.
F-32
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
14. CONTINGENCIES AND COMMITMENTS (cont'd)
A Contingent liabilities
2. Guarantees
The Company's guarantees at September 30, 2005 and 2004 are
summarized as follows:
2005 2004
$ $
Guaranteed for Shenzhen Tongli,
a non-related party 3,603,502 1,208,153
Guaranteed for Shenzhen Zhengda,
a non-related party 1,235,788 1,208,153
Notes receivable discounted 484,028 18,122
--------- ---------
Total guarantees 5,323,318 2,434,428
========= =========
The Company factors notes and accounts receivable from time to
time to banks. At the time of the factoring, all rights and
privileges of holding the note are transferred to the banks. The
Company removes the asset from its books and records a
corresponding expense for the amount of the discount. The Company
remains contingently liable on a portion of the amount
outstanding in the event the note maker defaults.
No provision has been made in the consolidated financial
statements for these contingencies.
BAK and Development and Construction (Group) Company Limited By
Shares ("Changchun Co.") of Changchun Economic & Technology
Development District, entered into a Cross-Guaranty Agreement,
dated February 20, 2004 (the "Agreement"), pursuant to which the
parties were obligated to guaranty a specified amount of each
other's indebtedness to specifically identified lending
institutions. On December 22, 2004, the Company received from
Changchun Co. a letter of termination pursuant to which the
Agreement was deemed terminated by Changchun Co. and the Company
was relieved of all obligations to guaranty any indebtedness of
Changchun Co. in the future. The termination of the Agreement in
no way affects Changchun Co.'s continuing guaranty of the BAK
Indebtedness. As of September 30, 2005, ChangChun Jingkai had not
guaranteed any indebtedness of the Company.
3. Social Insurance of BAK's Employees
As described in Note 4 (O), BAK is required to cover employees
with various types of social insurance. Although all insurances
have been purchased for management employees, BAK has not fully
covered other employees. Owing to the transient nature of most of
F-33
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
14. CONTINGENCIES AND COMMITMENTS (cont'd)
A Contingent liabilities
3. Social Insurance of BAK's Employees(cont'd)
its non-management employees and on the basis of historical
experience, management believes that BAK does not need to provide
all employees with the required insurance.
In the event that any current employee, or former employee, files
a complaint with the government, not only will BAK be required to
purchase insurance for such employee, but BAK may be subject to
administrative fines. As the Company believes that these fines
are nominal, no provision for any potential fines has been made
in the accompanying financial statements.
B. Commitments
1. Capital Commitments
BAK has outstanding commitments under construction contracts for
the construction of factory, office, employee residence
buildings, and equipments amounting to $3,916,021 at September
30, 2005. These contracts are expected to be completed by January
2006.
2. Lease Commitments
BAK leases various factory and office space under short term
operating leases and is obligated at September 30, 2005 for each
of the next three fiscal years as follows:
2006 - $ 95,169
2007 - $ 72,017
2008 - $ 47,716
15. CAPITAL CONTRIBUTIONS
During the year ended September 30, 2004, the existing stockholders
contributed $10,875,918 in cash to the Company, which has been recorded as
an increase to additional paid-in capital in the accompanying consolidated
financial statements.
On January 20, 2005, the Company completed a stock exchange transaction
with the stockholders of BAK International, as more fully described in Note
2. Prior to and in connection with the completion of the stock exchange
with BAK International, BAK International sold 8,600,433 shares of its
common stock to new investors in a private placement, as more fully
described in Note 1.
F-34
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
15. CAPITAL CONTRIBUTIONS (cont'd)
On September 16, 2005, the Company sold 7,899,863 shares of its common
stock to new investors. The Company granted certain registration rights to
such purchasers, including the Company's covenant to file with the
Securities and Exchange Commission a registration statement covering their
shares. Under this transaction, the stockholders contributed $43,449,247 to
the Company, which has been recorded as an increase in common stock of
$7,900 and an increase in additional paid in capital of $43,441,347 in the
accompanying consolidated financial statements. The Company also issued
warrants to purchase 631,989 shares of its common stock at an exercise
price of $7.92 per share, exercisable for three years after the date of
issuance, as a fee to certain persons in connection with this transaction.
