ITEM 1. BUSINESS.
Overview of Our Business
Upon the commencement of commercial operations of our Dalian manufacturing facilities, which is expected to be in the first quarter of calendar year 2015, we will be engaged in the business of developing, manufacturing and selling new energy high power lithium batteries, which are mainly used in the following applications:
Electric vehicles (“EV”), such as electric cars, electric buses, hybrid electric cars and buses;
Light electric vehicles (“LEV”), such as electric bicycles, electric motors, sight-seeing cars; and
Electric tools, energy storage, uninterruptible power supply, and other high power applications.
We are currently constructing new manufacturing facilities in Dalian and most of BAK Tianjin’s operating assets, including its machinery and equipment, customers, employees, patents and technologies are being relocated from BAK Tianjin. BAK Tianjin is one of the major manufacturers of high power lithium batteries in China which started operations in 2008, and has obtained many well-known customers in EV, LEV and other high power applications. The construction of the Dalian facilities is expected to be completed in January 2015 and its trial production will begin immediately thereafter. We expect that the Dalian facilities will commence commercial operations in the first quarter of calendar year 2015. We have outsourced and will continue to outsource our production to BAK Tianjin or other manufacturers until our Dalian manufacturing facility begins its commercial operations. As of September 30, 2014, Dalian BAK Power has generated revenues of approximately $1.2 million from the sale of batteries manufactured by BAK Tianjin under outsourcing arrangements.
During fiscal 2013, we received a subsidy of RMB150 million (approximately $24.4 million) from the Management Committee of Dalian Economic Zone, to finance our relocation of operating assets from Tianjin to Dalian. In October 2014, we received from Dalian government a subsidy of RMB46.2 million (approximately $7.5 million) for costs of land use rights relating to the new manufacturing site in Dalian. We also obtained a short term bank loan of RMB30 million (approximately $4.9 million) with a one-year term from Bank of Dandong in August 2014. The short term bank loan is bearing a fixed interest rate at 7.8% per annum and is guaranteed by Mr. Xiangqian Li, our CEO, and Shenzhen BAK. We plan to renew this loan upon maturity, and plan to raise additional funds in the future to meet our daily cash demands. In the meanwhile, due to the growing environmental pollution problem, the Chinese government is currently providing vigorous support to the new energy facilities and vehicles. It is expected that we will be able to secure more potential orders from the new energy market, especially from the electric car market. We believe with the significant reduction of liabilities and disposal of traditionally low margin battery business, supported by the future market demand in high power lithium ion products, we can continue as a going concern and return to profitability.
We had experienced net losses during the past two fiscal years. We generated revenues from the manufacture of lithium ion rechargeable batteries of $185.6 million and $123.0 million for the fiscal years ended September 30, 2013 and 2014, respectively. We incurred a net loss of $116.0 million in fiscal 2013 and a net profit of $37.8 million in 2014. As of September 30, 2014, we had an accumulated deficit of $141.8 million and net liabilities of $4.3 million. We had net liabilities, a working capital deficiency, accumulated deficit from recurring net losses incurred for the current and prior years and significant short-term debt obligations maturing in less than one year as of September 30, 2014.
Before the foreclosure of BAK International on June 30, 2014, we generated most of our revenues from BAK International and its subsidiaries during fiscal 2014. We were also engaged in the business segment of property lease and management of our Research and Development Centre in Shenzhen since its completion in July 2013 and up to June 30, 2014. As a result, we generated revenues from property lease and management of $0.4 million and $4.1 million for the years ended September 30, 2013 and 2014, respectively.
In order to repay our overdue bank loans, Shenzhen BAK borrowed from Mr. Jinghui Wang (“Mr. Wang”) an aggregate of RMB520 million (approximately $83.8 million) (the “Loans”) in December 2013 and January 2014. To secure the repayment of the Loans, we and BAK International separately entered into a corporate guarantee with Mr. Wang, under which each of us and BAK International irrevocably and unconditionally guaranteed to the lender timely performance by Shenzhen BAK of its obligation to repay the Loans. In addition, we pledged 100% of our equity interest in BAK International to the lender as security for Shenzhen BAK’s repayment of the Loans (the “Pledged BAK International Equity”).
On June 30, 2014, we received from Mr. Wang a notice that due to Shenzhen BAK’s default under the Loans, he had foreclosed his security interest in and sold and transferred to a third party the Pledged BAK International Equity for a purchase price of RMB520 million (approximately $83.8 million) to Mr. Wang.
On July 4, 2014, we, Shenzhen BAK, BAK International and Mr. Wang entered into certain Deed of Waiver and Release, pursuant to which, Mr. Wang absolutely waived all his title, rights, interests and benefits in and to the accrued and unpaid interest on the Loans in an amount of RMB51 million (approximately $8.3 million) as of June 30, 2014. In addition, we and BAK International were both released and discharged from the obligations under the corporate guarantees that the parties executed in favor of Mr. Wang. Under the Deed of Waiver and Release, we, Shenzhen BAK, BAK International and Mr. Wang will have no claim whatsoever against each other.
Our Corporate Structure
As a result of the above foreclosure, we no longer have the ownership of the following companies:
Our former Hong Kong subsidiary, BAK International;
Our former German subsidiary, BAK Europe;
Our former Canadian subsidiary, BAK Canada;
Our former Indian subsidiary, BAK India;
Our former PRC subsidiary, Shenzhen BAK;
Our former PRC subsidiary, BAK Tianjin;
Our former PRC subsidiary, BAK Battery; and
Our former PRC subsidiary, Tianjin Chenhao.
We currently wholly own the following two subsidiaries in China through BAK Asia:
Dalian BAK Power, located in Dalian, China, incorporated in December 27, 2013, which will focus on the development and manufacturing of high power lithium batteries; and
Dalian BAK Trading, located in Dalian, China, incorporated in August 14, 2013, which will focus on trading of our products.
The chart below presents our current corporate structure:
Before the foreclosure of BAK International on June 30, 2014 as described above, we conducted our business through BAK International and its subsidiaries, and our then corporate structure was as follows:
Our Products
The use of new materials have enabled the configuration of high-power lithium battery cells to contain much higher energy density and higher voltage and have a longer life cycle and shorter charge time than other types of lithium-based batteries. These special attributes, coupled with intrinsic safety features, are suitable for batteries used for high-power applications, such as electric cars, electric bicycles, electric tools, energy storage and UPS.
High power lithium batteries represent the main direction for new energy vehicle technologies during the “12th Five-Year Plan” period of the Chinese government.
Once commercial operations commence, our Dalian manufacturing facilities will focus on the development and manufacture of high power lithium batteries, for use in the following end applications:
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* Bracketed numbers denote number of cells per particular battery.
Key High Power Lithium Battery Applications
End-product applications that are driving the demand for high power lithium batteries include electric vehicles, such as electric cars, electric buses, hybrid electric cars and buses; light electric vehicles, such as electric bicycles, electric motors, sight-seeing cars; and electric tools, energy storage, uninterruptible power supply, and other high power applications.
Electric Vehicles
An electric vehicle, sometimes referred to as an electric drive vehicle, uses one or more electric motors for propulsion. Electric vehicles include electric cars, electric buses, electric trains, electric lorries, electric airplanes, electric boats, and hybrid electric vehicles, plug in hybrid electric vehicles and electric spacecraft. Electric cars and electric buses are propelled by one or more electric motors powered by rechargeable battery packs. Electric cars and buses have the potential to significantly reduce city pollution by having zero tail pipe emissions. Electric cars and buses are also expected to have less dependence on oil. World governments are pledging significant funds to fund the development of electric vehicles and their components due in part to these advantages. Due to these factors and a lithium battery’s relatively environmentally-friendly, light-weight and high-capacity features, the demand for lithium batteries in the field of electric cars and buses is increasing.
Due to such recent trends as renewed concerns relating to the availability and price of oil, increased legal fuel-efficiency requirements and incentives, and heightened interest in environmentally-friendly or “green” technologies, hybrid electric vehicles are likely to continue to attract substantial interest from vehicle manufacturers and consumers. Hybrid electric vehicles include automobiles, trucks, buses, and other vehicles that combine a conventional propulsion system with a rechargeable energy storage system to achieve better fuel economy than conventional vehicles. As these vehicles tend to be large and heavy, their rechargeable energy storage system generally consists of a large quantity of rechargeable high-power lithium cells.
The year 2014 is seen as the first real year for the development of China's new energy vehicle industry by many industry insiders. According to China Association of Automobile Manufacturers, in the first half of 2014, the production of new energy vehicles reached 20,700 units - up 230 percent year-on-year; and sales reached 20,500 units - up 220 percent year-on-year. As the core mechanism for new energy vehicles, the power battery industry has also recently welcomed an unprecedented growth. According to the Development Program for the Energy Efficient and New Energy Vehicle Industry 2012-2020 designed by the State Council of the PRC, some major objectives are: to enthusiastically advance innovation in power battery technologies; scientifically plan the industrial layout; focus on developing power battery industry clusters; and actively promote the mass production of power batteries. With the recent introduction of a number of supporting policies, the production of power batteries for vehicles has grown remarkably. The statistics from the Ministry of Industry and Information Technology of China (MIIT) have shown that the production of power lithium batteries for electric vehicles stood at 804 million watt-hours in the first half of 2014, compared to the 360 million watt-hours in the whole of 2013.
Light Electric Vehicles
Light electric vehicles include bicycles, scooters, and motorcycles, with rechargeable electric motors. Due to their relatively small size and light design, approximately 10-150 high-power lithium cells can be used to power light electric vehicles. The electric bicycle market in China is growing fast. According to Great Battery Industry Institute (“GBII”), in the first half of calendar year 2014, the sales of lithium battery-powered electric bicycles will reach 1.7 million units - up 36% year-on-year, and it is expected in the second half of calendar year 2014, the sales of lithium battery-powered electric bicycles reached 2 million units, and in calendar year 2015, the sales of lithium battery-powered electric bicycles will increase 20% over year 2014.
Energy Storage
Energy storage mainly means storage of electric energy by battery, inductor, and capacitor. Battery energy storage is mainly used for storage of emergency supply, battery car, and redundant energy of power plant.
Electric Tools
Electric tools such as drills, saws and grinders are used for both commercial and personal use. Due to high power requirements, many electric tools have historically used small combustion engines, used heavier nickel metal hydride batteries or relied on external power sources. Manufacturers of electric tools, such as Milwaukee Electric Tool Corporation, Stanley Black & Decker, Inc., the Bosch Group, Metabowerke GmbH and Rigid Tool Company have begun to use lithium-ion technology. The market for portable high-powered electric tools is rapidly growing and has prompted many users, both commercial and personal, to replace or upgrade their current power tools.
Uninterruptible Power Supplies
A UPS provides emergency power from a separate source when utility power is not available. The most common type of battery used in UPS is Sealed Lead-Acid, however, due to the lithium battery’s relatively small size, light design and environmentally-friendly features, the demand for lithium batteries in this industry is increasing.
Revenue by Products
Before June 30, 2014, we derived our revenues from BAK International and its subsidiaries which produced prismatic cells, cylindrical cells, lithium polymer cells and high-power lithium batteries. Since July 1, 2014, our revenue has been mainly from Dalian BAK Power for sale of batteries manufactured by BAK Tianjin under outsourcing arrangements. The following table sets forth the breakdown of our net revenues by each battery type during the last two fiscal years.
Sales and Marketing
We plan to build an extensive sales and service network in China, highlighted by our presence in the regions where China’s main EV and LEV productions are located, such as Beijing, Hubei Province, Shandong Province and Henan Province. We intend to gradually establish post-sales service offices in these areas to serve brand owners and pack manufacturers in each designated area as currently our marketing department at headquarters is responsible for our sales and marketing efforts. In doing so, our sales staff works closely with our customers to understand their needs and provide feedback to us so that we can better address their needs and improve the quality and features of our products.
We also engage in marketing activities such as attending industry-specific conferences and exhibitions to promote our products and brand name. We believe these activities are conducive in promoting our products and brand name among key industry participants.
Suppliers
The primary raw materials used in the manufacture of lithium-ion batteries include electrode materials, cases and caps, foils, electrolyte and separators. Cost of these raw materials is a key factor in pricing our products. We believe that there is an ample supply of most of the raw materials we need in China. We are seeking to identify alternative raw material suppliers to the extent there are viable alternatives and to expand our use of alternative raw materials.
We aim to maintain multiple supply sources for each of our key raw materials to ensure that supply problems with any one supplier will not materially disrupt our operations. In addition, we strive to develop strategic relationships with new suppliers to secure a stable supply of materials and introduce competition in our supply chain, thereby increasing our ability to negotiate better pricing and reducing our exposure to possible price fluctuations.
We are still outsourcing our orders from BAK Tianjin before our commencement of commercial operations in Dalian manufacturing base. We expect to receive all of BAK Tianjin’s comprehensive supply chain of materials and equipment in January 2015.
For the year ended September 30, 2014, our key raw material suppliers were as follows:
We source our manufacturing equipment both locally and from overseas, based on consideration of their cost and function. Our key equipment as of September 30, 2014 was purchased from the following suppliers:
Intellectual Property
On August 25, 2014, we entered into a certain intellectual property rights use agreement with Shenzhen BAK, pursuant to which we are authorized to use Shenzhen BAK’s registered logo, trademarks and patents for a period of 5 years for free from June 30, 2014. As of June 30, 2014, Shenzhen BAK had registered 80 trademarks in the PRC, including BAK in both English and in Chinese characters as well as its logo, and had registered 49 trademarks in the United States, European Union, Korea, Russia, Taiwan, India, Canada and Hong Kong. As of September 30, 2014, Shenzhen BAK had registered 522 patents in the PRC and other countries relating to battery cell materials, design and manufacturing processes. We have registered the following Internet and WAP domain name: www.cbak.com.cn.
As of September 30, 2014, Dalian BAK Power has 17 patents including 15 utility model patents and 2 patents for invention in the PRC. These patents were acquired by BAK Asia, from an unrelated third party at RMB1 and contributed as paid up capital of Dalian BAK Power.
We also have unpatented proprietary technologies for our product offerings and key stages of the manufacturing process. Our management and key technical personnel have entered into agreements requiring them to keep confidential all information relating to our customers, methods, business and trade secrets during their terms of employment with us and thereafter and to assign to us their inventions, technologies and designs they develop during their term of employment with us.
We have institutionalized our efforts to safeguard our intellectual property rights by establishing an internal department that includes professionals such as attorneys, engineers, information managers and archives managers responsible for handling matters relating to our intellectual property rights. We have published internally a series of rules to protect our intellectual property rights.
Seasonality
According to the market demands, we usually experience seasonal peaks during the months of October to March for electric vehicle markets, and during the months of May to October for light electric markets. Also, at various times during the year, our inventories may be increased in anticipation of increased demand for consumer electronics. The period from the end of September to February tends to be seasonally low sales months due to plant closures for National Day holiday and the Chinese New Year in the PRC.
Customers
Upon the commencement of the commercial operations of our Dalian facilities, which is expected to be by the end of the first quarter of calendar year 2015, almost all of the customers of BAK Tianjin will place orders with us. BAK Tianjin has many well-known customers, including electric vehicle manufacturers, such as Chery Automobile Co. Ltd., or Chery, Great Wall Motor Company Limited, or GWM, Brilliance Auto Group, or Brilliance; and EV battery pack manufacturers, such as Valence Technology Co., Ltd, or Valence, Robotics Technology Ltd, or Robtotics, and Guangdong Pisen Electronics Co., Ltd., or Pisen; and electric bicycle manufacturers, such as Tianjin FSD Bicycles Co., Ltd, or FSD, Shenzhen Xidesheng Bicycle Co., Ltd., or XDS, and Gamma Bicycle Co., Ltd, or Gamma. We believe that we will continue to increase our revenue and market share as we gradually increase our high-power batteries production as the demand for these batteries has been increasing.
Geography of Sales
Before June 30, 2014, we sold our products domestically and internationally. Thereafter, we sell high-power lithium battery primarily to customers in China. The following table sets forth certain information relating to our total revenues by location of our customers for the last two fiscal years.
Competition
We face intense competition from high-power lithium battery makers in China, as well as in Korea and Japan for each of our product types. The following table sets forth our major competitors for the EV market and LEV market as of September 30, 2014:
We believe that we are able to leverage our low-cost advantage to compete favorably with our competitors. Compared to Korean and Japanese battery makers, we are able to source our needs for skilled labor and raw materials locally and economically. Compared to Chinese battery makers, we believe we have higher consistency and safety in product quality, which enables us to compete favorably with local competitors.
Research and Development
The R&D of next-generation advanced lithium battery and its key materials - characterized by high energy density, high security, long-lasting life, and low cost - as well as the training of related technical talents, have become a major demand in the development of advanced electric vehicles in China. In April 2014, we reached a strategic cooperation agreement with Dalian Institute of Chemical Physics of Chinese Academy of Sciences ("DICP"). Under the agreement, the two parties will jointly research and develop the next-generation key technologies and materials with an aim to produce the most powerful battery worldwide. In addition, the two parties will join in training technical talents in China's power battery industry so as to further promote the industrial development.
We will establish an advanced R&D center at Dalian with receiving almost all the R&D achievements, R&D equipment and staff of BAK Tianjin. In December 2006, BAK Tianjin was incorporated to focus on research and development, manufacturing and distribution of high-power lithium battery and battery modules. In October 2008, BAK Tianjin completed construction of its first high-power lithium battery production line, and initiated trial production of high-power lithium cells. BAK Tianjin is capable of producing high-power lithium battery and battery modules for electric cars, electric bicycles, UPS, and other applications. This facility has received positive market feedback to samples of its high-power lithium battery and battery modules. Moreover, this facility’s “Electric Vehicles Lithium-phosphate Power Battery Industrialization Project” was accepted into the PRC’s National High Technology Research and Development Program, or “National 863 Program,” by the PRC’s Ministry of Science and Technology.
During the fiscal years ended September 30, 2013 and 2014, our expenditures for research and development activities were $5.4 million and $4.0 million, respectively, or 2.9% and 3.2% of net revenues, respectively.
Environmental Compliance
As we conduct our manufacturing activities in China, we are subject to the requirements of PRC environmental laws and regulations on air emission, waste water discharge, solid waste and noise. The major environmental regulations applicable to us include the PRC Environmental Protection Law, the PRC Law on the Prevention and Control of Water Pollution and its Implementation Rules, the PRC Law on the Prevention and Control of Air Pollution and its Implementation Rules, the PRC Law on the Prevention and Control of Solid Waste Pollution, and the PRC Law on the Prevention and Control of Noise Pollution. We aim to comply with environmental laws and regulations. We have built environmental treatment facilities concurrently with the construction of our manufacturing facilities, where waste air, waste water and waste solids we generate can be treated in accordance with the relevant requirements. We will outsource disposal of solid waste we generate to a third party contractor upon the commencement of operations. Certain key materials used in manufacturing, such as cobalt dioxide, electrolyte and separators, have proven innocuous to worker’s health and safety as well as the environment. We are not subject to any admonitions, penalties, investigations or inquiries imposed by the environmental regulators, nor are we subject to any claims or legal proceedings to which we are named as a defendant for violation of any environmental law or regulation. We do not have any reasonable basis to believe that there is any threatened claim, action or legal proceedings against us that would have a material adverse effect on our business, financial condition or results of operations.
Employees
We had a total of approximately 58 employees as of September 30, 2014.
Executive Officers
Our current executive officers are as follows:
Xiangqian Li. Mr. Li has served as the Chairman of our Board, our President and Chief Executive Officer since January 20, 2005. He has been a director of BAK International Limited, our former Hong Kong subsidiary, since November 2004. Mr. Li is the founder and has served as the Chairman of the Board of Shenzhen BAK, our former wholly owned subsidiary, since its inception in August 2001, and served as Shenzhen BAK’s General Manager since December 2003. Pursuant to a memorandum of understanding with the buyer of our disposed former subsidiaries dated August 20, 2014, Mr. Li remains as a director of BAK International, Shenzhen BAK, BAK Battery and BAK Tianjin until Shenzhen BAK’s full settlement of its existing bank loans of $63.1 million maturing in various periods through March 2015. During this period, Mr. Li should not participate in any operational and managerial decision making of these entities. From June 2001 to June 2003, Mr. Li was the chairman of Huaran Technology Co., Ltd., a PRC-incorporated company engaged in the car audio business. Mr. Li received a bachelor’s degree in thermal energy and power engineering from the Lanzhou Railway Institute, China and a doctorate degree in quantitative economics from Jilin University in China.
Jian Lin. Dr. Lin has served as our Interim Chief Technical Officer since April 17, 2014. He served as Vice Director of R&D Centre of Shenzhen BAK from March 2012 to April 2014, where he was responsible for the overall R&D activities of Shenzhen BAK. From October 2009 to February 2012, he worked for Postdoctoral R&D Station of Shenzhen BAK, which was co-established by Shenzhen BAK and Xiamen University, where he focused on the research of high performance liquid electrolytes for Li-ion battery. From August 2008 to September 2009, he worked as R&D scientist for U.S. Brady (Beijing) R&D Center. Dr. Lin has extensive knowledge of lithium-ion battery technologies and holds three patents relating to lithium-ion technology. Dr. Lin received a doctorate degree in polymer science and engineering from Case Western Reserve University, where he focused on novel lithium salts and polymer electrolyte membranes/separators for lithium batteries.
Wenwu Wang. Mr. Wang has served as our Interim Chief Financial Officer since August 28, 2014. He has served as the financial controller of Dalian BAK Power since April 2014, and served as the vice financial manager of Shenzhen BAK from August 2013 to June 2014. He has also served as our consolidation and financial reporting manager since September 2012. From November 2010 to September 2012, he served as the financial manager of BAK India. From October 2008 to November 2010, Mr. Wang was account receivable supervisor of Shenzhen BAK and consolidation and financial reporting assistant of the Company. Mr. Wang received a bachelor’s degree in Accounting from Southwest University in China.
Available Information
Our internet website is at http://www.cbak.com.cn. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, including exhibits, and amendments to those reports filed or furnished pursuant to Sections 13(a) or 15(d) of the Exchange Act, and other public filings with the SEC, are available free of charge on our website as soon as reasonably practicable after such filings are electronically filed with, or furnished to, the SEC. Copies of these filings may also be obtained free of charge by sending written requests to our Secretary, BAK Industrial Park, Meigui Street, Huayuankou Economic Zone, Dalian City, Liaoning Province, China, 116422, attention Corporate Secretary. The information posted on our website is not part of this or any other report we file with or furnish with the SEC. Investors can also read and copy any materials filed by us with the SEC at the SEC’s Public Reference Room which is located at 100 F Street, NE, Washington, DC 20549. Information about the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. Our filings can also be accessed at the SEC’s internet website: www.sec.gov.
ITEM 1A.
ITEM 1A. RISK FACTORS.
RISKS RELATED TO OUR BUSINESS
Our failure to timely complete the construction of our Dalian facility and commence its commercial operations could negatively affect our business operations.
We are currently constructing our Dalian facility and relocating most of the operating assets, including machinery and equipment, as well as the customers, employees, patents and technologies from BAK Tianjin to the Dalian facility. The construction is expected to be completed in January 2015 and commercial operation is expected to begin by the end of the first quarter of calendar year 2015, but we cannot give assurance that the construction will be completed as scheduled or, without cost overrun. Even if the construction is completed on a timely basis, we cannot give assurance that the commercial operation can begin as scheduled. In addition, we may not be able to attract a sufficient number of skilled workers to meet the needs of the new facility. If we experience delays in construction or commencement of commercial operations, increased costs or lack of skilled labor, or other unforeseen events occur, our business, financial condition and results of operations could be adversely impacted. Operating results could also be unfavorably impacted by start-up costs until production at the new facility reaches planned levels.
Our independent registered auditors have expressed substantial doubt about our ability to continue as a going concern
Our audited consolidated financial statements included in this report include an explanatory paragraph that indicates that they were prepared assuming that we would continue as a going concern. As discussed in Note 1 to the consolidated financial statements included with this report, we had net liabilities, a working capital deficiency, accumulated deficit from recurring net losses incurred for the current and prior years and short-term debt obligations as of September 30, 2014. These conditions raise substantial doubt about our ability to continue as a going concern. As disclosed under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Recent Development” and Note 1 to the consolidated financial statements, we are building a new manufacturing site in Dalian which will focus on production and sale of the new energy high power batteries for use in electric vehicles, light electric vehicles and other high power applications. We had advances from the Management Committee of Dalian Economic Zone of $24,437,131 to finance our removal of our production facilities to Dalian. We expect that the removal will be completed in January 2015 and formal production will commence by the end of March 2015. On October 17, 2014, we received another subsidy of $7.52 million from the Management Committee for costs of land use rights relating to the new manufacturing site in Dalian. We obtained a short term bank loan of $4.9 million from Bank of Dandong for the period from August 19, 2014 to August 18, 2015. We plan to renew our bank borrowing upon maturity and borrow additional funds from local banks to meet our daily cash demands. However, there can be no assurance that we will be successful in obtaining the financing. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
We rely mainly on BAK Tianjin, our former subsidiary, for most of our high power lithium batteries production prior to the commercial operations of our Dalian facility and our operations could be materially adversely affected if we fail to effectively manage our relationships with, or lose the services of, BAK Tianjin. If we cannot substitute suitable alternative suppliers for our customers’ orders prior to the commercial production of our Dalian facility, our operations would be materially adversely affected.
As we are currently constructing our Dalian facility, we have been actively working with the existing customers of BAK Tianjin to transfer of their orders to Dalian BAK Power. In addition, before the Dalian manufacturing facility commences its commercial operation, which is expected to be the end of the first quarter of calendar 2015, we expect to generate revenues by outsourcing our customers’ orders to BAK Tianjin and few other suppliers.
Although we are negotiating on the terms of the outsourcing arrangements with BAK Tianjin and other suppliers, there is no assurance that we will be able to enter into written contracts with BAK Tianjin and other suppliers. If our business relationship with BAK Tianjin and other suppliers changes negatively or their financial condition deteriorates, or their operating environment changes, our business may be harmed in many ways. BAK Tianjin and other suppliers may unilaterally terminate battery supply to us or increase the prices. As a result, we are not assured of an uninterrupted supply of high power lithium batteries of acceptable quality or at acceptable prices from BAK Tianjin and other suppliers. We may not be able to substitute suitable alternative contract manufacturers in a timely manner on commercially acceptable term or at all. We may be forced to default on the agreements with our customers. This may negatively impact our revenues and adversely affect our reputation and relationships with our customers, causing a material adverse effect on our financial condition, results of operations and prospects.
Our business depends on the growth in demand for electric vehicles, light electric vehicles, electric tools, energy storage, UPS, and other high-power electric devices.
As the demand for our products is directly related to the market demand for high-power electric devices, a fast growing high-power electric devices market will be critical to the success of our business. In anticipation of an expected increase in the demand for high-power electric devices such as electric vehicles, light electric vehicles, electric tools, energy storage and UPS in the next few years, we are in the process of building our Dalian manufacturing facilities. However, the markets we have targeted, primarily those in the PRC, may not achieve the level of growth we expect. If this market fails to achieve our expected level of growth, we will have excess production capacity and may not be able to generate enough revenue to maintain our profitability.
If we cannot continue to develop new products in a timely manner, and at favorable margins, we may not be able to compete effectively.
The battery industry has been notable for the pace of innovations in product life, product design and applied technology. We and our competitors have made, and continue to make, investments in research and development with the goal of further innovation. The successful development and introduction of new products and line extensions face the uncertainty of customer acceptance and reaction from competitors, as well as the possibility of cannibalization of sales of our existing products. In addition, our ability to create new products and line extensions and to sustain existing products is affected by whether we can:
develop and fund research and technological innovations;
receive and maintain necessary intellectual property protections;
obtain governmental approvals and registrations;
comply with governmental regulations; and
anticipate customer needs and preferences successfully.
The failure to develop and launch successful new products could hinder the growth of our business and any delay in the development or launch of a new product could also compromise our competitive position. If competitors introduce new or enhanced products that significantly outperform ours, or if they develop or apply manufacturing technology which permits them to manufacture at a significantly lower cost relative to ours, we may be unable to compete successfully in the market segments affected by these changes.
Our efforts to develop products for new commercial applications could fail.
Although we are involved with developing certain products for new commercial applications, we cannot provide assurance that acceptance of our products will occur due to the highly competitive nature of the business. There are many new product and technology entrants into the marketplace, and we must continually reassess the market segments in which our products can be successful and seek to engage customers in these segments that will adopt our products for use in their products. In addition, these companies must be successful with their products in their markets for us to gain increased business. Increased competition, failure to gain customer acceptance of products, the introduction of competitive technologies or failure of our customers in their markets could have a further adverse effect on our business.
Our future success depends on the success of manufacturers of the end applications that use our products.
As we expand to the battery markets for global electric vehicles, light electric vehicles, electric tools, energy storage, UPS and other high-power electric devices, our future success depends on whether end-application manufacturers are willing to use batteries that incorporate our products. To secure acceptance of our products, we must constantly develop and introduce more reliable and cost-effective battery cells with enhanced functionality to meet evolving industry standards. Our failure to gain acceptance of our products from these manufacturers could materially and adversely affect our future success.
Even if a manufacturer decides to use batteries that incorporate our products, the manufacturer may not be able to market and sell its products successfully. The manufacturer’s inability to market and sell its products successfully, whether from lack of market acceptance or otherwise, could materially and adversely affect our business and prospects because this manufacturer may not order new products from us. If we cannot achieve the expected level of sales, we will not be able to make sufficient profits to offset the expenditures we have incurred to expand our production capacity, nor will we be able to grow our business. Accordingly, our business, financial condition, results of operations and future success would be materially and adversely affected.
Our failure to keep up with rapid technological changes and evolving industry standards may cause our products to become obsolete and less marketable, resulting in loss of market share to our competitors.
The lithium-based battery market is characterized by changing technologies and evolving industry standards, which are difficult to predict. This, coupled with frequent introduction of new products and models, has shortened product life cycles and may render our products obsolete or unmarketable. Our ability to adapt to evolving industry standards and anticipate future standards will be a significant factor in maintaining and improving our competitive position and our prospects for growth. To achieve this goal, we have invested and plan to continue investing significant financial resources in our R&D infrastructure. R&D activities, however, are inherently uncertain, and we might encounter practical difficulties in commercializing our research results. Accordingly, our significant investment in our R&D infrastructure may not bear fruit. On the other hand, our competitors may improve their technologies or even achieve technological breakthroughs that would render our products obsolete or less marketable. Therefore, our failure to effectively keep up with rapid technological changes and evolving industry standards by introducing new and enhanced products may cause us to lose our market share and to suffer a decrease in our revenue.
A change in our product mix may cause our results of operations to differ substantially from the anticipated results in any particular period.
Our overall profitability may not meet expectations if our products, customers or geographic mix are substantially different than anticipated. Our profit margins vary among products, customers and geographic markets. Consequently, if our mix of any of these is substantially different from what is anticipated in any particular period, our profitability could be lower than anticipated.
We may be subject to declining average selling prices, which may harm our revenue and gross profits.
Consumer electronics such as electric vehicles, light electric vehicles, electric tools, energy storage, UPS are subject to declines in average selling prices due to rapidly evolving technologies, industry standards and consumer preferences. As a result, manufacturers of these electronic devices expect us as suppliers to cut our costs and lower the price of our products in order to mitigate the negative impact on their own margins. We have reduced the price of some of our electric bike batteries in the past in order to meet market demand and expect to continue to face market-driven downward pricing pressures in the future. Our revenue and profitability will suffer if we are unable to offset any declines in our average selling prices by developing new or enhanced products with higher selling prices or gross profit margins, increasing our sales volumes or reducing our costs on a timely basis.
We may face impairment charges if economic environments in which our businesses operate and key economic and business assumptions substantially change.
Assessment of the potential impairment of property, plant and equipment and other identifiable intangible assets is an integral part of our normal ongoing review of operations. Testing for potential impairment of long-lived assets is dependent on numerous assumptions and reflects our best estimates at a particular point in time, which may vary from testing date to testing date. The economic environments in which our businesses operate and key economic and business assumptions with respect to projected product selling prices and materials costs, market growth and inflation rates, can significantly affect the outcome of impairment tests. Estimates based on these assumptions may differ significantly from actual results. Changes in factors and assumptions used in assessing potential impairments can have a significant impact on both the existence and magnitude of impairments, as well as the time at which such impairments are recognized. Future changes in the economic environment and the economic outlook for the assets being evaluated could also result in impairment charges. Any significant asset impairments would adversely impact our financial results.
We experience fluctuations in quarterly and annual operating results.
Our quarterly and annual operating results have fluctuated in the past and likely will fluctuate in the future. The demand for our products is driven largely by the demand for the end-product applications that are powered by our products. Accordingly, the rechargeable battery industry is affected by market conditions that are often outside our control. Our results of operations may fluctuate significantly from period to period due to a number of factors, including seasonal variations in consumer demand for batteries and their end applications, capacity ramp up by competitors, industry-wide technological changes, the loss of a key customer and the postponement, rescheduling or cancellation of large orders by a key customer. As a result of these factors and other risks discussed in this section, period-to-period comparisons should not be relied upon to predict our future performance.
After our Dalian facilities start commercial operations, we may not be able to substantially increase our manufacturing output in order to maintain our cost competitiveness.
We believe that our ability to provide cost-effective products is one of the most significant factors that contributed to our past success and will be essential for our future growth. We believe this is one of our competitive advantages over our Japanese and Korean competitors. Once our Dalian facilities start commercial operations, we will need to increase our manufacturing output to a level that will enable us to substantially reduce the cost of our products on a per unit basis through economies of scale. However, our ability to substantially increase our manufacturing output is subject to significant constraints and uncertainties, including:
the need to raise significant additional funds to purchase and prepay raw materials or to build additional manufacturing facilities, which we may be unable to obtain on reasonable terms or at all;
delays and cost overruns as a result of a number of factors, many of which may be beyond our control, such as increases in raw material prices and problems with equipment vendors;
delays or denial of required approvals by relevant government authorities;
diversion of significant management attention and other resources; and
failure to execute our expansion plan effectively.
If we are unable to increase our manufacturing output because of any of the risks described above, we may be unable to maintain our competitive position or achieve the growth we expect. Moreover, even if we expand our manufacturing output, we may not be able to generate sufficient customer demand for our products to support our increased production output.
Maintaining our manufacturing operations will require significant capital expenditures, and our inability or failure to maintain our operations would have a material adverse impact on our market share and ability to generate revenue.
We had capital expenditures of approximately $13.3 million and $19.0 million in fiscal years 2013 and 2014, respectively. We may incur significant additional capital expenditures as a result of unanticipated expenses, regulatory changes and other events that impact our business. If we are unable or fail to adequately maintain our manufacturing capacity or quality control processes, we could lose customers and there could be a material adverse impact on our market share and our ability to generate revenue.
We may incur significant costs because of the warranties we supply with our products and services.
With respect to our battery products, we typically offer warranties against any defects due to product malfunction or workmanship for a period of six-to-twelve months from the date of purchase. We provide a reserve for these potential warranty expenses, which is based on an analysis of historical warranty issues. There is no assurance that future warranty claims will be consistent with past history, and in the event we experience a significant increase in warranty claims, there is no assurance that our reserves will be sufficient. This could have a material adverse effect on our business, financial condition and results of operations.
We do not have insurance coverage against damages or losses of our products. Defects in our products could result in a loss of customers and decrease in revenue, unexpected expenses and a loss of market share.
We have not purchased product liability insurance to provide against any claims against us based on our product quality. We expect that we will purchase product liability insurance after the Dalian facilities are put into commercial production. If we fail to purchase product liability insurance, defects in our products could result in a loss of customers and decrease in revenue, unexpected expenses and a loss of market share, and any of our products are found to have reliability, quality or compatibility problems, we will be required to accept returns, provide replacements, provide refunds, or pay damages. As the insurance policy imposes a ceiling for maximum coverage and high deductibles, we may not be able to obtain from the insurance policy a sufficient amount to compensate our customers for damages they suffered attributable to the quality of the products. Moreover, the insurance policy also excludes certain types of claims from its coverage, and if any of our customers’ claims against us falls into those exclusions, we would not receive any amount from the insurance policy at all. In either case, we may still be required to incur substantial amounts to indemnify our customers in respect of their product quality claims against us, which would materially and adversely affect the results of our operations and severely damage our reputation.
We may not be able to accurately plan our production based on our sales contracts, which may result in excess product inventory or product shortages.
Our sales contracts typically provide for a non-binding, three-month forecast on the quantity of products that our customers may purchase from us. We typically have only a 30-day lead time to manufacture products to meet our customers’ requirements once our customers place orders with us. To meet the short delivery deadline, we generally make significant decisions on our production level and timing, procurement, facility requirements, personnel needs and other resources requirements based on our estimate in light of this forecast, our past dealings with such customers, market conditions and other relevant factors. Our customers’ final purchase orders may not be consistent with our estimates. If the final purchase orders substantially differ from our estimates, we may have excess product inventory or product shortages. Excess product inventory could result in unprofitable sales or write-offs as our products are susceptible to obsolescence and price declines. Producing additional products to make up for any product shortages within a short time frame may be difficult, making us unable to fill out the purchase orders. In either case, our results of operation would fluctuate from period to period.
We historically depended on third parties to supply key raw materials and components to us. After our Dalian facilities start commercial operations, failure to obtain a sufficient supply of these raw materials and components in a timely fashion and at reasonable costs could significantly delay our production and shipments, which would cause us to breach our sales contracts with our customers.
We historically purchased from Chinese domestic suppliers certain key raw materials and components such as electrolytes, electrode materials and import separators, a key component of battery cells, from foreign countries. We purchased raw materials and components on the basis of purchase orders. In the absence of firm and long-term contracts, we may not be able to obtain a sufficient supply of these raw materials and components from our existing suppliers or alternates in a timely fashion or at a reasonable cost. After our Dalian facilities start commercial operations, if we fail to secure a sufficient supply of key raw materials and components in a timely fashion, it would result in a significant delay in our production and shipments, which may cause us to breach our sales contracts with our customers. Furthermore, failure to obtain sufficient supply of these raw materials and components at a reasonable cost could also harm our revenue and gross profit margins.
Fluctuations in prices and availability of raw materials, particularly lithium cobalt dioxide, could increase our costs or cause delays in shipments, which would adversely impact our business and results of operations.
Our operating results could be adversely affected by increases in the cost of raw materials, particularly lithium cobalt dioxide, the primary cost component of our battery products, or other product parts or components. Our average purchase price of lithium cobalt oxide (the most important lithium cobalt dioxide we used) was $29.1 per kilogram and $30.3 per kilogram during the years ended September 30, 2014 and 2013, respectively. The price of lithium cobalt dioxide is not stable as most output of cobalt is conducted in unstable or developing countries such as the Democratic Republic of the Congo, and we cannot predict the price trend. If the price increases, it will negatively impact our financial results in years ahead. We historically have not been able to fully offset the effects of higher costs of raw materials through price increases to customers or by way of productivity improvements.
A significant increase in the price of one or more raw materials, parts or components or the inability to successfully implement price increases / surcharges to mitigate such cost increases could have a material adverse effect on our results of operations.