16. BUSINESS SEGMENT AND GEOGRAPHIC AREA DATA
The Company currently engages in the manufacture, commercialization and
distribution of a wide variety of standard and customized lithium ion
rechargeable batteries for use in a wide array of applications. The Company
manufactures five types of Li-ion rechargeable batteries: steel cell,
aluminum cell, cylindrical cell, polymer cell and industrial batteries. The
Company's products are sold to packing plants operated by third parties
primarily for use in mobile phones and other electronic devices. Revenue
and long-term asset components for 2005 and 2004 were as follows:
2005 2004
--------------- --------------
$ % $ %
Revenues by Product ($ in millions):
Steel cell 56.96 55.89 37.97 59.56
Aluminum cell 23.72 23.27 13.08 20.52
Cylindrical cell 1.05 1.03 .26 .41
Polymer cell .02 .02 -- --
Industrial battery 20.17 19.79 12.44 19.51
------ ------ ----- ------
Total revenues 101.92 100.00 63.75 100.00
------ ------ ----- ------
Revenues by Geographic Area ($ in millions):
Domestic sales - PRC 72.35 70.99 43.36 68.02
Foreign sales 29.57 29.01 20.39 31.98
------ ------ ----- ------
Total revenues 101.92 100.00 63.75 100.00
------ ------ ----- ------
Long-Term Assets ($ in millions)
Domestic - PRC 67.34 100.00 45.19 100.00
------ ------ ----- ------
The above geographic area data consists of revenues based on product
shipment destination and long-term assets are based on physical location.
F-35
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
17. INCOME TAXES
The reconciliation between PRC income taxes at the statutory rate and the
Company's provision for income taxes at September 30, 2005 and 2004 are as
follows:
2005 2004
$ $
(000's) (000's)
Computed tax at the PRC statutory rate of 15% 1,935 1,071
Nondeductible Items -- 15
PRC tax holiday and tax reduction (1,408) (692)
---------- ----------
Current provision for income taxes 527 394
========== ==========
As of September 30, 2005 and 2004, the Company had no deferred tax assets
or liabilities and was not liable for any taxes in the United States or any
other foreign jurisdictions outside the PRC.
18. WARRANTY RESERVES
Warranty reserve activity for the years ended September 30, 2005 and 2004
is summarized as follows:
2005 2004
$ $
Balance, beginning of year 220,503 95,874
Warranty expense 5,948,776 3,507,151
Claims paid (5,826,154) (3,382,522)
---------- ----------
Balance, end of year 343,125 220,503
========== ==========
Warranty expense is included in cost of goods sold and warranty reserves
are offset against accounts receivable in the accompanying consolidated
financial statements.
19. STOCK-BASED COMPENSATION
In May 2005, the Board of Directors adopted the China BAK Battery, Inc.
2005 Stock Option Plan ("Plan"). The Plan authorizes the issuance of up to
4,000,000 shares of the Company's common stock. The exercise price of the
options granted, pursuant to the Plan, must be at least equal to the fair
market value of the Company's common stock at the date of the grant. The
Plan will generally terminate on May 16, 2055. Pursuant to the Plan, the
Company issued 2,000,000 options with an exercise price of $6.25 per share
on May 16, 2005. In accordance with the vesting provisions of the grants,
the options will become vested and exercisable under the following
schedule:
F-36
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
19. STOCK-BASED COMPENSATION (cont'd)
Numbers of Shares % of Shares Issued Initial Vesting Date
800,000 40% July 1, 2007
600,000 30% January 1, 2008
600,000 30% July 1, 2008
--------- ---
2,000,000 100%
========= ===
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure." This standard provides alternative methods of transition for a
voluntary change to the fair value based method of accounting for
stock-based employee compensation. Additionally, the standard also requires
prominent disclosures in the Company's financial statements about the
method of accounting used for stock-based employee compensation, and the
effect of the method used when reporting financial results.
The Company accounts for stock-based compensation in accordance with SFAS
No. 123, "Accounting for Stock-Based Compensation." As permitted by SFAS
No.123, the Company continues to measure compensation for such plans using
the intrinsic value based method of accounting, prescribed by Accounting
Principles Board (APB), Opinion No. 25, "Accounting for Stock Issued to
Employees." Had compensation cost for the Company's stock-based
compensation plans been determined based on the fair value at the grant
dates for awards consistent with the method of SFAS No. 123, the Company's
net income and net income per common share would have been adjusted to the
pro forma amounts indicated below:
2005 2004
----------- -----------
Net income, as reported $12,374,377 $ 6,746,307
Add: total stock-based compensation expense
included in net income, net of related tax effects -- --
Deduct: total stock-based compensation
expense determined under the fair value, net of
related tax effects (1,068,243) --
----------- -----------
Pro forma net income $11,306,134 $ 6,746,307
=========== ===========
F-37
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
19. STOCK-BASED COMPENSATION (cont'd)
Net income per common share:
As reported - Basic $0.32 $0.22
Diluted $0.32 $0.22
Pro forma - Basic $0.30 $0.22
Diluted $0.29 $0.22
For purposes of the disclosure above, the fair value of each option grant
in 2005 is estimated on the date of the grant using the Black-Scholes
option pricing model, with the following weighted average assumptions:
Dividend yield 0.00%
Expected volatility 59.85%
Risk-free interest rate 4.12%
Expected life 6 Years
For the year ended September 30, 2004, no stock options were granted.