We mainly manufacture and market lithium-based battery cells. If a viable substitute product or chemistry emerges and gains market acceptance, our business, financial condition and results of operations will be materially and adversely affected.
We mainly manufacture (currently through BAK Tianjin) and market lithium-based battery cells. As we believe that the market for lithium-based batteries has good growth potential, we have focused our R&D activities on exploring new chemistries and formulas to enhance our product quality and features while reducing cost. Some of our competitors are conducting R&D on alternative battery technologies, such as fuel cells. If any viable substitute product emerges and gains market acceptance because it has more enhanced features, more power, more attractive pricing, or better reliability, the market demand for our products may be reduced, and accordingly our business, financial condition and results of operations would be materially and adversely affected.
Manufacturing or use of our products may cause accidents, which could result in significant production interruption, delay or claims for substantial damages.
Due to the high energy density inherent in lithium-based batteries, our batteries can pose certain safety risks, including the risk of fire. Although we incorporate safety procedures in the research, development, manufacture and transportation of batteries that are designed to minimize safety risks, the manufacture or use of our products may still cause accidents. Any accident, whether occurring at the manufacturing facilities or from the use of our products, may result in significant production interruption, delays or claims for substantial damages caused by personal injuries or property damages.
We face intense competition from other battery manufacturers, many of which have significantly greater resources.
The market for batteries used in electric vehicles and light electric vehicles is intensely competitive and is characterized by frequent technological changes and evolving industry standards. We expect competition to become more intense. Increased competition may result in declines in average selling prices, causing a decrease in gross profit margins. We have faced and will continue to face competition from manufacturers of traditional rechargeable batteries, such as lead-acid batteries other manufacturers of lithium-ion batteries, as well as from companies engaged in the development of batteries incorporating new technologies. Other manufacturers of high-power lithium batteries currently include Panasonic Corporation, Samsung Electronics Co., Ltd., BYD Co. Ltd., Tianjin Lishen Battery Joint Stock Co., Ltd., Amperex Technology Limited and Chilwee Power Holdings Limited.
Many of these existing competitors have greater financial, personnel, technical, manufacturing, marketing, sales and other resources than we do. As a result, these competitors may be in a stronger position to respond quickly to market opportunities, new or emerging technologies and evolving industry standards. 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 lines. Other companies undertaking R&D activities of solid-polymer lithium-ion batteries have developed prototypes and are constructing commercial scale production facilities. It is possible that our competitors will be able to introduce new products with more desirable features than ours and their new products will gain market acceptance. If our competitors successfully do so, we may not be able to maintain our competitive position and our future success would be materially and adversely affected.
We are dependent on a limited number of customers for a significant portion of our revenues and this dependence is likely to continue.
We have been dependent on a limited number of customers for a significant portion of our revenue. Our top five customers accounted for approximately 41.6% and 40.8% of our revenues in the years ended September 30, 2013 and 2014, 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. We expect that a limited number of customers will continue to contribute a significant portion of our sales in the near future. Our ability to maintain close relationships with these top customers is essential to the growth and profitability of our business. If we fail to sell our products to one or more of these top customers in any particular period, or if a large customer purchases fewer of our products, defers orders or fails to place additional orders with us, or if we fail to develop additional major customers, our revenue could decline, and our results of operations could be adversely affected.
We do not have long-term purchase commitments from our customers, which may result in significant uncertainties and volatility with respect to our revenue from period to period.
We do not have long-term purchase commitments from our customers and the term of our sales contracts with our customers is typically one year. Furthermore, these contracts leave certain major terms such as price and quantity of products open to be determined in each purchase order. These contracts also allow parties to re-adjust the contract price for substantial changes in market conditions. As a result, if our customers hold stronger bargaining power than us or the market conditions are in their favor, we may not be able to enjoy the price downside protection or upside gain. Furthermore, our customers may decide not to continue placing purchase orders with us in the future at the same level as in prior periods. As a result, our results of operations may vary from period to period and may fluctuate significantly in the future.
We extend relatively long payment terms to some large customers.
As is customary in the industry in the PRC, we extend relatively long payment terms and provide generous return policies to some large customers. As a result of the size of many of our orders, these extended terms may 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. Our customers’ failure to pay may force us to defer or delay further product orders, which may adversely affect our cash flows, sales or income in subsequent periods.
We face risks associated with the marketing, distribution and sale of our products internationally, and if we are unable to effectively manage these risks, they could impair our ability to expand our business abroad.
For the years ended September 30, 2013 and 2014, we derived 22.6% and 13.4% respectively of our sales from outside the PRC mainland. The marketing, international distribution and sale of our products expose us to a number of risks, including:
fluctuations in currency exchange rates;
difficulty in engaging and retaining distributors that are knowledgeable about, and can function effectively in, overseas markets;
increased costs associated with maintaining marketing efforts in various countries;
difficulty and cost relating to compliance with the different commercial and legal requirements of the overseas markets in which we offer our products;
inability to obtain, maintain or enforce intellectual property rights; and
trade barriers such as export requirements, tariffs, taxes and other restrictions and expenses, which could increase the prices of our products and make us less competitive in some countries.
Our business depends substantially on the continuing efforts of our senior executives and other key personnel, and our business may be severely disrupted if we lost their services.
Our future success heavily depends on the continued service of our senior executives and other key employees. In particular, we rely on the expertise and experience of our Chairman, Chief Executive Officer, President Mr. Xiangqian Li, our Interim Chief Financial Officer, Mr. Wenwu Wang, and our Interim Chief Technology Officer, Dr. Jian Lin. If one or more of our other senior executives are unable or unwilling to continue to work for us in their present positions, we may encounter similar problems, but on a compounded basis. Moreover, if any of our current or former senior executives joins a competitor or forms a competing company, we may lose customers, suppliers, know-how and key personnel. Each of our executive officers has entered into an employment agreement with us, which contains non-competition and confidentiality clauses. However, if any dispute arises between our current or former executive officers and the Company, it is hard to predict the extent to which any of these agreements could be enforced in China, where these executive officers reside, in light of the uncertainties with China’s legal system.
We have experienced significant management changes which could increase our control risks and have a material adverse effect on our ability to do business and our results of operations.
Since February 2009, we have had a number of changes in our senior management, including multiple changes in our Chief Financial Officer. The magnitude of these past and expected changes and the short time interval in which they have occurred or are expected to occur, particularly during the ongoing economic and financial crisis, add to the risks of control failures, including a failure in the effective operation of our internal control over financial reporting or our disclosure controls and procedures. Control failures could result in material adverse effects on our financial condition and results of operations. It may take time for the new management team to become sufficiently familiar with our business and each other to effectively develop and implement our business strategies. This turnover of key management positions could further harm our financial performance and results of operations. Management attention may be diverted from regular business concerns by reorganizations.
The success of our business depends on our ability to attract, train and retain highly skilled employees and key personnel.
Because of the highly specialized, technical nature of our business, we must attract, train and retain a sizable workforce comprising highly skilled employees and other key personnel. Since our industry is characterized by high demand and intense competition for talent, we may have to pay higher salaries and wages and provide greater benefits in order to attract and retain highly skilled employees or other key personnel that we will need to achieve our strategic objectives. As we are still a relatively young company and our business has grown rapidly, our ability to train and integrate new employees into our operations may not meet the requirements of our growing business. Our failure to attract, train or retain highly skilled employees and other key personnel in numbers that are sufficient to satisfy our needs would materially and adversely affect our business.
We may be exposed to infringement or misappropriation claims by third parties, which, if determined adversely to us, could cause our loss of significant rights and inability to continue providing our existing product offerings.
Our success also depends largely on our ability to use and develop our technology and know-how without infringing the intellectual property rights of third parties. The validity and scope of claims relating to lithium-ion battery technology patents involve complex scientific, legal and factual questions and analysis and, therefore, may be highly expensive and time-consuming. If there is a successful claim of infringement against us, we may be required to pay substantial damages to the party claiming infringement, develop non-infringing technologies or enter into royalty or license agreements that may not be available on acceptable terms, if at all. Our failure to develop non-infringing technologies or license the proprietary rights on a timely basis would harm our business. Protracted litigation could result in our customers, or potential customers, deferring or limiting their purchase or use of our products until resolution of such litigation. Parties making the infringement claim may also obtain an injunction that can prevent us from selling our products or using technology that contains the allegedly infringing contents. Any intellectual property litigation could have a material adverse effect on our business, results of operation and financial condition.
We can make no assurance that we will continue to get authorization from Shenzhen BAK to use its intellectual property rights when the current intellectual property rights use agreement with Shenzhen BAK expires, nor can we make assurance that we can get the authorization at a favorable price, which could harm our business and competitive position.
We lack intellectual property rights for the business we operate. As of September 30, 2014, Dalian BAK Power only owns 17 patents including 15 utility model patents and 2 patents for invention in the PRC. On August 25, 2014, we entered into an intellectual property rights use agreement with Shenzhen BAK under which we are authorized to use Shenzhen BAK’s registered logo, trademarks and patents for a period of 5 years for free from June 30, 2014. As of June 30, 2014, Shenzhen BAK owned 462 registered patents in PRC and 60 registered patents in other countries, 80 registered trademarks in PRC and 49 registered trademarks in the United States, European Union, Korea, Russia, Taiwan, Canada, India and Hong Kong that cover various categories of goods and services. We cannot provide assurance that we will continue to get authorization from Shenzhen BAK to use its intellectual property rights when the current intellectual property rights use agreement with Shenzhen BAK expires, nor can we make assurance that we can get the authorization at a favorable price, which could harm our business and competitive position.
We do not hold the property ownership rights for facilities located in the PRC. Our manufacturing activities could be adversely affected if we lose the facilities that we do not have property ownership rights.
We have obtained land use rights for our Dalian manufacture facilities, but have not yet obtained the property ownership of the Dalian manufacture facilities including its plants, office building, warehouse, and related supporting facilities. We expect that we will obtain the property ownership rights after the construction of these facilities is expected to be completed by the end of January 2015. If we lose our Dalian facility due to the lack of the property ownership, our manufacturing activities will be adversely impacted.
Compliance with environmental regulations can be expensive, and our failure to comply with these regulations may result in adverse publicity and a material adverse effect on our business.
As a manufacturer, we are subject to various PRC environmental laws and regulations on air emission, waste water discharge, solid waste and noise. Although we believe that our operations are in substantial compliance with current environmental laws and regulations, we may not be able to comply with these regulations at all times as the PRC environmental legal regime is evolving and becoming more stringent. Therefore, if the PRC government imposes more stringent regulations in the future, we will have to incur additional substantial costs and expenses in order to comply with new regulations, which may negatively affect our results of operations. If we fail to comply with any of the present or future environmental regulations in material aspects, we may suffer from negative publicity and may be required to pay substantial fines, suspend or even cease operations. Failure to comply with PRC environmental laws and regulations may materially and adversely affect our business, financial condition and results of operations.
To the extent we ship our products outside of the PRC, or to the extent our products are used in products sold outside of the PRC, they may be affected by the following: The transportation of non-rechargeable and rechargeable lithium batteries is regulated by the International Civil Aviation Organization, or ICAO, and corresponding International Air Transport Association, or IATA, Pipeline & Hazardous Materials Safety Administration, or PHMSA, Dangerous Goods Regulations and the International Maritime Dangerous Goods Code, or IMDG, and in the PRC by General Administration of Civil Aviation of China and Maritime Safety Administration of People’s Republic of China. These regulations are based on the United Nations, or UN, Recommendations on the Transport of Dangerous Goods Model Regulations and the UN Manual of Tests and Criteria. We currently ship our products pursuant to ICAO, IATA and PHMSA hazardous goods regulations. New regulations that pertain to all lithium battery manufacturers went into effect in 2003, 2004, and 2009, and 2010. The regulations require companies to meet certain testing, packaging, labeling and shipping specifications for safety reasons. We comply with all current PRC and international regulations for the shipment of our products, and will comply with any new regulations that are imposed. We have established our own testing facilities to ensure that we comply with these regulations. If we were unable to comply with the new regulations, however, or if regulations are introduced that limit our ability to transport our products to customers in a cost-effective manner, this could have a material adverse effect on our business, financial condition and results of operations.
We do not have insurance coverage against damages or losses of our Dalian facilities.
We currently do not have insurance for our buildings located at our Dalian facilities, which are under construction. We expect we will purchase related insurance for these buildings after the construction is completed. If we were to suffer any losses or damages to any of the facilities before the purchase of insurance, our business, financial condition and results of operations would be materially and adversely affected.
We have identified material weaknesses in our internal control over financial reporting. If we fail to remediate the material weaknesses or maintain an effective system of internal control over financial reporting, we may be unable to accurately report our financial results or prevent fraud, and investor confidence and the market price of our shares may be adversely affected.
To implement Section 404 of the Sarbanes-Oxley Act of 2002, or SOX 404, the SEC adopted rules requiring public companies to include a report of management on the company’s internal control over financial reporting in their annual reports on Form 10-K. Under current law, we are subject to the requirement that we maintain internal controls and that management perform periodic evaluation of the effectiveness of the internal controls, assuming our filing status remains as a smaller reporting company. A report of our management is included under Item 9A of this Annual Report on Form 10-K. Our management has identified the following material weakness in our internal control over financial reporting: we did not have appropriate policies and procedures in place to evaluate the proper accounting and disclosures of key documents and agreements, and there was insufficient accounting personnel with an appropriate level of technical accounting knowledge and experience in the application of accounting principles generally accepted in the United States of America, or U.S. GAAP, commensurate with our financial reporting requirements. A "material weakness" is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis. We have taken measures and plan to continue to take measures to remedy this material weakness. However, the implementation of these measures may not fully address the material weakness in our internal control over financial reporting. Our failure to address any control deficiency could result in inaccuracies in our financial statements and could also impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis. Moreover, effective internal control over financial reporting is important to prevent fraud. As a result, our business, financial condition, results of operations and prospects, as well as the trading price of our shares, may be materially and adversely affected.
If we become directly subject to the recent scrutiny, criticism and negative publicity involving U.S.-listed Chinese companies, we may have to expend significant resources to investigate and resolve the matter which could harm our business operations, stock price and reputation and could result in a loss of your investment in our stock, especially if such matter cannot be addressed and resolved favorably.
Recently, U.S. public companies that have substantially all of their operations in China, particularly companies like us which have completed so-called reverse merger transactions, have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators and regulatory agencies, such as the SEC. Much of the scrutiny, criticism and negative publicity has centered around financial and accounting irregularities and mistakes, a lack of effective internal controls over financial accounting, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result of the scrutiny, criticism and negative publicity, the publicly traded stock of many U.S. listed Chinese companies has sharply decreased in value and, in some cases, has become virtually worthless. Many of these companies are now subject to shareholder lawsuits and SEC enforcement actions, and are conducting internal and external investigations into the allegations. It is not clear what effect this sector-wide scrutiny, criticism and negative publicity will have on our Company, our business and our stock price. If we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources to investigate such allegations and/or defend our company. This situation will be costly and time consuming and distract our management from growing our company. If such allegations are not proven to be groundless, our company and business operations will be severely and your investment in our stock could be rendered worthless.
The disclosures in our reports and other filings with the SEC and our other public pronouncements are not subject to the scrutiny of any regulatory bodies in the PRC. Accordingly, our public disclosure should be reviewed in light of the fact that no governmental agency that is located in China where substantially all of our operations and business are located have conducted any due diligence on our operations or reviewed or cleared any of our disclosures.
We are regulated by the SEC and our reports and other filings with the SEC are subject to SEC review in accordance with the rules and regulations promulgated by the SEC under the Securities Act and the Exchange Act. Unlike public reporting companies whose operations are located primarily in the United States, however, substantially all of our operations are located in China. Since substantially all of our operations and business take place in China, it may be more difficult for the Staff of the SEC to overcome the geographic and cultural obstacles that are present when reviewing our disclosures. These same obstacles are not present for similar companies whose operations or business take place entirely or primarily in the United States. Furthermore, our SEC reports and other disclosures and public pronouncements are not subject to the review or scrutiny of any PRC regulatory authority. For example, the disclosure in our SEC reports and other filings are not subject to the review of China Securities Regulatory Commission, a PRC regulator that is tasked with oversight of the capital markets in China. Accordingly, you should review our SEC reports, filings and our other public pronouncements with the understanding that no local regulator has done any due diligence on our company and with the understanding that none of our SEC reports, other filings or any of our other public pronouncements has been reviewed or otherwise been scrutinized by any local regulator.
Our auditors, based in Hong Kong, China, like other independent registered public accounting firms operating in China and to the extent their audit clients have operations in China, is not permitted to be subject to full inspection by the Public Company Accounting Oversight Board and, as such, you may be deprived of the benefits of such inspection.
Our independent registered public accounting firms that issued the audit reports included in our annual reports filed with the SEC, as auditors of companies that are traded publicly in the United States and a firm registered with the US Public Company Accounting Oversight Board (United States), or PCAOB, are required by the laws of the United States to undergo regular inspections by the PCAOB to assess their compliance with the laws of the United States and professional standards.
However, our operations are solely located in the PRC, a jurisdiction where PCAOB is currently unable to conduct inspections without the approval of the PRC authorities. Our independent registered public accounting firm, like others operating in China (and Hong Kong, to the extent their audit clients have operations in China), is currently not subject to inspection conducted by the PCAOB. Inspections of other firms that the PCAOB has conducted outside China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. The inability of the PCAOB to conduct full inspections of auditors operating in China makes it more difficult to evaluate our auditors’ audit procedures or quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.
We face risks related to general domestic and global economic conditions and to the recent credit crisis.
The current uncertainty arising out of domestic and global economic conditions, including the recent disruption in credit markets, poses a risk to the economies in which we operate that has impacted demand for our products and services, and may impact our ability to manage normal relationships with our customers, suppliers and creditors. If the current situation deteriorates significantly, our business could be materially negatively impacted, including such areas as reduced demand for our products and services from a slow-down in the general economy, or supplier or customer disruptions resulting from tighter credit markets. In addition, terrorist activities may cause unpredictable or unfavorable economic conditions and could have a material adverse impact on the Company’s operating results and financial condition.
RISKS RELATED TO DOING BUSINESS IN CHINA
Changes in the economic and political policies of the PRC government could have a material and adverse effect on our business and operations.
We conduct substantially all our business operations in China. Accordingly, our results of operations, financial condition and prospects are significantly dependent on economic and political developments in China. China’s economy differs from the economies of developed countries in many aspects, including the level of development, growth rate and degree of government control over foreign exchange and allocation of resources. While China’s economy has experienced significant growth in the past 30 years, the growth has been uneven across different regions and periods and among various economic sectors in China. We cannot assure you that China’s economy will continue to grow, or that if there is growth, such growth will be steady and uniform, or that if there is a slowdown, such slowdown will not have a negative effect on its business and results of operations.
The PRC government exercises significant control over China’s economic growth through the allocation of resources, control over payment of foreign currency-denominated obligations, implementation of monetary policy, and preferential treatment of particular industries or companies. Certain measures adopted by the PRC government may restrict loans to certain industries, such as changes in the statutory deposit reserve ratio and lending guidelines for commercial banks by the People’s Bank of China, or PBOC. These current and future government actions could materially affect our liquidity, access to capital, and ability to operate our business.
The global financial markets experienced significant disruptions in 2008 and the United States, Europe and other economies went into recession. Since 2012, growth of the Chinese economy has slowed down. The PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures may benefit the overall PRC economy but may also have a negative effect on us. Our financial condition and results of operation could be materially and adversely affected by government control over capital investments or changes in tax regulations that are applicable to us. In addition, any stimulus measures designed to boost the Chinese economy, may contribute to higher inflation, which could adversely affect our results of operations and financial condition.
Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.
We conduct substantially all of our business through our operating subsidiaries in China. Our operating subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises, or FIEs. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference, but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties for you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. Moreover, most of our executive officers and directors are residents of China and not of the United States, and substantially all the assets of these persons are located outside the United States. As a result, it could be difficult for investors to affect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese operations and subsidiaries.
The PRC government exerts substantial influence over the manner in which we must conduct our business activities.
The PRC government 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 harmed by changes in its 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 material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which we operate 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, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.
We rely on dividends and other distributions on equity paid by our subsidiaries for our cash needs.
We are a holding company, and we conduct all of our operations through our PRC subsidiaries. We rely on dividends and other distributions on equity paid by our PRC subsidiaries for our cash needs, including the funds necessary to pay dividends and other cash distributions to our stockholders, to service any debt we may incur and to pay our operating expenses. Current regulations in the PRC permit payment of dividends only out of accumulated profits as determined in accordance with PRC accounting standards and regulations. According to the articles of association of our PRC subsidiaries, each of our PRC subsidiaries is required to set aside at least 10% of its after-tax profit based on the PRC accounting standards and regulations each year to its statutory general reserve, until the balance in the reserve reaches 50% of the registered capital of the company. Funds in the reserve are not distributable to us in forms of cash dividends, loans or advances. In addition, if our PRC subsidiaries incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other distributions to us, which in turn will adversely affect our available cash. Any limitations on the ability of our PRC subsidiaries to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.
Restrictions on currency exchange may limit our ability to receive and use our sales revenue effectively.
The majority of our sales will be settled in RMB and U.S. dollars, and any future restrictions on currency exchanges may limit our ability to use revenue generated in RMB to fund any future business activities outside China or to make dividend or other payments in U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the RMB 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 in China authorized to conduct foreign exchange business. In addition, conversion of RMB for capital account items, including direct investment and loans, is subject to governmental approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the RMB in the future.
In addition, the Notice of the General Affairs Department of the State Administration of Foreign Exchange on the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises, issued by the PRC State Administration of Foreign Exchange (“SAFE”), and effective as of August 29, 2008 (“Circular 142”), regulates the conversion by foreign-invested enterprises of foreign currency into RMB by restricting how the converted RMB may be used. Circular 142 requires that RMB converted from the foreign currency-dominated capital of a foreign-invested enterprise may only be used for purposes within the business scope approved by the relevant government authority and may not be used to make equity investments in PRC, unless specifically provided otherwise. SAFE further strengthened its oversight over the flow and use of RMB funds converted from the foreign currency-dominated capital of a foreign-invested enterprise. The use of such RMB may not be changed without approval from SAFE, and may not be used to repay RMB loans if the proceeds of such loans have not yet been used. Any violation of Circular 142 may result in severe penalties, including substantial fines.
Fluctuations in exchange rates could adversely affect our business and the value of our securities.
The value of our securities will be indirectly affected by the foreign exchange rate between the U.S. dollar and RMB and between those currencies and other currencies in which our sales may be denominated. Appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars, as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
Since July 2005, the RMB has no longer been pegged to the U.S. dollar. However, the PBOC regularly intervenes in the foreign exchange market to limit fluctuations in RMB exchange rates and achieve policy goals. Following the removal of the U.S. dollar peg, the RMB appreciated more than 20% against the U.S. dollar over the following three years. From July 2008 to June 2010, the RMB traded within a narrow range against the U.S. dollar. Since June 2010 the RMB has further appreciated against the U.S. dollar, from approximately RMB6.83 per U.S. dollar as of June 1, 2010 to approximately RMB6.14 per U.S. dollar as of September 30, 2014. It is difficult to predict how RMB exchange rates may change going forward.
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies. As a result, fluctuations in exchange rates may have a material adverse effect on your investment.
Failure to comply with PRC regulations relating to the investment in offshore special purpose companies by PRC residents may subject our PRC resident stockholders to personal liability, limit our ability to acquire PRC companies or to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us or otherwise materially adversely affect us.
On July 14, 2014, SAFE issued the Circular on Relevant Issues Relating to Domestic Residents’ Investment and Financing and Roundtrip Investment through Special Purpose Vehicles (“Circular 37”), which replaced the Circular 75, promulgated by SAFE on October 21, 2005. Circular 37 requires PRC residents to register with local branches of SAFE in connection with their direct establishment or indirect control of an offshore entity, for the purpose of overseas investment and financing, with such PRC residents’ legally owned assets or equity interests in domestic enterprises or offshore assets or interests, referred to in Circular 37 as a “special purpose vehicle.”
We have notified substantial beneficial owners of our company who we know are PRC residents to comply with the registration obligation. However, we may not be aware of the identities of all our beneficial owners who are PRC residents. In addition, we do not have control over our beneficial owners and cannot assure you that all of our PRC resident beneficial owners will comply with Circular 37. The failure of our beneficial owners who are PRC residents to register or amend their SAFE registrations in a timely manner pursuant to Circular 37 or the failure of future beneficial owners of our company who are PRC residents to comply with the registration procedures set forth in Circular 37 may subject such beneficial owners or our PRC subsidiaries to fines and legal sanctions. Failure to register or amend the registration may also limit our ability to contribute additional capital to our PRC subsidiaries or receive dividends or other distributions from our PRC subsidiaries or other proceeds from disposal of our PRC subsidiaries, or we may be penalized by SAFE. These risks may have a material adverse effect on our business, financial condition and results of operations.
The M&A Rule establishes more complex procedures for some acquisitions of Chinese companies by foreign investors, which could make it more difficult for us to pursue growth through acquisitions in China.
On August 8, 2006, six PRC regulatory agencies, including the China Securities Regulatory Commission, promulgated the Provisions Regarding Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rule, which became effective on September 8, 2006. The M&A Rule establishes additional procedures and requirements that could make some acquisitions of Chinese companies by foreign investors more time-consuming and complex, including requirements in some instances that the PRC Ministry of Commerce be notified in advance of any change-of-control transaction and in some situations, require approval of the PRC Ministry of Commerce when a foreign investor takes control of a Chinese domestic enterprise. The regulations prohibit a transaction at an acquisition price obviously lower than the appraised value of the PRC business or assets and in certain transaction structures, require that consideration must be paid within defined periods, generally not in excess of a year. The regulation also limits our ability to negotiate various terms of the acquisition, including aspects of the initial consideration, contingent consideration, holdback provisions, indemnification provisions and provisions relating to the assumption and allocation of assets and liabilities. Transaction structures involving trusts, nominees and similar entities are prohibited. Government approvals will have expiration dates by which a transaction must be completed and reported to the government agencies. In the future, we may grow our business in part by acquiring complementary businesses, although we do not have any plans to do so at this time. The M&A Rule also requires PRC Ministry of Commerce anti-trust review of any change-of-control transactions involving certain types of foreign acquirers. On February 3, 2011, the Circular on Establishing the Security Review System for Merger and Acquisition of Domestic Enterprises by Foreign Investors was promulgated by the General Office of the State Council, which went into effect on March 4, 2011. On August 25, 2011, the Ministry of Commerce issued the corresponding implementation rules. According to these rules, a foreign investor’s acquisitions of Chinese companies in the fields of military, important agricultural products, energy and resources, infrastructure, transport service, key technology and major equipment manufacturing, and other restricted fields requires security review by a ministerial panel established and governed under the direction of the State Council and led by the National Development and Reform Commission and Ministry of Commerce. Complying with the requirements of the M&A Rule to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval from the PRC Ministry of Commerce, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.
Investors 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.
All of our current operations are conducted in China. Moreover, most 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.
Under the Enterprise Income Tax Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.
Under China’s Enterprise Income Tax Law, or the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. The implementing rules of the EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.
The State Administration of Taxation has issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of de facto Management Bodies, or the Notice, further interpreting the application of the EIT Law and its implementation non-Chinese enterprise or group controlled offshore entities. Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “non-domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) its substantial assets and properties, accounting books, corporate chops, board and shareholder minutes are kept in China; and (iv) at least half of its directors with voting rights or senior management often resident in China. A resident enterprise would be subject to an enterprise income tax rate of 25% on its worldwide income and must pay a withholding tax at a rate of 10% when paying dividends to its non-PRC shareholders. However, it remains unclear as to whether the Notice is applicable to an offshore enterprise incorporated by a Chinese natural person. Nor are detailed measures on imposition of tax from non-domestically incorporated resident enterprises are available. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.
If the PRC tax authorities determine that China BAK Battery, Inc. is a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on offering proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the EIT Law and its implementing rules dividends paid to us from our PRC subsidiaries would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC stockholders and with respect to gains derived by our non-PRC stockholders from transferring our shares. We are actively monitoring the possibility of “resident enterprise” treatment for the 2013 tax year and are evaluating appropriate organizational changes to avoid this treatment, to the extent possible.
In addition, under the EIT Law, dividends payable by a FIE to any of its foreign non-resident enterprise investors shall be subject to a 10% withholding tax, unless such foreign non-resident enterprise investor’s jurisdiction of incorporation has signed a tax treaty or arrangement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income with China that provides for a reduced rate of withholding tax on dividends. Since the PRC and Hong Kong have signed the above-mentioned tax arrangement for the avoidance of double taxation, and Shenzhen BAK, BAK Battery and BAK Tianjin are wholly owned by BAK International, the dividends payable by each of Shenzhen BAK, BAK Battery and BAK Tianjin to its foreign non-resident enterprise investors are expected to be subject to a 5% withholding tax pursuant to the China-Hong Kong double tax arrangement.
We face uncertainty from the Circular on Strengthening the Administration of Enterprise Income Tax on Non-resident Enterprises' Share Transfer released in December 2009 by China's State Administration of Taxation (SAT), effective as of January 1, 2008.
Pursuant to the Circular on Strengthening the Administration of Enterprise Income Tax on Non-resident Enterprises' Share Transfer, or Circular 698, released in December 2009 by China's State Administration of Taxation, or SAT, effective as of January 1, 2008, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company, and the latter is located in a country (jurisdiction) where the effective tax burden is less than 12.5% or where the offshore income of its residents is not taxable, the foreign investor shall provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers.
Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through the abuse of form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided, the tax authority shall have the power to re-assess the nature of the equity transfer in accordance with the “substance-over-form” principle and deny the existence of the offshore holding company that is used for tax planning purposes.
“Income derived from equity transfers” as mentioned in Circular 698 refers to income derived by non-resident enterprises from direct or indirect transfers of equity interests in China resident enterprises, excluding shares in Chinese resident enterprises that are bought and sold openly on a stock exchange.
While the term “indirectly transfer” is not defined, we understand that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. The relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax in every country (jurisdiction) and to what extent and the process of the disclosure to the tax authority in charge of that Chinese resident enterprise. Meanwhile, there are not any formal declarations with regard to how to decide “abuse of form of organization” and “reasonable commercial purpose,” which can be utilized to help comply with Circular 698.
We may be exposed to liabilities under the Foreign Corrupt Practices Act and Chinese anti-corruption laws, and any determination that we violated these laws could have a material adverse effect on our business.
We are subject to the Foreign Corrupt Practice Act (“FCPA”), and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute, for the purpose of obtaining or retaining business. We have operations, have agreements with third parties, and make most of our sales in China. The PRC also strictly prohibits bribery of government officials. Our activities in China create the risk of unauthorized payments or offers of payments by the employees, consultants, sales agents, or distributors of our subsidiaries, even though they may not always be subject to our control. It is our policy to implement safeguards to discourage these practices by our employees. However, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants, sales agents, or distributors of our subsidiaries may engage in conduct for which we might be held responsible. Violations of the FCPA or Chinese anti-corruption laws may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. In addition, the U.S. government may seek to hold our subsidiaries liable for successor liability FCPA violations committed by companies in which we invest or that we acquire.
The implementation of the new PRC employment contract law and increases in the labor costs in China may hurt our business and profitability.
China adopted a new Labor Contract Law, effective on January 1, 2008, and issued its implementation rules, effective on September 18, 2008. The Labor Contract Law and related rules and regulations impose more stringent requirements on employers with regard to, among others, minimum wages, severance payment and non-fixed-term employment contracts, time limits for probation periods, as well as the duration and the times that an employee can be placed on a fixed-term employment contract. Due to the limited period of effectiveness of the Labor Contract Law and its implementation rules and regulations, and the lack of clarity with respect to their implementation and potential penalties and fines, it is uncertain how they will impact our current employment policies and practices. In particular, compliance with the Labor Contract Law and its implementation rules and regulations may increase our operating expenses. In the event that we decide to terminate some of our employees or otherwise change our employment or labor practices, the Labor Contract Law and its implementation rules and regulations may also limit our ability to effect those changes in a manner that we believe to be cost-effective or desirable, and could result in a material decrease in our profitability.
Proceedings instituted by the SEC against five PRC-based accounting firms could result in adverse impact on our business and price of our stock.
In December 2012, the SEC instituted proceedings under Rule 102(e)(1)(iii) of the SEC’s Rules of Practice against five PRC-based accounting firms alleging that these firms had violated U.S. securities laws and the SEC’s rules and regulations thereunder by failing to provide to the SEC the firms’ work papers related to their audits of certain PRC-based companies that are publicly traded in the United States. On January 22, 2014, an initial administrative law discuss was issued, sanctioning four of these accounting firms and suspending them from practicing before the SEC for a period of six months. The sanction will not take effect until there is an order of effectiveness issued by the SEC. The accounting firms involved have appealed and the sanction will not become effective until after a full appeal process is concluded and a final decision is issued by the SEC.
While these issues raised by the proceedings are not specific to our auditor or to us, they potentially affect equally all PCAOB-registered audit firms based in China and all businesses based in China (or with substantial operations in China) with securities listed in the United States.
Depending upon the final outcome, public companies in the United States with major PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the PRC, which may result in SEC’s revocation of the registration of their shares under the Exchange Act. Such a determinate would cause the immediate delisting of our Common Stock from the NASDAQ Capital Market, and the effective termination of the trading market for our securities in the United States, which would likely have a significant adverse effect on the value of our securities. Moreover, although our independent registered public accounting firm was not named as a defendant in the above SEC administrative proceedings, any negative news about the proceedings against these audit firms may erode investor confidence in China-based, US public companies, including us, and the market price of our shares may be adversely affected.
RISKS RELATED TO OUR COMMON STOCK
Numerous factors, many of which are beyond our control, may cause the market price of our common stock to fluctuate significantly.
There are numerous factors, many of which are beyond our control, may cause the market price of our common stock to fluctuate significantly. These factors include:
our earnings releases, actual or anticipated changes in our earnings, fluctuations in our operating results or our failure to meet the expectations of financial market analysts and investors;
changes in financial estimates by us or by any securities analysts who might cover our shares;
speculation about our business in the press or the investment community;
significant developments relating to our relationships with our customers or suppliers;
stock market price and volume fluctuations of other publicly traded companies and, in particular, those that are in the our industries;
customer demand for our products;
investor perceptions of the our industry in general and our company in particular;
the operating and stock performance of comparable companies;
general economic conditions and trends;
major catastrophic events;
announcements by us or our competitors of new products, significant acquisitions, strategic partnerships or divestitures;
changes in accounting standards, policies, guidance, interpretation or principles;
loss of external funding sources;
sales of our shares, including sales by our directors, officers or significant shareholders; and
additions or departures of key personnel.
Securities class action litigation is often instituted against companies following periods of volatility in their share price. This type of litigation could result in substantial costs to us and divert our management’s attention and resources. Moreover, securities markets may from time to time experience significant price and volume fluctuations for reasons unrelated to operating performance of particular companies. For example, in July 2008, the securities markets in the United States, China and other jurisdictions experienced the largest decline in share prices since September 2001. These market fluctuations may adversely affect the price of our shares and other interests in our company at a time when you want to sell your interest in us.
If we fail to comply with the continued listing requirements of NASDAQ, we would face possible delisting, which would result in a limited public market for our shares and make obtaining future debt or equity financing more difficult for us.
Our common stock is traded and listed on the NASDAQ Global Market under the symbol “CBAK.” The common stock may be delisted if we fail to maintain certain NASDAQ listing requirements. On May 25, 2012, we received a letter from NASDAQ indicating that for the last 30 consecutive business days, the bid price of our common stock closed below the minimum $1.00 per share requirement pursuant to NASDAQ Listing Rule 5450(a)(1) for continued inclusion on the NASDAQ Global Market. After we effected a one-for-five reverse split on October 26, 2012, we regained compliance with the minimum bid price requirement for continued listing set forth in NASDAQ Listing Rule 5450(a)(1). On June 5, 2013, we received another letter from NASDAQ indicating that for the last 30 consecutive business days, the bid price of our common stock closed below the minimum $1.00 per share. We again regained compliance within a short period of time. As of January 8, 2015, the closing price of our common stock was $1.96 per share.
We cannot ensure you that the Company will continue to comply with the requirements for continued listing on the NASDAQ Global Market in the future. If our common stock loses its status on The NASDAQ Global Market and we are not successful in obtaining a listing on The NASDAQ Capital Market, our common stock would likely trade in the over-the-counter market. If our shares were to trade on the over-the-counter market, selling our common stock could be more difficult because smaller quantities of shares would likely be bought and sold, transactions could be delayed, and security analysts’ coverage of us may be reduced. In addition, in the event our common stock is delisted, broker-dealers have certain regulatory burdens imposed upon them, which may discourage broker-dealers from effecting transactions in our common stock, further limiting the liquidity of our common stock. These factors could result in lower prices and larger spreads in the bid and ask prices for our common stock. Such delisting from the NASDAQ Global Market and continued or further declines in our share price could also greatly impair our ability to raise additional necessary capital through equity or debt financing, and could significantly increase the ownership dilution to shareholders caused by our issuing equity in financing or other transactions.
If we were delisted from NASDAQ, we may become subject to the trading complications experienced by “Penny Stocks” in the over-the-counter market.
Delisting from NASDAQ may cause our shares of common stock to become the SEC’s “penny stock” rules. The SEC generally defines a penny stock as an equity security that has a market price of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to specific exemptions. One such exemption is to be listed on NASDAQ. Therefore, were we to be delisted from NASDAQ, our common stock may become subject to the SEC’s “penny stock” rules. These rules require, among other things, that any broker engaging in a purchase or sale of our securities provide its customers with: (i) a risk disclosure document, (ii) disclosure of market quotations, if any, (iii) disclosure of the compensation of the broker and its salespersons in the transaction and (iv) monthly account statements showing the market values of our securities held in the customer’s accounts. A broker would be required to provide the bid and offer quotations and compensation information before effecting the transaction. This information must be contained on the customer’s confirmation. Generally, brokers are less willing to effect transactions in penny stocks due to these additional delivery requirements. These requirements may make it more difficult for shareholders to purchase or sell our shares. Because the broker, not us, prepares this information, we would not be able to assure that such information is accurate, complete or current.
Our directors and executive officers, collectively, own approximately 31.0% of our outstanding common stock and may be able to control our management and affairs.
As of September 30, 2014, Mr. Xiangqian Li, our president and chief executive officer and chairman of our board, and our other executive officers and directors beneficially owned an aggregate of 31.0% of our outstanding common stock. As a result, our directors and executive officers, acting together, may be able to control our management and affairs, including the election of directors and approval of significant corporate transactions, such as mergers, consolidation, and sale of all or substantially all of our assets. Consequently, this concentration of ownership may have the effect of delaying or preventing a change of control, including a merger, consolidation or other business combination involving us, even if such a change of control would benefit our stockholders.
Provisions in our articles of incorporation and bylaws could entrench our board of directors and prevent a change in control.