20. SUBSEQUENT EVENTS
A. During November and December 2005, the Company refinanced two of its
credit facilities totaling $3.8 million, and entered into two new
credit facilities totaling $3.7 million with existing lenders. The
four new facilities provide for monthly interest payments at fixed
annual interest rates from 5.2% to 6.1%, with principal repayments at
maturities during the second calendar quarter of 2006. There were no
changes in assets pledged or payment guarantees from September 30,
2005 as a result of these new facilities. On January 11, 2006, the
Company repaid in full one of its loans with a principal balance of
$6.2 million at September 30, 2005.
B. Included in capital commitments at September 30, 2005 (Note 14 (B)(1)
is $1,183,000 of equipment that has been purchased by a customer on
behalf of the Company. The Company will hold title to the equipment
and will reimburse the customer by offsetting the purchase price
against future product sales. The Company received equipment totaling
$778,750 in November 2005 and an additional $298,000 of equipment in
December 2005. The Company expects to receive the remaining $106,250
of equipment in 2006.
C. On January 11, 2006, the Company guaranteed an additional $617,894 to
a bank for Shenzhen Tongli, a non-related party.
D. On January 10, 2006, BAK International completed the formation of a
new wholly owned subsidiary, BAK Electronics (Shenzhen) Co., Ltd.,
focused on the research, development, manufacture and distribution of
rechargeable lithium polymer batteries.
E. On February 22, 2006, the Company renewed its $3,708,190 loan with
China Construction Bank for a term of six months, with interest
accruing at an annual rate of 5.481%, payable monthly, and principal
payable at maturity.
F. Between October 1,2005 and March 7, 2006, the Company discounted an
additional $11,714,046 of notes receivable, increasing the Company's
maximum exposure for guarantees to $17.7 million on that date.
F-38
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
21. RESTATEMENT TO CONSOLIDATED FINANCIAL STATEMENTS
A. Based on comments from the Securities and Exchange Commission, the
Company amended the consolidated statement of cash flows for the year
ended September 30, 2004, as summarized below:
2004
----
As previously
As restated reported
(USD$) (USD$)
----------- ------------
Net cash provided from operating activities 88,874 209,689
Net cash provided from investing activities (38,333,208) (38,333,200)
Net cash provided from financing activities 40,785,680 40,664,762
Effects of exchange rates changes on cash
and cash equivalents (95) --
The restatement had no effect on net income or net income per share.
B. Based on additional comments from the Securities and Exchange
Commission, the Company amended the consolidated balance sheet as of
September 30, 2004 and the consolidated statement of changes in
stockholders' equity for the year ended September 30, 2004. The
restatement was made to retroactively reflect that 1,152,458 shares of
common stock of Medina Coffee, Inc. were outstanding immediately prior
to the share exchange and the resulting recapitalization. (See Note
2). The effect of the restatement was to decrease common stock
outstanding as of the earliest date presented with a corresponding
increase to additional paid in capital. The restatement had no effect
on net income, net income per share or total stockholders' equity in
the accompanying consolidated financial statements. The following
table presents the effects of this amendment to the consolidated
financial statements:
As of September 30, 2004
-----------------------------
As previously
As restated reported
(USD$) (USD$)
------------- -------------
Common Stock 31,226 32,378
Additional Paid in Capital 12,052,845 12,051,693
Retained Earnings 5,437,854 5,437,854
As of September 30, 2003
-----------------------------
As previously
As restated reported
(USD$) (USD$)
------------- -------------
Common Stock 31,226 32,378
Additional Paid in Capital 1,176,927 1,175,298
Retained Earnings 3,630,298 3,630,298
F-39
China BAK Battery, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
(Amounts expressed in US Dollars)
21. RESTATEMENT TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
C. Based on further comments from the Securities and Exchange Commission,
the Company amended the consolidated statement of operations for the
year ended September 30, 2004. The restatement was made to reclassify
depreciation and amortization expense from a separate item in
operating expenses into cost of goods sold, selling expenses and
general and administrative expenses. The effect of the restatement was
to decrease gross profit. The restatement had no effect on operating
income, net income or net income per share. The following table
presents the effects of this amendment to the consolidated statement
of operations:
For the Year Ended
September 30, 2004
-----------------------------
As previously
As restated reported
(USD$) (USD$)
------------- -------------
Gross Profit 13,824,384 15,460,355
F-40