Our articles of incorporation provide that special meetings of the stockholders can only be called by our president or any other executive officer, or the board of directors, or any member thereof, the record holder or holders of at least 10% of all shares entitled to vote at the meeting, or the president or secretary at the written request of our stockholders holding not less than 30% of all shares issued, outstanding and entitled to vote. In addition, our bylaws and/or our articles of incorporation (i) allow vacancies in the board of directors to be filled by a majority of the remaining directors, though less than a quorum, (ii) provide that no contract or transaction between us and one or more of our directors or officers is void if certain criteria are met, (iii) provide that our bylaws may be amended or appealed at any meeting of the board of directors at which a quorum is present, by the affirmative vote of a majority of the directors present at such meeting, and (iv) provide that at an annual meeting, our stockholders elect a board of directors and transact such other business as may properly be brought before the meeting; by contrast, at a special meeting, our stockholders may transact only the business for the purposes specified in the notice of the meeting unless all of our stockholders entitled to vote are present at the special meeting and consent.
In addition, our board of directors may cause us to issue our authorized but unissued shares of common stock in the future without stockholders’ approval. These additional shares may be utilized for a variety of corporate purposes, including future public offerings to raise additional capital, corporate acquisitions and employee benefit plans. The existence of authorized but unissued shares of common stock could render more difficult or discourage an attempt to obtain control of a majority of our common stock by means of a proxy contest, tender offer, merger or otherwise.
Collectively, these provisions may have the effect of entrenching our existing board members, discouraging or preventing a transaction including a change in control transaction where such transaction would be beneficial to our stockholders.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES.
We have almost completed the construction of our Dalian site and will initially put into use facilities measuring 40,100 square meters comprised of manufacturing facilities, warehousing and packaging facilities and administrative offices at the BAK Industrial Park in Dalian in the first quarter of calendar year 2015. Of that space, approximately 16,908 square meters are manufacturing facilities. We believe that these facilities will meet our recent business needs as well as the needs of our expanded operations in the future.
The following table sets forth the breakdown of our facilities as of September 30, 2014 based on use:
We currently do not have insurance for our buildings located at our Dalian facilities, which are under construction. We expect we will purchase related insurance for these buildings after the construction is completed.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
From time to time, we may become involved in various lawsuits and legal proceedings, which arise, in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these, or other matters, may arise from time to time that may harm our business. Other than the legal proceedings set forth below, we are currently not aware of any such legal proceedings or claims that we believe will have an adverse effect on our business, financial condition or operating results:
China BAK Battery, Inc. was named as a second defendant in the case of Safeco Ins. Co. of Am. v. Hewlett-Packard Co. et al., filed in the Superior Court of the State of California, County of Ventura. It was an action for negligence and strict product liability. The plaintiff alleged that a product manufactured by the Company was used in a Hewlett Packard laptop, which malfunctioned and caused fire damage in the home of a consumer (the Plaintiff’s insured). The total damages sought were $126,978, plus interest and fees. On September 24, 2014, the plaintiff, Hewlett Packard Co. and China BAK Battery, Inc. agreed to release all claims against each other arising out of the incident described above. The plaintiff and Hewlett Packard dismissed their complaints against China BAK Battery, Inc. with prejudice. Pursuant to the settlement agreement reached among the parties, China BAK Battery, Inc. also dismissed with prejudice its cross-complaint against Hewlett Packard. Further, pursuant to the settlement agreement, the plaintiff has agreed to indemnify and defend China BAK Battery, Inc. for any future actions/claims against China BAK Battery, Inc. relating to this incident.
An individual named Steven R. Ruth filed suit against China BAK Battery, Inc. in United States District Court for the Western District of Texas on August 15, 2013 alleging breach of contract. China BAK Battery, Inc. did not receive notice of this lawsuit and the plaintiff sought a default judgment, which the court granted in January 2014. Accordingly, the court entered judgment in favor of Mr. Ruth in the amount of $553,773.51 inclusive of costs and attorneys’ fees (the “First Judgment”).
Subsequent to the entry of the First Judgment, Mr. Ruth has made efforts to have the judgment enforced in Canada. On September 19, 2014, Mr. Ruth also filed a second complaint in the United States District Court for the Western District of Texas. On November 12, 2014, a second default judgment was entered against China BAK Battery, Inc. in the amount of $553,773.51 for the First Judgment plus an additional $7,550 in attorneys’ fees. The second judgment is inclusive of the amounts ordered in the First Judgment. BAK International thereafter agreed to indemnify China BAK Battery, Inc. from any expenses, losses and damages that were incurred and will incur to China BAK Battery, Inc. due to the lawsuit filed by Mr. Ruth.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
Our common stock is listed on The NASDAQ Global Market under the symbol “CBAK.”
The following table sets forth the quarterly high and low sales prices of a share of our common stock as reported by NASDAQ for the periods indicated. These prices do not include retail markup, markdown or commission and may not represent actual transactions.
(1) The above table sets forth the range of high and low closing prices per share of our common stock as reported by Yahoo! Finance for the periods indicated. Prices have been adjusted to reflect the one-for-five reverse stock split effected on October 26, 2012.
Approximate Number of Holders of Our Common Stock
As of January 8, 2015, there were approximately 38 holders of record of our common stock. This number excludes the shares of our common stock owned by stockholders holding stock under nominee security position listings.
Dividend Policy
We have never declared or paid any dividends, nor do we have any present plan to pay any cash dividends on our common stock in the foreseeable future. We currently intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.
As we are a holding company, we rely on dividends paid to us by our subsidiaries in the PRC through our Hong Kong subsidiary, BAK Asia. In accordance with its articles of association, each of our subsidiaries in the PRC is required to allocate to its statutory general reserve at least 10% of its respective after-tax profits determined in accordance with the PRC accounting standards and regulations. Each of our subsidiaries in the PRC may stop allocations to its general reserve if such reserve has reached 50% of its registered capital. Allocations to the reserve can only be used for making up losses and other specified purposes and may not be paid to us in the form of loans, advances, or cash dividends. Dividends paid by our PRC subsidiaries to BAK Asia, our Hong Kong subsidiary, will not be subject to Hong Kong capital gains or other income tax under current Hong Kong laws and regulations because they will not be deemed to be assessable income derived from or arising in Hong Kong. Such dividends, however, may be subject to a 10% withholding tax in the PRC.
Our board of directors has discretion on whether to pay dividends unless the distribution would render us unable to repay our debts as they become due, as provided in Chapter 78.288 of the Nevada Revised Statutes. Even if our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth certain information about the securities authorized for issuance under our Stock Option Plan and our Compensation Plan for Non-Employee Directors as of September 30, 2014. Options exercisable for all of the securities shown in column (a) below were granted under our Stock Option Plan.
(1) Includes 86,500 shares of restricted stock that were available for future issuance under our Compensation Plan for Non-Employee Directors and 135,901 shares of restricted stock that were available for future issuance under our Stock Option Plan, as of September 30, 2014. All information in and below this table gives retroactive effect to our one-for-five reverse stock split effected on October 26, 2012.
Recent Sales of Unregistered Securities
We have not sold any equity securities during the 2014 fiscal year that were not previously disclosed in a quarterly report on Form 10-Q or a current report on Form 8-K that was filed during the 2014 fiscal year.
Purchases of Equity Securities
No repurchases of our common stock were made during the fiscal year of 2014.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
Not applicable.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following management’s discussion and analysis should be read in conjunction with our financial statements and the notes thereto and the other financial information appearing elsewhere in this report. 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 U.S. dollars and in accordance with U.S. GAAP.
Overview
Although the business climate in China is recovering, the global economic environment remains weak. We have experienced net losses during the past two fiscal years. We generated revenues from the manufacture of lithium ion rechargeable batteries of $185.6 million and $123.0 million for the fiscal years ended September 30, 2013 and 2014, respectively, and net losses from continuing operations of $116.4 million and $26.7 million during the same years, respectively. However, we believe that we will yield long-term growth of revenues and positive net income with the expected commencement of commercial operations of our Dalian facilities in the first quarter of calendar year 2015.
Before the foreclosure of BAK International on June 30, 2014, we generated most of our revenues from BAK International and its subsidiaries. Before the Dalian facilities commerce commercial operations, we continue to outsource our production to BAK Tianjin or other manufacturers. We were also engaged in the business segment of property lease and management of our Research and Development Centre in Shenzhen since its completion in July 2013 and up to June 30, 2014. We generated revenues from property lease and management of $0.4 million and $4.1 million for the years ended September 30, 2013 and 2014, respectively.
We had net liabilities, a working capital deficiency, accumulated deficit from recurring net losses incurred for the current and prior years and significant short-term debt obligations maturing in less than one year as of September 30, 2014.
In order to repay our overdue bank loans, Shenzhen BAK borrowed from Mr. Jinghui Wang (“Mr. Wang”) an aggregate of RMB520 million (approximately $83.8 million) (the “Loans”) in December 2013 and January 2014. To secure the repayment of the Loans, we and BAK International separately entered into a corporate guarantee with Mr. Wang, under which each of us and BAK International irrevocably and unconditionally guaranteed to the lender timely performance by Shenzhen BAK of its obligation to repay the Loans. In addition, the Company pledged 100% of its equity interest in BAK International to the lender as security for Shenzhen BAK’s repayment of the Loans (the “Pledged BAK International Equity”).
On June 30, 2014, we received from Mr. Wang a notice that due to Shenzhen BAK’s default under the Loans, he had foreclosed his security interest in and sold and transferred to a third party the Pledged BAK International Equity for a purchase price of RMB520 million (approximately $83.8 million) to Mr. Wang.
On July 4, 2014, we, Shenzhen BAK, BAK International and Mr. Wang entered into a certain Deed of Waiver and Release, pursuant to which, Mr. Wang absolutely waived all his title, rights, interests and benefits in and to the accrued and unpaid interest on the Loans in an amount of RMB51 million (approximately $8.3 million) as of June 30, 2014. In addition, we and BAK International were both released and discharged from their obligations under the corporate guarantees that they executed in favor of Mr. Wang. Under the Deed of Waiver and Release, we, Shenzhen BAK, BAK International and Mr. Wang will have no claim whatsoever against each other.
As a result of the above foreclosure, we lost ownership of BAK International and its subsidiaries, and only retained Dalian BAK Power as our operating subsidiary.
Recent Development
Upon the commencement of commercial operations of our Dalian manufacturing facilities, which is expected to be in the first quarter of calendar year 2015, we will manufacture new energy high power lithium batteries, which are mainly used in the following applications:
Electric vehicles (“EV”), such as electric cars, electric buses, hybrid electric cars and buses;
Light electric vehicles (“LEV”), such as electric bicycles, electric motors, sight-seeing cars; and
Electric tools, energy storage, uninterruptible power supply, and other high power applications.
We are currently constructing new manufacturing facilities in Dalian with most of BAK Tianjin’s operating assets, including its machinery and equipment, customers, employees, patents and technologies being relocated from BAK Tianjin. BAK Tianjin is one of the major manufacturers of high power lithium batteries in China which started operations in 2008, and has obtained many well-known customers in EV, LEV and other high power applications. The construction of the Dalian facilities is expected to be completed in January 2015 and its trial production will begin immediately thereafter. We expect that the Dalian facilities will commence commercial operations in the first quarter of calendar year 2015. We have outsourced and will continue to outsource our production to BAK Tianjin or other manufacturers until our Dalian manufacturing facility begins its commercial operations. As of September 30, 2014, Dalian BAK Power generated revenues of approximately $1.2 million from the sale of batteries manufactured by BAK Tianjin under outsourcing arrangements.
During fiscal 2013, we received a subsidy of RMB150 million (approximately $24.4 million) from the Management Committee of Dalian Economic Zone, to finance our relocation of operating assets from Tianjin to Dalian. In October 2014, we received from Dalian government a subsidy of RMB46.2 million (approximately $7.5 million) for costs of land use rights relating to the new manufacturing site in Dalian. We also obtained a short term bank loan of RMB30 million (approximately $4.9 million) with a one-year term from Bank of Dandong in August 2014. The short term bank loan is bearing a fixed interest rate at 7.8% per annum and guaranteed Mr. Xiangqian Li, our CEO, and Shenzhen BAK. We plan to renew this loan upon maturity, and plan to raise additional funds from local banks in the future to meet our daily cash demands. In the meanwhile, due to the growing environmental pollution problem, the Chinese government is currently providing vigorous support to the new energy facilities and vehicle. It is expected that we will be able to secure more potential orders from the new energy market, especially from the electric car market. We believe with the significant reduction of liabilities and disposal of traditionally low margin battery business, supported by the booming future market demand in high power lithium ion products, we can continue as a going concern and return to profitability.
Financial Statement Presentation
Net revenues. Our net revenues represent the invoiced value of our products sold, net of value added taxes, or VAT, sales returns, trade discounts and allowances. We are subject to VAT, which is levied on most of our products at the rate of 17% on the invoiced value of our products. Provision for sales returns are recorded as a reduction of revenue in the same period that revenue is recognized. The provision for sales returns represents our best estimate of the amount of goods that will be returned from our customers based on historical sales return data.
Cost of revenues. Cost of revenues consists primarily of material costs, employee remuneration for staff engaged in production activity, share-based compensation, depreciation and related expenses that are directly attributable to the production of products. Cost of revenues also includes write-downs of inventory to lower of cost or market. Cost of revenues from the sales of battery packs includes the fees we pay to pack manufacturers for assembling our prismatic cells into battery packs.
Research and development expenses. Research and development expenses primarily consist of remuneration for R&D staff, share-based compensation, depreciation and maintenance expenses relating to R&D equipment, and R&D material costs.
Sales and marketing expenses. Sales and marketing expenses consist primarily of remuneration for staff involved in selling and marketing efforts, including staff engaged in the packaging of goods for shipment, advertising cost, depreciation, share-based compensation and travel and entertainment expenses. We do not pay slotting fees to retail companies for displaying our products, engage in cooperative advertising programs, participate in buy-down programs or similar arrangements. No material estimates are required by management to determine our actual marketing or advertising costs for any period.
General and administrative expenses. General and administrative expenses consist primarily of employee remuneration, share-based compensation, professional fees, insurance, benefits, general office expenses, depreciation, liquidated damage charge and bad debt expenses.
Impartment charge on property, plant and equipment. Impairment charge consist primarily of impairment losses for long-lived assets. These losses reflect the amounts by which the carrying values of these assets exceed their estimated fair value as determined by their estimated future discounted cash flows.
Government grant income. We present the government subsidies received as part of other income unless the subsidies received are earmarked to compensate a specific expense, which have been accounted for by offsetting the specific expense, such as research and development expense, interest expenses and removal costs. Unearned government subsidies received are deferred for recognition until the criteria for such recognition could be met. Grants applicable to land are amortized over the life of the depreciable facilities constructed on it. For research and development expenses, we match and offset the government grants with the expenses of the research and development activities as specified in the grant approval document in the corresponding period when such expenses are incurred.
Finance costs, net. Finance costs consist primarily of interest income and interest on bank loans and other short term loans, net of capitalized interest.
Income tax expenses. Our subsidiaries in PRC are subject to an income tax rate of 25%. We have not paid any income tax as we incurred losses during the year. Our former subsidiaries BAK Canada, BAK Europe, BAK India and BAK International, and our Hong Kong subsidiary BAK Asia-are subject to a profits tax in their respective countries at rates of 38%, 25%, 30%, 16.5% and 16.5%, respectively. However, because we do not have any assessable income derived from or arising in those countries, they have not paid any such tax.
Pursuant to the Provisional Regulation of China on Value Added Tax and its implementing rules, all entities and individuals that are engaged in the sale of goods, the provision of repairs and replacement services and the importation of goods in China are generally required to pay VAT at a rate of 17% of the gross sales proceeds received, less any deductible VAT already paid or borne by the taxpayer. Further, when exporting goods, the exporter is entitled to some or all of the refund of VAT that it has already paid or borne. Our imported raw materials that are used for manufacturing exported products and deposited in bonded warehouses are exempt from import VAT.
Results of Operations
The following table sets forth key components of our results of operations for the years indicated, both in dollars and as a percentage of our revenue.
(All amounts, other than percentages, in thousands of U.S. dollars)
Net revenues. Net revenues were $123.0 million for the fiscal year ended September 30, 2014, as compared to $185.6 million for the fiscal year of 2013, a decrease of $62.6 million, or 33.7% . This decrease was primary attributable to the disposal of BAK International and its subsidiaries that manufactured prismatic cells, cylindrical cells and lithium polymer cells. We only realized sales from high-power lithium battery cells after the disposal of BAK International on June 30, 2014.
The following table sets forth the breakdown of our net revenues by battery cell type.
(All amounts in thousands of U.S. dollars)
The following table sets forth the breakdown of our net revenues from reconditioned and normal products.
(All amounts in thousands of U.S. dollars)
Net revenues from sales of aluminum-case cells decreased to $24.5 million in fiscal year 2014, from $28.8 million in the fiscal year 2013, a decrease of $4.3 million, or 14.9%, resulting from a decrease of 45.9% in sales volume offset by an increase of 57.2% in average selling price. The decrease in sales volume was because of the continuing decrease in demand for aluminum-case cells in view of the popularity of polymer smartphone batteries in this period. The increase in average selling price was because we disposed of a large quantity of obsolete and low quality products at a lower selling price in the same corresponding period of last year. In addition, we disposed of our former subsidiaries which were engaged in the sale of aluminum-case cell products in June 2014.
Net revenues from sales of battery packs, which are a crucial component of smartphones, decreased to $61.8 million in the fiscal year 2014, from $63.7 million in the fiscal year 2013, a decrease of $1.9 million, or 3.0% . This resulted from a decrease of 21.2% in sales volume offset by an increase of 23.3% in average selling price. The decrease in sales volume was because of fewer reconditioned products sold in 2014. The increase in average selling price was mainly attributable to a relatively higher percentage of sales in 2014 attributable to the sale of high value batteries used in smartphones with higher capacity and long standby time requirements sold for the nine months ended June 30, 2014 as compared to the same period last year. In addition, we disposed of our former subsidiaries which were engaged in the sale of battery packs products in June 2014.
Net revenues from sales of cylindrical cells decreased to $9.3 million in the fiscal year 2014, from $46.0 million in fiscal year 2013, a decrease of $36.7 million, or 79.8% . This resulted from a decrease of 73.9% in sales volume accompanied with a decrease of 22.6% in average selling price. The decrease in sales volume and price were attributable to the fierce competition in cylindrical cells, especially from South Korean competitors. In addition, we disposed of our former subsidiaries which were engaged in sale of cylindrical cells products in June 2014.
We sold $17.1 million in lithium polymer cells in fiscal year 2014, compared to $30.6 million in lithium polymer cells in the fiscal year 2013, a decrease of $13.5 million, or 44.0%, resulting from a decrease of 50.1% in sales volume offset by an increase of 12.3% in average selling price. The decrease in sales volume was attributable to the fierce competition in the battery market. The increase of average selling price was mainly attributed to a higher proportion of sales made from high value products in fiscal 2014. In addition, we disposed of our former subsidiaries which were engaged in the sale of lithium polymer cell products in June 2014.
We also sold approximately $10.3 million in high-power lithium battery cells for the fiscal year 2014, as compared to $16.5 million in high-power lithium battery cells in 2013, a decrease of $6.2 million, or 37.5%, resulting from a decrease of 55.1% in sales volume offset by an increase of 40.5% in average selling price. The light electric vehicle market, in particular the electric bicycle market, is becoming more competitive, and we became more selective in customers and gave up low value customers while trying to retain higher end customers.
Cost of revenues. Cost of revenues decreased to $113.5 million for the year ended September 30, 2014, as compared to $202.2 million for fiscal year 2013, a decrease of $88.7 million, or 43.9% . Included in cost of revenues were write-downs of obsolete inventories of $59.6 million and $8.8 million for fiscal years 2013 and 2014 respectively. We write down the inventory value whenever there is an indication that they are impaired. However, as the market conditions continued to deteriorate, further write-downs were necessary. In addition, as we disposed of the major subsidiaries which generated most of our sales in June 2014, our sales revenue and cost of sales decreased sharply in the last quarter of fiscal year 2014.
Gross profit/(loss). Gross profit for the year ended September 30, 2014 was $9.6 million, or 7.8% of net revenues as compared to a gross loss of $16.6 million, or 9.0% of net revenues, for fiscal year 2013. Our change in gross profit was largely due to the decrease in write-downs of inventory and fewer reconditioned products being sold at a loss in this period, compared with fiscal year 2013.
Research and development expenses. Research and development expenses decreased to $4.0 million for the year ended September 30, 2014, as compared to $5.4 million for fiscal year 2013, a decrease of $1.4 million, or 25.8% . This was mainly attributable to a decrease of $1.0 million in salary and wages compared last year due to the closure of our former Canadian research center in this year. Secondly, our certification fees decreased by $0.3 million, mainly because we sold fewer products to overseas markets and most of our certificate fees were generated from sales to overseas.
Sales and marketing expenses. Sales and marketing expenses decreased to $4.5 million for the year ended September 30, 2014, as compared to $7.6 million for fiscal year 2013, a decrease of $3.1 million, or 41.4% . This was mainly attributable to a decrease of $1.1 million, $0.5 million and $0.7 million in salary and wages, packaging and transportation, respectively. As a percentage of revenues, sales and marketing expenses were 3.7% and 4.1% for the fiscal year 2014 and 2013, respectively.
General and administrative expenses. General and administrative expenses decreased to $12.3 million, or 10.0% of revenues, for the year ended September 30, 2014, as compared to $17.5 million, or 9.4% of revenues, for fiscal year 2013, a decrease of $5.1 million, or 29.3% . The decrease was mainly attributable to the reduction of $1.6 million of salaries and $1.0 million of depreciation and amortization after the disposal of BAK International. Also, we recorded loss on disposal of assets after the liquidation of BAK Canada of $2.6 million in fiscal 2013.
Operating loss. As a result of the above, our operating loss totaled $10.6 million for the year ended September 30, 2014, as compared to $100.7 million for the fiscal 2013, a decrease of $90.1 million, or 89.4% .
Finance costs, net. Finance costs, net, increased to $16.8 million for the year ended September 30, 2014, as compared to $11.5 million for the prior year, an increase of $5.3 million, or 45.8% . In fiscal year 2014, we borrowed loans of $83.8 million from Mr. Jinghui Wang which bore interest of 20% per annum.
Income tax expense. Income tax expense was approximately $0.02 million for the fiscal year 2014, as compared to $6.1 million income tax expense for 2013. Last year we recorded a net valuation allowance of $5.8 million on our deferred tax assets arising on tax losses primarily before the fiscal year 2012. Since we continued to experience significant losses, we were uncertain that we could generate sufficient profit to claim the deferred income tax benefits in the future.
Income from discontinued operations, net of tax. Income from discontinued operations, net of tax represents the income from the leasing and management of our Research and Development Centre in Shenzhen. During the year ended September 30, 2014, this leasing and management operation generated income of $3.1 million, and profit of $61.3 million on disposal of BAK International and its subsidiaries as a result of the foreclosure described above, which was mainly related to the market value appreciation of our Research and Development Centre.
Net profit (loss). As a result of the foregoing, we had a net profit of $37.8 million for the year ended September 30, 2014, compared to a net loss of $116.0 million for the year ended September 30, 2013.
Liquidity and Capital Resources
Before the foreclosure of the pledged ownership of BAK International, we had historically financed our liquidity requirements from a variety of sources, including short-term bank loans, other short-term loans and bills payable under bank credit agreements, factoring of bills receivable to banks and issuance of capital stock.
After the foreclosure of the pledged ownership of BAK International and as of September 30, 2014, we had cash and cash equivalents of $1.0 million. Our total current assets were $12.7 million and our total current liabilities were $48.3 million, which results in a net working capital deficiency of $35.6 million. These factors raise substantial doubts about our ability to continue as a going concern. As of September 30, 2014, we had received from the Management Committee of Dalian Economic Zone of $24,437,131 to finance the relocation of our operations to Dalian. We will offset the subsidy against related expenditures and recognize the balance as income in fiscal year 2015. In October 2014, we received from Dalian government a subsidy of $7.5 million (RMB46.2 million) for costs of land use rights relating to the new manufacturing site in Dalian. We obtained a short term bank loan of $4.9 million (RMB30 million) from Bank of Dandong for a period from August 19, 2014 to August 18, 2015. The short term bank loan is bearing fixed interest at 7.8% per annum and was guaranteed by Shenzhen BAK and Mr. Xiangqian Li.
We may require additional cash to complete the construction of the new Dalian manufacturing facilities. We may also require additional cash due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. We plan to renew the short term bank loan of $4.9 million in August 2015 upon maturity, and plan to borrow additional funds from local banks to meet the Company’s cash needs. However, there can be no assurance that we will be successful in obtaining this financing. If our existing cash and bank borrowing are insufficient to meet our requirements, we may seek to sell equity securities, debt securities or borrow from lending institutions. We can make no assurance that financing will be available in the amounts we need or on terms acceptable to us, if at all. The sale of equity securities, including convertible debt securities, would dilute the interests of our current shareholders. The incurrence of debt would divert cash for working capital and capital expenditures to service debt obligations and could result in operating and financial covenants that restrict our operations and our ability to pay dividends to our shareholders. If we are unable to obtain additional equity or debt financing as required, our business operations and prospects may suffer.
The following table sets forth a summary of our cash flows for the periods indicated:
(All amounts in thousands of U.S. dollars)
Operating Activities
Net cash provided by operating activities was $23.6 million for the year ended September 30, 2013, as compared with net cash used in operating activities of $29.3 million in fiscal year 2014. The increase of $52.9 million in net cash used in operating activities was mainly attributable to the increase of accounts receivable.
Investing Activities
Net cash used in investing activities decreased from $19.1 million in fiscal 2013 to $17.5 million in fiscal 2014. The net cash used in investing activities for the year ended September 30, 2014 was mainly used to purchase the land use rights and construction of the production facilities of Dalian BAK Power.
Financing Activities
Net cash used in financing activities was $0.1 million in fiscal 2013, compared with net cash provided by financing activities of $33.8 million in fiscal 2014. During fiscal 2014, we borrowed $137.7 million from unrelated parties (primarily Mr. Jinhui Wang) to repay our bank borrowings matured during the year.
As of September 30, 2014, the principal amounts outstanding under our credit facilities and lines of credit were as follows:
(All amounts in thousands of U.S. dollars)
We obtained a short term bank loan of $4.9 million (RMB30 million) from Bank of Dandong for a period from August 19, 2014 to August 18, 2015. The short term bank loan is bearing fixed interest at 7.8% per annum and was guaranteed by Shenzhen BAK, our former subsidiary and Mr. Xiangqian Li.
Capital Expenditures
We incurred capital expenditures of $13.3 million and $19.0 million in fiscal 2013 and 2014, respectively. Our capital expenditures in 2014 were primarily related to the purchase of land use rights, the construction costs and acquisition of plant and equipment of our new Dalian facility. The table below sets forth the breakdown of our capital expenditures by use for the periods indicated.
(All amounts in thousands of U.S. dollars)
We estimate that our total capital expenditures in fiscal year 2015 will reach approximately $14.8 million. Such funds will be used to purchase manufacturing equipment and for the construction of the production plant at our new Dalian facility.
Contractual Obligations and Commercial Commitments
The following table sets forth our contractual obligations and commercial commitments as of September 30, 2014: (All amounts in thousands of U.S. dollars)
Other than the contractual obligations and commercial commitments set forth above, we did not have any other long-term debt obligations, operating lease obligations, capital commitments, purchase obligations or other long-term liabilities as of September 30, 2014.
Off-Balance Sheet Transactions
We have not entered into any transactions, agreements or other contractual arrangements to which an entity unconsolidated with us is a party and under which we have (i) any obligation under a guarantee, (ii) any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity, (iii) any obligation under derivative instruments that are indexed to our shares and classified as shareholders’ equity in our consolidated balance sheets, or (iv) any obligation arising out of a variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.
Critical Accounting Policies
Our consolidated financial information has been prepared in accordance with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect (1) the reported amounts of our assets and liabilities, (2) the disclosure of our contingent assets and liabilities at the end of each fiscal period and (3) the reported amounts of revenues and expenses during each fiscal period. We continually evaluate these estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and reasonable assumptions, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.
When reviewing our financial statements, the following should also be considered: (1) our selection of critical accounting policies, (2) the judgment and other uncertainties affecting the application of those policies, and (3) the sensitivity of reported results to changes in conditions and assumptions. We believe the following accounting policies involve the most significant judgment and estimates used in the preparation of our financial statements.
We consider the following to be the most critical accounting policies:
Revenue Recognition
We recognize revenue on product sales when products are delivered and the customer takes ownership and assumes risk of loss, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the sales price is fixed or determinable.
Net sales of products represent the invoiced value of goods sold, net of value added taxes (“VAT”), sales returns, trade discounts and allowances. We are subject to VAT which is levied on the majority of our products at the rate of 17% on the invoiced value of sales. Output VAT is borne by customers in addition to the invoiced value of sales and input VAT is borne by us in addition to the invoiced value of purchases to the extent not refunded for export sales. Provision for sales returns are recorded as a reduction of revenue in the same period that revenue is recognized. The provision for sales returns, which is based on historical sales returns data, is our best estimate of the amount of goods that will be returned from our customers.
Impairment of Long-lived Assets
Long-lived assets, which include property, plant and equipment, prepaid land use rights and intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Recoverability of long-lived assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset.
Trade Accounts Receivable
Trade accounts receivable are recorded at the invoiced amount, net of allowances for doubtful accounts and sales returns. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing trade accounts receivable. We determine the allowance based on historical write-off experience, customer specific facts and economic conditions.
Outstanding accounts receivable balances are reviewed individually for collectability. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.
Inventories
Inventories are stated at the lower of cost or market. The cost of inventories is determined using the weighted average cost method, and includes expenditure incurred in acquiring the inventories and bringing them to their existing location and condition. In case of finished goods and work in progress, cost includes an appropriate share of production overhead based on normal operating capacity.
We regularly review the cost of inventories against their estimated fair market value and record a lower of cost or market write-down for inventories that have costs in excess of estimated market value.
Changes in Accounting Standards
Please refer to note 2 to our consolidated financial statements, “Summary of Significant Accounting Polices and Practices -Recently Issued Accounting Standards” for a discussion of relevant pronouncements.
Exchange Rates
The financial records of our PRC subsidiaries are maintained in RMB. In order to prepare our financial statements, we have translated amounts in RMB into amounts in U.S. 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 in our stockholders’ equity section of our balance sheet. All other amounts that were originally booked in RMB and translated into U.S. dollars were translated using the closing exchange rate on the date of recognition. Consequently, the exchange rates at which the amounts in those comparisons were computed varied from year to year.
The exchange rates used to translate amounts in RMB into U.S. dollars in connection with the preparation of our financial statements were as follows:
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The full text of our audited consolidated financial statements begins on page of this annual report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15 under the Exchange Act, our management has carried out an evaluation, with the participation and under the supervision of our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2014. Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating and implementing possible controls and procedures.
Management conducted its evaluation of disclosure controls and procedures under the supervision of our chief executive officer and our chief financial officer. Based upon, and as of the date of this evaluation, our Chief Executive Officer and Interim Chief Financial Officer concluded that, due to the material weakness as described below, our disclosure controls and procedures were ineffective as of September 30, 2014.
Management’s Annual Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting refers to the process designed by, or under the supervision of, our chief executive officer and chief financial officer, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP, and includes those policies and procedures that:
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with the authorization of our management and directors; and
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of September 30, 2014. In making this assessment, management used the framework set forth in the report entitled Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. The COSO framework summarizes each of the components of a company’s internal control system, including (i) the control environment, (ii) risk assessment, (iii) control activities, (iv) information and communication, and (v) monitoring.
Based on this evaluation and as a result of the material weakness discussed below, our chief executive officer and interim chief financial officer concluded that the Company’s disclosure controls and procedures as of September 30, 2014 were not effective because of the following material weakness in our internal control over financial reporting has been identified:
-
We did not have appropriate policies and procedures in place to evaluate the proper accounting and disclosures of key documents and agreements.
-
We do not have sufficient and skilled accounting personnel with an appropriate level of technical accounting knowledge and experience in the application of accounting principles generally accepted in the United States commensurate with our financial reporting requirements.
In order to cure the foregoing material weakness, we have taken or are taking the following remediation measures:
-
We are in the process of hiring a permanent chief financial officer with significant U.S. GAAP and SEC reporting experience. Mr. Wenwu Wang was appointed by the Board of Directors of the Company as the Interim Chief Financial Officer on August 28, 2014.
-
We plan to make necessary changes by providing training to our financial team and our other relevant personnel on the U.S. GAAP accounting guidelines applicable to our financial reporting requirements.
We intend to complete the remediation of the material weaknesses discussed above as soon as practicable but we can give no assurance that we will be able to do so. Designing and implementing an effective disclosure controls and procedures is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to devote significant resources to maintain a financial reporting system that adequately satisfies our reporting obligations. The remedial measures that we have taken and intend to take may not fully address the material weakness that we have identified, and material weaknesses in our disclosure controls and procedures may be identified in the future. Should we discover such conditions, we intend to remediate them as soon as practicable. We are committed to taking appropriate steps for remediation, as needed.
Changes in internal control over financial reporting
Except for the matters described above, there were no changes in our internal controls over financial reporting during the fourth quarter of our fiscal year ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
We have no information to disclose that was required to be disclosed in a report on Form 8-K during the fourth quarter of fiscal year 2014, but was not reported.
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
The information required by this item will be contained in our Proxy Statement relating to our 2015 Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item will be contained in our Proxy Statement relating to our 2015 Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The information required by this item will be contained in our Proxy Statement relating to our 2015 Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
The information required by this item will be contained in our Proxy Statement relating to our 2015 Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
The information required by this item will be contained in our Proxy Statement relating to our 2015 Annual Meeting of Stockholders and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
Financial Statements and Schedules
The financial statements are set forth under Item 8 of this annual report on Form 10-K. Financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included.
Exhibit List
The list of exhibits in the Exhibit Index to this Report is incorporated herein by reference.
FINANCIAL STATEMENTS
CHINA BAK BATTERY, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED
SEPTEMBER 30, 2013 AND 2014
CHINA BAK BATTERY, INC.
AND SUBSIDIARIES
Report of Independent Registered Public Accounting Firm
Crowe Horwath (HK) CPA Limited
To the Board of Directors and Shareholders of
China BAK Battery, Inc.
We have audited the accompanying consolidated balance sheets of China BAK Battery, Inc. and its subsidiaries (the “Company”) as of September 30, 2014 and 2013, and the related consolidated statements of operations and comprehensive loss, changes in shareholders' equity and cash flows for each of the years in the two-year period ended September 30, 2014. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 consolidated financial position of the Company and its subsidiaries as of September 30, 2014 and 2013, and the consolidated results of their operations and their cash flows for each of the years in the two-year period ended September 30, 2014, in conformity with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has net liabilities, a working capital deficiency, accumulated deficit from recurring net losses and significant short-term debt obligations maturing in less than one year as of September 30, 2014. All these factors raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also discussed in Note 1 to the consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Crowe Horwath (HK) CPA Limited
Hong Kong, China
January 13, 2015
China BAK Battery, Inc. and Subsidiaries
Consolidated Balance Sheets
As of September 30, 2013 and 2014
(In US$)
See accompanying notes to the consolidated financial statements.
China BAK Battery, Inc. and Subsidiaries
Consolidated Statements of Operations and Comprehensive Loss
For the years ended September 30, 2013 and 2014
(In US$ except for number of shares)
See accompanying notes to the consolidated financial statements.
China BAK Battery, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders’ Equity
For the years ended September 30, 2013 and 2014
(In US$ except for number of shares)
See accompanying notes to the consolidated financial statements.
China BAK Battery, Inc. and subsidiaries
Consolidated statements of cash flows
For the years ended September 30, 2013 and 2014
(In US$)
See accompanying notes to the consolidated financial statements.
China BAK Battery, Inc. and subsidiaries
Notes to the Consolidated Financial Statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
1.
Principal Activities, Basis of Presentation and Organization
Principal Activities
China BAK Battery, Inc. (“China BAK”) is a corporation formed in the State of Nevada on October 4, 1999 as Medina Copy, Inc. The Company changed its name to Medina Coffee, Inc. on October 6, 1999 and subsequently changed its name to China BAK Battery, Inc. on February 14, 2005. China BAK and its subsidiaries (hereinafter, collectively referred to as the “Company”) are principally engaged in the manufacture, commercialization and distribution of a wide variety of standard and customized lithium ion (known as "Li-ion" or "Li-ion cell") high power rechargeable batteries. Prior to the disposal of BAK International Limited (“BAK International”) and its subsidiaries (see below), the batteries produced by the Company were for use in cellular telephones, as well as various other portable electronic applications, including high-power handsets telephones, laptop computers, power tools, digital cameras, video camcorders, MP3 players, electric bicycles, hybrid/electric vehicles, and general industrial applications. After the disposal of BAK International and its subsidiaries, the Company will focus on the manufacture, commercialization and distribution of high power lithium ion rechargeable batteries for use in cordless power tools, light electric vehicles, hybrid electric vehicles, electric cars, electric busses, uninterruptable power supplies and other high power applications.
The shares of the Company traded in the over-the-counter market through the Over-the-Counter Bulletin Board from 2005 until May 31, 2006, when the Company obtained approval to list its common stock on The NASDAQ Global Market, and trading commenced that same date under the symbol "CBAK".
Basis of Presentation and Organization
On November 6, 2004, BAK International, a non-operating holding company that had substantially the same shareholders as Shenzhen BAK Battery Co., Ltd (“Shenzhen BAK”), entered into a share swap transaction with the shareholders of Shenzhen BAK for the purpose of the subsequent reverse acquisition of the Company. The share swap transaction between BAK International and the shareholders of Shenzhen BAK was accounted for as a reverse acquisition of Shenzhen BAK with no adjustment to the historical basis of the assets and liabilities of Shenzhen BAK.
On January 20, 2005, the Company completed a share swap transaction with the shareholders of BAK International. The share swap transaction, also referred to as the “reverse acquisition” of the Company, was consummated under Nevada law pursuant to the terms of a Securities Exchange Agreement entered by and among China BAK, BAK International and the shareholders of BAK International on January 20, 2005. The share swap transaction has been accounted for as a capital-raising transaction of the Company whereby the historical financial statements and operations of Shenzhen BAK are consolidated using historical carrying amounts.
Also on January 20, 2005, immediately prior to consummating the share swap transaction, BAK International executed a private placement of its common stock with unrelated investors whereby it issued an aggregate of 1,720,087 shares of common stock for gross proceeds of $17,000,000. In conjunction with this financing, Mr. Xiangqian Li, the Chairman and Chief Executive Officer of the Company (“Mr. Li”), agreed to place 435,910 shares of the Company's common stock owned by him into an escrow account pursuant to an Escrow Agreement dated January 20, 2005 (the “Escrow Agreement”). Pursuant to the Escrow Agreement, 50% of the escrowed shares were to be released to the investors in the private placement if audited net income of the Company for the fiscal year ended September 30, 2005 was not at least $12,000,000, and the remaining 50% was to be released to investors in the private placement if audited net income of the Company for the fiscal year ended September 30, 2006 was not at least $27,000,000. If the audited net income of the Company for the fiscal years ended September 30, 2005 and 2006 reached the above-mentioned targets, the 435,910 shares would be released to Mr. Li in the amount of 50% upon reaching the 2005 target and the remaining 50% upon reaching the 2006 target.
Under accounting principles generally accepted in the United States of America (“US GAAP”), escrow agreements such as the one established by Mr. Li generally constitute compensation if, following attainment of a performance threshold, shares are returned to a company officer. The Company determined that without consideration of the compensation charge, the performance thresholds for the year ended September 30, 2005 would be achieved. However, after consideration of a related compensation charge, the Company determined that such thresholds would not have been achieved. The Company also determined that, even without consideration of a compensation charge, the performance thresholds for the year ended September 30, 2006 would not be achieved.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
1.
Principal Activities, Basis of Presentation and Organization (continued)
Basis of Presentation and Organization (continued)
While the 217,955 escrow shares relating to the 2005 performance threshold were previously released to Mr. Li, Mr. Li executed a further undertaking on August 21, 2006 to return those shares to the escrow agent for the distribution to the relevant investors. However, such shares were not returned to the escrow agent, but, pursuant to a Delivery of Make Good Shares, Settlement and Release Agreement between the Company, BAK International and Mr. Li entered into on October 22, 2007 (the “Li Settlement Agreement”), such shares were ultimately delivered to the Company as described below. Because the Company failed to satisfy the performance threshold for the fiscal year ended September 30, 2006, the remaining 217,955 escrow shares relating to the fiscal year 2006 performance threshold were released to the relevant investors. As Mr. Li has not retained any of the shares placed into escrow, and as the investors party to the Escrow Agreement are only shareholders of the Company and do not have and are not expected to have any other relationship to the Company, the Company has not recorded a compensation charge for the years ended September 30, 2005 and 2006.
At the time the escrow shares relating to the 2006 performance threshold were transferred to the investors in fiscal year 2007, the Company should have recognized a credit to donated shares and a debit to additional paid-in capital, both of which are elements of shareholders’ equity. This entry is not material because total ordinary shares issued and outstanding, total shareholders’ equity and total assets do not change; nor is there any impact on income or earnings per share. Therefore, previously filed consolidated financial statements for the fiscal year ended September 30, 2007 will not be restated. This share transfer has been reflected in these financial statements by reclassifying the balances of certain items as of October 1, 2007. The balances of donated shares and additional paid-in capital as of October 1, 2007 were credited and debited by $7,955,358 respectively, as set out in the consolidated statements of changes in shareholders’ equity.
In November 2007, Mr. Li delivered the 217,955 shares related to the 2005 performance threshold to BAK International pursuant to the Li Settlement Agreement; BAK International in turn delivered the shares to the Company. Such shares (other than those issued to investors pursuant to the 2008 Settlement Agreements, as described below) are now held by the Company. Upon receipt of these shares, the Company and BAK International released all claims and causes of action against Mr. Li regarding the shares, and Mr. Li released all claims and causes of action against the Company and BAK International regarding the shares. Under the terms of the Li Settlement Agreement, the Company commenced negotiations with the investors who participated in the Company’s January 2005 private placement in order to achieve a complete settlement of BAK International’s obligations (and the Company’s obligations to the extent it has any) under the applicable agreements with such investors.
Beginning on March 13, 2008, the Company entered into settlement agreements (the “2008 Settlement Agreements”) with certain investors in the January 2005 private placement. Since the other investors have never submitted any claims regarding this matter, the Company did not reach any settlement with them.
Pursuant to the 2008 Settlement Agreements, the Company and the settling investors have agreed, without any admission of liability, to a settlement and mutual release from all claims relating to the January 2005 private placement, including all claims relating to the escrow shares related to the 2005 performance threshold that had been placed into escrow by Mr. Li, as well as all claims, including claims for liquidated damages relating to registration rights granted in connection with the January 2005 private placement. Under the 2008 Settlement Agreement, the Company has made settlement payments to each of the settling investors of the number of shares of the Company’s common stock equivalent to 50% of the number of the escrow shares related to the 2005 performance threshold these investors had claimed; aggregate settlement payments as of September 30, 2014 amounted to 73,749 shares. Share payments to date have been made in reliance upon the exemptions from registration provided by Section 4(2) and/or other applicable provisions of the Securities Act of 1933, as amended. In accordance with the 2008 Settlement Agreements, the Company filed a registration statement covering the resale of such shares which was declared effective by the SEC on June 26, 2008.
Pursuant to the Li Settlement Agreement, the 2008 Settlement Agreements and upon the release of the 217,955 escrow shares relating to the fiscal year 2006 performance threshold to the relevant investors, neither Mr. Li or the Company have any obligations to the investors who participated in the Company’s January 2005 private placement relating to the escrow shares.
As of September 30, 2014, the Company had not received any claim from the other investors who have not been covered by the “2008 Settlement Agreements” in the January 2005 private placement.
As the Company has transferred the 217,955 shares related to the 2006 performance threshold to the relevant investors in fiscal year 2007 and we also have transferred 73,749 shares relating to the 2005 performance threshold to the investors who had entered the “2008 Settlement Agreements” with us in fiscal year 2008, pursuant to “Li Settlement Agreement” and “2008 Settlement Agreements”, neither Mr. Li nor the Company has not had any remaining obligations to those related investors who participated in the Company’s January 2005 private placement relating to the escrow shares.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
1.
Principal Activities, Basis of Presentation and Organization (continued)
Basis of Presentation and Organization (continued)
On October 26, 2012, the Company effected a 1-for-5 reverse stock split of its issued and outstanding shares of common stock and a proportional reduction of its authorized shares of common stock. All common share and per share amounts, and exercise prices of common stock options disclosed herein and in the accompanying consolidated financial statements have been retroactively restated to reflect the reverse stock split.
On December 27, 2013, Dalian BAK Power was established as a wholly owned subsidiary of BAK Asia with a registered capital of $30,000,000 (Note 19(i)). Pursuant to Dalian BAK Power’s article of association and relevant PRC regulations, BAK Asia was required to contribute $6,000,000 to Dalian BAK Power as capital (representing 20% of Dalian BAK Power’s registered capital) on or before December 27, 2015. Up to the date of this report, the Company has contributed $5,000,000 to Dalian BAK Power through an injection of a series of patents.
The Company’s consolidated financial statements have been prepared under accounting principles generally accepted in the United States of America (“US GAAP”).
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. This basis of accounting differs in certain material respects from that used for the preparation of the books of account of the Company’s principal subsidiaries, which are prepared in accordance with the accounting principles and the relevant financial regulations applicable to enterprises with limited liabilities established in the PRC, Hong Kong, India, Canada or Germany, The accompanying consolidated financial statements reflect necessary adjustments not recorded in the books of account of the Company's subsidiaries to present them in conformity with US GAAP.
The Company had net liabilities, a working capital deficiency, accumulated deficit from recurring net losses incurred for current and prior years and short-term debt obligations as of September 30, 2014. The Company has been suffering severe cash flow deficiencies.
In order to repay Shenzhen BAK’s overdue bank loans, Shenzhen BAK borrowed from Mr. Jinghui Wang (“Mr. Wang”), an unrelated third party, in December 2013 and January 2014, an aggregate of $83.8 million (RMB520 million) bearing interest at 20% per annum and repayable by March 31, 2014 (the “Loans”). The Loans were secured by the Company’s 100% equity interest in BAK International (the “Shares”), guaranteed by BAK International and the Company (collectively the “Collateral”).
The Company failed to repay the loans to Mr. Wang on March 31, 2014. On April 24, 2014, the Company received a default notice from Mr. Wang. On June 30, 2014, the Company received a further notice from Mr. Wang that due to Shenzhen BAK’s default under the Loans, he had foreclosed his security interest in BAK International and sold and transferred to a third party the Shares for a purchase price of $83.8 million (RMB520 million). Pursuant to a debt waiver agreement also dated June 30, 2014. Following the disposal and pursuant to a deed of waiver and release signed on July 4, 2014, the Company and BAK International were both released and discharged from their obligations under the corporate guarantees that they executed in favor of Mr. Wang, and the Company, Shenzhen BAK, BAK International and Mr. Wang shall have no claim whatsoever against each other.
As a result of the foreclosure, the equity interest of BAK International and its wholly owned subsidiaries, namely Shenzhen BAK, BAK Battery (Shenzhen) Co., Ltd. (“BAK Battery”), BAK International (Tianjin) Ltd. (“BAK Tianjin”), Tianjin Chenhao Technological Development Limited (a subsidiary of BAK Tianjin established on May 8, 2014,“Tianjin Chenhao”), BAK Battery Canada Ltd. (“BAK Canada”), BAK Europe GmbH (“BAK Europe”) and BAK Telecom India Private Limited (“BAK India”) (collectively the “Disposal Group”) was disposed of effective on June 30, 2014. The consolidated financial statements were consolidated up to the date of disposal. The Company recorded a gain on disposal of subsidiaries of $61.3 million, which was mainly related to the market value appreciation of the Company’s Research and Development Centre in Shenzhen.
After the disposal of the BAK International and its subsidiaries effective on June 30, 2014, the Company’s subsidiaries consisted of: i) China BAK Asia Holdings Limited(“BAK Asia”), a wholly owned limited liability company incorporated in Hong Kong on July 9, 2013; ii) Dalian BAK Trading Co., Ltd. (“Dalian BAK Trading”), a wholly owned limited company established on August 14, 2013 in the PRC; and iii) Dalian BAK Power Battery Co., Ltd. (“Dalian BAK Power”), a wholly owned limited liability company established on December 27, 2013 in the PRC.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
1.
Principal Activities, Basis of Presentation and Organization (continued)
Basis of Presentation and Organization (continued)
The following table represents the net assets of the Disposal Group as of June 30, 2014 (date of disposal):
Note: The Disposal Group owed the Company a sum of $17,844,674. Up to September 30, 2014, the Disposal Group repaid $876,240 in cash to the Company. The former subsidiaries agreed to repay $15,131,854 primary in the form of:-
(a)
Property, plant and equipment to be provided to the Company at a total carrying amount of $10,969,796. Title to property, plant and equipment of $4,268,397 had been passed to the Company as of September 30, 2014, $6,107,084 had been passed to the Company in December 2014 and the remaining $594,315 will be passed to the Company by the end of January 2015;
(b)
Inventories provided to the Company at a total carrying amount of $3,295,456 as of September 30, 2014; and
(c)
Payment of $558,577 to the Company’s subcontractors on its behalf as of September 30, 2014.
Management of the Company evaluated the collectability of the remaining amount and determined that $1.8 million should be impaired (Note 7).
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
The following table presents the components of the Disposal Group in relation to the manufacture, commercialization and distribution of lithium ion rechargeable batteries reported in the consolidated statements of operations and comprehensive loss for the years ended September 30, 2013 and 2014:
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
1.
Principal Activities, Basis of Presentation and Organization (continued)
Basis of Presentation and Organization (continued)
DISCONTINUED OPERATIONS
The Company had also been engaged in property leasing and management of its Research and Development Centre in Shenzhen since its completion in July 2013. Following the disposal of BAK International and in subsidiaries on June 30, 2014, this business is now accounted for as discontinued operations in the accompanying consolidated financial statements for all periods presented. Accordingly, assets and liabilities, revenues and expenses, and cash flows related to the property leasing and management business have been appropriately reclassified in the accompanying consolidated financial statements as discontinued operations for all periods presented.
The following table presents the major classes of assets and liabilities of discontinued operations of the property leasing and management business reported in the consolidated balance sheets:
The following table presents the components of discontinued operations in relation to the property leasing and management business reported in the consolidated statements of operations and comprehensive loss for the years ended September 30, 2013 and 2014:
As a result of the above foreclosure, the Company currently owns a Hong Kong subsidiary, BAK Asia, which in turn wholly owns two Chinese subsidiaries, Dalian BAK Trading and Dalian BAK Power. China BAK will continue to be a US listing company. The Company has outsourced its manufacturing operations to BAK Tianjin before the completion of construction and operation of facility in Dalian. BAK Tianjin is now a supplier of the Company and the Company does not have any significant benefits or liability from the operating results of BAK Tianjin except the normal risk with any major supplier.
Pursuant to a memorandum of understanding with the buyer of the Company’s former subsidiaries dated August 20, 2014, Mr. Xiangqian Li remains as a director of BAK International, Shenzhen BAK, BAK Battery and BAK Battery until Shenzhen BAK’s full settlement of its bank loans of $63.1 million expiring on various dates through March 2015. During this period, Mr. Li should not participate in any operational and managerial decision making of these entities.
As of September 30, 2014, the Company is building a new manufacturing site in Dalian which will focus on production and sale of the new energy high power batteries for use in electric vehicles, light electric vehicles and other high power applications. The Company had advances from the Management Committee of Dalian Economic Zone of $24,437,131 to finance the Company’s removal of its production facilities to Dalian. The Company expects that the removal will be completed in January 2015 and formal production will commence by the end of March 2015. These advances will be recognized as income or offset against related expenditures when there are no present or future obligations for the subsidized projects.
On October 17, 2014, the Company received a subsidy of $7.52 million (RMB46,150,000) from the Management Committee for costs of land use rights relating to the new manufacturing site in Dalian. The subsidy will be amortized on a straight-line basis over the estimated useful lives of the depreciable facilities constructed thereon (Note 13).
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
1.
Principal Activities, Basis of Presentation and Organization (continued)
Basis of Presentation and Organization (continued)
After the disposal of BAK International, the Company continued its business and continued to generate revenues from sale of batteries via subcontracting the production to BAK Tianjin, a former subsidiary. BAK Tianjin before the commencement of production of the Dalian factory.
The Company obtained a short term bank loan of $4.9 million (RMB30 million) from Bank of Dandong for the period from August 19, 2014 to August 18, 2015. The short term loan is bearing fixed interest at 7.8% per annum and was guaranteed by Shenzhen BAK and Mr. Li. The Company expects to renew the bank loan in August 2015 upon maturity, and plans to raise further financing from local banks to meet its daily cash demands. However, there can be no assurance that the Company will be successful in obtaining this financing. The Company believes that with the significant reduction of liabilities and disposal of traditionally low margin battery business after the foreclosure of BAK International, it can continue as a going concern and return to profitability.
The accompanying consolidated financial statements have been prepared assuming the Company will continue to operate as a going concern, which contemplates the realization of assets and the settlement of liabilities in the normal course of business. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty related to the Company’s ability to continue as a going concern.
2.
Summary of Significant Accounting Policies and Practices
(a)
Principles of Consolidation
The consolidated financial statements include the financial statements of the Company and its subsidiaries up to the date of disposal. All significant inter-company balances and transactions have been eliminated prior to consolidation.
(b)
Cash and Cash Equivalents
Cash consists of cash on hand and in banks excluding pledged deposits. The Company considers all highly liquid debt instruments, with initial terms of less than three months to be cash equivalents. As of September 30, 2013 and 2014, there were no cash equivalents.
(c)
Trade Accounts Receivable
Trade accounts receivable are recorded at the invoiced amount, net of allowances for doubtful accounts and sales returns. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing trade accounts receivable. The Company determines the allowance based on historical write-off experience, customer specific facts and economic conditions.
Outstanding accounts receivable balances are reviewed individually for collectability. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.
(d)
Inventories
Inventories are stated at the lower of cost or market. The cost of inventories is determined using the weighted average cost method, and includes expenditures incurred in acquiring the inventories and bringing them to their existing location and condition. In case of finished goods and work in progress, the cost includes an appropriate share of production overhead based on normal operating capacity.
The Company regularly reviews the cost of inventories against their estimated fair market value and records a lower of cost or market write-down for inventories that have costs in their excess of estimated market value.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
2.
Summary of Significant Accounting Policies and Practices (continued)
(e)
Property, Plant and Equipment
Property, plant and equipment (except construction in progress) are stated at cost less accumulated depreciation and impairment charges. Depreciation is calculated based on the straight-line method (after taking into account their respective estimated residual values) over the estimated useful lives of the assets as follows:
The cost and accumulated depreciation of property, plant and equipment sold are removed from the consolidated balance sheets and resulting gains or losses are recognized in the consolidated statements of operations and comprehensive loss.
Construction in progress mainly represents expenditures in respect of the Company’s corporate campus, including offices, factories and staff dormitories, under construction. All direct costs relating to the acquisition or construction of the Company’s corporate campus and equipment, including interest charges on borrowings, are capitalized as construction in progress. No depreciation is provided in respect of construction in progress.
A long-lived asset to be disposed of by abandonment continues to be classified as held and used until it is disposed of.
(f)
Prepaid Land Use Rights
Land use rights are carried at cost and amortized on a straight-line basis over the period of rights of 50 years.
(g)
Foreign Currency Transactions and Translation
The reporting currency of the Company is the United States dollar (“US dollar”). The financial records of the Company’s PRC operating subsidiaries are maintained in their local currency, the Renminbi (“RMB”), which is the functional currency. The financial records of the Company’s subsidiaries established in other countries are maintained in their local currencies. Assets and liabilities of the subsidiaries are translated into the reporting currency at the exchange rates at the balance sheet date, equity accounts are translated at historical exchange rates, and income and expense items are translated using the average rate for the period. The translation adjustments are recorded in accumulated other comprehensive income under shareholders’ equity.
Monetary assets and liabilities denominated in currencies other than the applicable functional currencies are translated into the functional currencies at the prevailing rates of exchange at the balance sheet date. Nonmonetary assets and liabilities are re-measured into the applicable functional currencies at historical exchange rates. Transactions in currencies other than the applicable functional currencies during the period are converted into the functional currencies at the applicable rates of exchange prevailing at the transaction dates. Transaction gains and losses are recognized in the consolidated statements of operations and comprehensive loss.
RMB is not a fully convertible currency. All foreign exchange transactions involving RMB must take place either through the People’s Bank of China (the “PBOC”) or other institutions authorized to buy and sell foreign exchange. The exchange rates adopted for the foreign exchange transactions are the rates of exchange quoted by the PBOC, which are determined largely by supply and demand. Translation of amounts from RMB into US dollars has been made at the following exchange rates for the respective years:
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
2.
Summary of Significant Accounting Policies and Practices (continued)
(h)
Intangible Assets
Intangible assets are stated in the balance sheet at cost less accumulated amortization and impairment, if any. The costs of the intangible assets are amortized on a straight-line basis over their estimated useful lives. The respective amortization periods for the intangible assets are as follows:
(i)
Impairment of Long-lived Assets
Long-lived assets, which include property, plant and equipment, prepaid land use rights and intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Recoverability of long-lived assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset.
(j)
Revenue Recognition
The Company recognizes revenue on product sales when products are delivered and the customer takes ownership and assumes risk of loss, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the sales price is fixed or determinable.
Net sales of products represent the invoiced value of goods sold, net of value added taxes (“VAT”), sales returns, trade discounts and allowances. The Company is subject to VAT which is levied on the majority of the products of Shenzhen BAK, BAK Battery, BAK Tianjin, Dalian BAK Trading and Dalian BAK Power at the rate of 17% on the invoiced value of sales. Output VAT is borne by customers in addition to the invoiced value of sales and input VAT is borne by the Company in addition to the invoiced value of purchases to the extent not refunded for export sales. Provision for sales returns are recorded as a reduction of revenue in the same period that revenue is recognized. The provision for sales returns, which is based on historical sales returns data, is the Company’s best estimate of the amount of goods that will be returned from its customers.
(k)
Cost of Revenues
Cost of revenues consists primarily of material costs, employee compensation, depreciation and related expenses, which are directly attributable to the production of products. Write-down of inventories to lower of cost or market is also recorded in cost of revenues.
(l)
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statement of operations and comprehensive loss in the period that includes the enactment date.
The impact of an uncertain income tax positions on the income tax return must be recognized at the largest amount that is more-likely-than not to be sustained upon audit by the relevant tax authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Interest and penalties on income taxes will be classified as a component of the provisions for income taxes.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
2.
Summary of Significant Accounting Policies and Practices (continued)
(m)
Research and Development and Advertising Expenses
Research and development and advertising expenses are expensed as incurred. Research and development expenses consist primarily of remuneration for research and development staff, depreciation and maintenance expenses of research and development equipment and material costs for research and development. Advertising expenses, included in sales and marketing expenses were insignificant for the years ended September 30, 2013 and 2014.
(n)
Bills Payable
Bills payable represent bills issued by financial institutions to the Company’s vendors. The Company’s vendors receive payments from the financial institutions directly upon maturity of the bills and the Company is obliged to repay the face value of the bills to the financial institutions.
(o)
Government Grants
The Company’s subsidiaries in China receive government subsidies from local Chinese government agencies in accordance with relevant Chinese government policies. In general, the Company presents the government subsidies received as part of other income unless the subsidies received are earmarked to compensate a specific expense, which have been accounted for by offsetting the specific expense, such as research and development expense, interest expenses and removal costs. Unearned government subsidies received are deferred for recognition until the criteria for such recognition could be met.
Grants applicable to land are amortized over the life of the depreciable facilities constructed on it. For research and development expenses, the Company matches and offsets the government grants with the expenses of the research and development activities as specified in the grant approval document in the corresponding period when such expenses are incurred.
(p)
Share-based Compensation
The Company adopted the provisions of ASC Topic 718 which requires the Company to measure and recognize compensation expenses for an award of an equity instrument based on the grant-date fair value. The cost is recognized over the vesting period (or the requisite service period). ASC Topic 718 also requires the Company to measure the cost of a liability-classified award based on its current fair value. The fair value of the award will be re-measured subsequently at each reporting date through the settlement date. Changes in fair value during the requisite service period are recognized as compensation cost over that period. Further, ASC Topic 718 requires the Company to estimate forfeitures in calculating the expense related to stock-based compensation.
The fair value of each option award is estimated on the date of grant using the Black-Scholes Option Valuation Model. The expected volatility was based on the historical volatilities of the Company’s listed common stocks in the United States and other relevant market information. The Company uses historical data to estimate share option exercises and employee departure behavior used in the valuation model. The expected terms of share options granted is derived from the output of the option pricing model and represents the period of time that share options granted are expected to be outstanding. Since the share options once exercised will primarily trade in the U.S. capital market, the risk-free rate for periods within the contractual term of the share option is based on the U.S. Treasury yield curve in effect at the time of grant.
(q)
Retirement and Other Post-retirement Benefits
Contributions to retirement schemes (which are defined contribution plans) are charged to cost of revenues, research and development expenses, sales and marketing expenses and general and administrative expenses in the statement of operations and comprehensive loss as and when the related employee service is provided.
(r)
(Loss) earnings per Share
Basic (loss) earnings per share is computed by dividing net loss by the weighted average number of ordinary shares outstanding during the year. Diluted (loss) earnings per share is computed by dividing net (loss) earnings by the sum of the weighted average number of ordinary shares outstanding and dilutive potential ordinary shares during the year.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
2.
Summary of Significant Accounting Policies and Practices (continued)
(s)
Use of Estimates
The preparation of the consolidated financial statements in accordance with US GAAP requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the recoverability of the carrying amount of long-lived assets; valuation allowance for obsolete inventories, receivables and deferred tax assets; provision for sales returns; valuation of share-based compensation expense; and fair value assessment of financial guarantees. Actual results could differ from those estimates.
(t)
Segment Reporting
The Company uses the “management approach” in determining reportable operating segments. The management approach considers the internal organization and reporting used by the Company’s chief operating decision maker for making operating decisions and assessing performance as the source for determining the Company’s reportable segments. Management, including the chief operating decision maker, reviews operating results solely by monthly revenue of Li-ion rechargeable batteries (but not by sub-product type or geographic area) and operating results of the Company and, as such, the Company has determined that the Company has one operating segment as defined by ASC Topic 280 “Segment Reporting”. Starting from the three-months ended December 31, 2013 and until June 30, 2014, the Company was also engaged in the business segment of property leasing and arrangement (see Note 1).
(u)
Commitments and Contingencies
Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated.
(v)
Recently Issued Accounting Standards
In April 2014, the FASB issued ASU 2014-08 “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360) - Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity”, which changes the threshold for reporting discontinued operations and adds new disclosures. The new guidance defines a discontinued operation as a disposal that “represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.” The standard is required to be adopted by public business entities in annual periods beginning on or after December 15, 2014, and interim periods within those annual periods. Entities may “early adopt” the guidance for new disposals. The Company does not expect that the adoption will have a material impact on its consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)" which clarifies and improves the principles for recognizing revenue and develops a common revenue standard for United States generally accepted accounting principles (U.S. GAAP) and International Financial Reporting Standards (IFRS) that among other things, improves comparability of revenue recognition practices and provides more useful information to users of financial statements through improved disclosure requirements. The amendments in ASU 2014-09 are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. The Company is currently reviewing the effect of ASU 2014-09 on its revenue recognition.
In June 2014, the FASB issued ASU 2014-12, "Compensation - Stock Compensation (Topic 718)" which provides explicit guidance on the treatment of awards with performance targets that could be achieved after the requisite service period. The amendments in ASU 2014-12 are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. The Company does not expect that the adoption will have a material impact on its consolidated financial statements.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
2.
Summary of Significant Accounting Policies and Practices (continued)
(v)
Recently Issued Accounting Standards (continued)
In June 2014, the FASB issued ASU 2014-15, "Presentation of Financial Statements-Going concern (Subtopic 205-40) which provides guidance to an organization’s management, with principles and definitions that are intended to reduce diversity in the timing and content of disclosures that are commonly provided by organizations today in the financial statement footnotes. This guidance in ASU 2014-15 is effective for annual periods ending after December 15, 2016, and interim periods within annual periods beginning after December 15, 2016. Early application is permitted for annual or interim reporting periods for which the financial statements have not previously been issued. The Company does not expect that the adoption will have a material impact on its consolidated financial statements.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s consolidated financial statements upon adoption.
3.
Pledged Deposits
Pledged deposits as of September 30, 2013 and 2014 consisted of the following:
4.
Trade Accounts Receivable, net
Trade accounts receivable as of September 30, 2013 and 2014 consisted of the following:
An analysis of the allowance for doubtful accounts is as follows:
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
5.
Inventories
Inventories as of September 30, 2013 and 2014 consisted of the following:
During the years ended September 30, 2013 and 2014, obsolete inventory write-downs to lower of cost or market of $59,584,817 and $8,752,543, respectively, were charged to cost of revenue.
6.
Prepayments and Other Receivables
Prepayments and other receivables as of September 30, 2013 and 2014 consisted of the following:
(a)
Advance to an unrelated third party was interest-free, unsecured and repayable on demand.
(b)
BAK Canada filed for bankruptcy on March 28, 2013. As of September 30, 2013, its net assets were held under the custody of its trustee.
(c)
As of September 30, the Company advanced to Tianjin BAK New Energy Research Institute Co., Ltd (“Tianjin New Energy”), a related party under the common control of Mr. Xiangqian Li, the Company's CEO, an amount of $885,052 which was interest-free, unsecured and repayable on demand.
(d)
An analysis of the allowance for doubtful accounts is as follows:
7.
Receivables from Former Subsidiaries
Receivable from former subsidiaries as of September 30, 2013 and 2014 consisted of the following:
As of September 30, 2014, receivables from former subsidiaries were interest free, unsecured and repayable on demand.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
8.
Property, Plant and Equipment, net
Property, plant and equipment as of September 30, 2013 and 2014 consisted of the following:
(i)
Depreciation expense for the years ended September 30, 2013 and 2014 is included in the consolidated statements of operations as follows:
(ii)
Construction in progress
Construction in progress as of September 30, 2013 was mainly comprised of capital expenditures for the automation production line of BAK Tianjin. Construction in progress as of September 30, 2014 was mainly comprised of capital expenditures for the construction of the facilities and production lines of Dalian BAK Power.
For the years ended September 30, 2013 and 2014, the Company capitalized interest of $1,678,489 and $388,798 respectively to the cost of construction in progress.
(iii)
Impairment charge
During the course of the Company’s strategic review of its operations, the Company assessed the recoverability of the carrying value of certain property, plant and equipment which resulted in impairment losses of $62.5 million and nil for the years ended September 30, 2013 and 2014, respectively. The impairment charge represented the excess of carrying amounts of the Company’s property, plant and equipment over the estimated fair value of the Company’s production facilities in Shenzhen primarily for the production of aluminum-case cells and lithium polymer cells and Tianjin primarily for the production of high-power lithium batteries.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
9.
Prepaid Land Use Rights, net
(a)
Prepaid land use rights as of September 30, 2013 and 2014 consisted of the followings:
Pursuant to a land use rights acquisition agreement dated August 10, 2014, the Company acquired the rights to use a piece of land with an area of 153,832 m2 in Dalian Economic Zone for 50 years up to August 9, 2064, at a total consideration of $8,646,000 (RMB53.1 million). Other incidental costs incurred totaled $506,400 (RMB3.1 million).
Amortization expenses of the prepaid land use rights were $728,208 and $418,720 for the years ended September 30, 2013 and 2014, respectively.
(b)
Disposal of Tianjin Meicai
In May 2013, management of the Company decided to sell the land use rights and the related construction in progress of the new energy base in Tianjin owned by Tianjin Meicai. On July 12, 2013, BAK Tianjin entered into an equity transfer agreement with Tianjin Zhantuo to transfer all the equity interest of Tianjin Meicai to Tianjin Zhantuo with a consideration of RMB 180 million (approximately $29.3 million). The equity transfer was completed on August 27, 2013 and a gain on disposal of approximately $1.3 million was recognized for the year ended September 30, 2013.
The consideration of RMB180 million (approximately $29.3 million) was repaid as follows:-
-
Offset against other short-term loans of RMB15,688,200 (approximately $2.6 million) owed to Tianjin Aifuyi Auto Parts Co., Ltd. and RMB30,000,000 (approximately $4.9 million) owed by BAK Tianjin to Tianjin Zhantuo;
-
Offset against an amount owed by BAK Tianjin to Tianjin Meicai in the amount of RMB91,635,000 (approximately $15.0 million); and
-
Remaining balance of RMB42,676,800 (approximately $7.0 million) payable in cash within 30 days upon completion. As of September 30, 2013, an amount of RMB3 million (approximately $0.5 million) had been paid. The remaining balance of RMB39.7 million (approximately $6.5 million) remained outstanding as of September 30, 2013 (Note 6).
10.
Intangible Assets, net
Intangible assets as of September 30, 2013 and 2014 consist of the following:
Intangible assets represented the trademarks, computer software and technology used for battery production and research.
Amortization expenses were $285,044 and $154,662 for the years ended September 30, 2013 and 2014 respectively.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
11.
Short-term Bank Loans
As of the September 30, 2014, the Company borrowed $4,887,216 (RMB30 million) from Bank of Dandong for a period from August 19, 2014 to August 18, 2015, bearing interest at 7.8% per annum. The loan was guaranteed by Mr. Xiangqian Li, the Company’s CEO and Shenzhen BAK, a former subsidiary of the Company.
As of September 30, 2013, the Company had several short-term bank loans with aggregate outstanding balances of $151,404,677. The loans were primarily obtained for general working capital, carried at interest rates ranging from 4.44% to 15. 0% per annum, and had maturity dates ranging from 9 to 12 months. The loans were guaranteed by Mr. Xiangqian Li, the Company’s CEO, and Ms. Xiaoqiu Yu, the wife of the CEO, who did not receive any compensation for acting as a guarantor. The loans were also guaranteed by Shenzhen BAK, Tianjin New Energy, BAK Tianjin and BAK International. These facilities were secured by the Company’s assets with the following carrying values:
During the years ended September 30, 2013 and 2014, interest expenses of $12,720,653 and $5,737,093, respectively, was incurred on the Company's bank borrowings.
12.
Other Short-term Loans, Accrued Expenses and Other Payables
(i)
Other short-term loans as of September 30, 2013 and 2014 consisted of the following:
(a)
The advance from Tianjin New Energy was unsecured, non-interest bearing and repayable on demand.
(b)
As of September 30, 2013 and 2014, the Company had advances from unrelated parties of $28,282,322 and $4,900,460, respectively, which were unsecured, non- interest bearing and repayable on demand except for:
-
A loan from Shenzhen Huo Huang Import & Export Co., Ltd. which was interest bearing at 18% per annum;
-
A loan from Gold State Securities Limited which was interest bearing at 2.31% per annum, secured by fixed deposits of the same amount plus interest placed with a bank (Note 3) and guaranteed by Mr. Xiangqian Li; and
-
A loan of $3,267,387 (RMB20 million) from Shenzhen Wellgain Industrial Co., Ltd. which was interest bearing at 0.5% per month and repayable by July 9, 2013, guaranteed by Mr Xiangqian Li and Mr. Chunzhi Zhang. The Company repaid principal of $2,450,540 and default interest of $201,958 prior to September 30, 2013, and repaid the remaining balance of $816,847 on October 21, 2013.
During the years ended September 30, 2013 and 2014, interest expense of $480,416 and $11,452,109 (including loan interest of $8.3 million accruing on the loans from Mr. Wang as described in Note 1), respectively, was incurred on the Company’s other short-term loans.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
12.
Other Short-term Loans, Accrued Expenses and Other Payables (continued)
(ii)
Accrued expenses and other payables as of September 30, 2013 and 2014 consisted of the following:
(c)
Other payables and accruals as of September 30, 2013 and 2014 included a payable for liquidated damages of approximately $1,210,000.
On August 15, 2006, the SEC declared effective a post-effective amendment that the Company had filed on August 4, 2006, terminating the effectiveness of a resale registration statement on Form SB-2 that had been filed pursuant to a registration rights agreement with certain shareholders to register the resale of shares held by those shareholders. The Company subsequently filed Form S-1 for these shareholders. On December 8, 2006, the Company filed its Annual Report on Form 10-K for the year ended September 30, 2006 (the “2006 Form 10-K”). After the filing of the 2006 Form 10-K, the Company’s previously filed registration statement on Form S-1 was no longer available for resale by the selling shareholders whose shares were included in such Form S-1. Under the registration rights agreement, those selling shareholders became eligible for liquidated damages from the Company relating to the above two events totaling approximately $1,051,000. As of September 30, 2013 and 2014, no liquidated damages relating to both events have been paid.
On November 9, 2007, the Company completed a private placement for the gross proceeds to the Company of $13,650,000 by selling 3,500,000 shares of common stock at the price of $3.90 per share. Roth Capital Partners, LLC acted as the Company’s exclusive financial advisor and placement agent in connection with the private placement and received a cash fee of $819,000. The Company may have become liable for liquidated damages to certain shareholders whose shares were included in a resale registration statement on Form S-3 that the Company filed pursuant to a registration rights agreement that the Company entered into with such shareholders in November 2007. Under the registration rights agreement, among other things, if a registration statement filed pursuant thereto was not declared effective by the SEC by the 100th calendar day after the closing of the Company’s private placement on November 9, 2007, or the “Effectiveness Deadline”, then the Company would be liable to pay partial liquidated damages to each such investor of (a) 1.5% of the aggregate purchase price paid by such investor for the shares it purchased on the one month anniversary of the Effectiveness Deadline; (b) an additional 1.5% of the aggregate purchase price paid by such investor every thirtieth day thereafter (pro rated for periods totaling less than thirty days) until the earliest of the effectiveness of the registration statement, the ten-month anniversary of the Effectiveness Deadline and the time that the Company is no longer required to keep such resale registration statement effective because either such shareholders have sold all of their shares or such shareholders may sell their shares pursuant to Rule 144 without volume limitations; and (c) 0.5% of the aggregate purchase price paid by such investor for the shares it purchased in our November 2007 private placement on each of the following dates: the ten-month anniversary of the Effectiveness Deadline and every thirtieth day thereafter (prorated for periods totaling less than thirty days), until the earlier of the effectiveness of the registration statement and the time that the Company no longer is required to keep such resale registration statement effective because either such shareholders have sold all of their shares or such shareholders may sell their shares pursuant to Rule 144 without volume limitations. Such liquidated damages would bear interest at the rate of 1% per month (prorated for partial months) until paid in full.
On December 21, 2007, pursuant to the registration rights agreement, the Company filed a registration statement on Form S-3, which was declared effective by the SEC on May 7, 2008. As a result, the Company estimated liquidated damages amounting to $561,174 for the November 2007 registration rights agreement. As of September 30, 2013 and 2014, the Company had settled the liquidated damages with all the investors and the remaining provision of approximately $159,000 was included in other payables and accruals.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
13.
Deferred Revenue
As of September 30, 2013, deferred revenue mainly represents a government grant subsidy of $9.2 million (RMB56 million) for costs of land use rights relating to BAK Industrial Park, which is amortized on a straight-line basis over the estimated useful lives of the depreciable facilities constructed thereon of 35 years. As of September 30, 2013, non-current deferred revenue was $7,560,386 and current portion of deferred revenue of $346,509 was included in accrued expenses and other payable (Note 12 (ii)).
On October 17, 2014, the Company received a subsidy of $7.52 million (RMB46,150,000) from the agreement with the Management Committee dated July 2, 2014 for costs of land use rights relating to the new manufacturing site in in Dalian. The subsidy will be amortized on a straight-line basis over the estimated useful lives of the depreciable facilities constructed thereon.
14.
Deferred Government Grants
Deferred government grants as of September 30, 2013 and 2014 consist of the following:
The Management Committee provided a subsidy of RMB150 million to finance the removal of the Company’s production facilities to Dalian. As of September 30, 2014, removal expenditures of $1,018,016 were incurred and included in construction in progress. The Company expects that the removal will be completed in January 2015.
The Company recognizes the government subsidies as income or offsets them against the related expenditures when there are no present or future obligations for the subsidized projects.
15.
Income Taxes, Deferred Tax Assets and Deferred Tax Liabilities
(a)
Income taxes in the consolidated statements of comprehensive loss
The Company’s provision for income taxes consisted of:
United States Tax
China BAK is subject to a statutory tax rate of 35% under United States of America tax law. No provision for income taxes in the United States or elsewhere has been made as China BAK had no taxable income for the years ended September 30, 2013 and 2014.
Canada States Tax
BAK Canada was subject to a statutory tax rate of 38% under Canada tax law. No provision for income taxes in Canada has been made as BAK Canada had no taxable income for the years ended September 30, 2013 and 2014.
German States Tax
BAK Europe was subject to a 25% statutory tax rate under Germany tax law. No provision for income taxes in Germany has been made as BAK Europe had no taxable income for the years ended September 30, 2013 and 2014.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
15.
Income Taxes, Deferred Tax Assets and Deferred Tax Liabilities (continued)
India Tax
BAK India was subject to a 30% statutory tax rate under India tax law. No provision for income taxes in India has been made as BAK India had no taxable income for the years ended September 30, 2013 and 2014.
Hong Kong Tax
BAK Asia and BAK International are subject to Hong Kong profits tax rate of 16.5% . These two companies did not incur any Hong Kong profits tax during the years ended September 30, 2013 and 2014 as there was no taxable income for BAK Asia and BAK International during these periods.
PRC Tax
Shenzhen BAK was recognized as a new and high technology enterprise on October 31, 2011 and is entitled to a preferential enterprise income tax rate of 15% for each of the fiscal years 2012, 2013 and is subject to 25% since the fiscal year 2014.
All the other subsidiaries in China are subject to an income tax rate of 25%.
A reconciliation of the provision for income taxes determined at the statutory income tax rate to the Company's income taxes is as follows:
As of September 30, 2013 and 2014, the Company’s U.S. entity had net operating loss carry forwards of $2,511,374 and $35,318,443, respectively, available to reduce future taxable income which will expire in various years through 2034 and the Company’s PRC subsidiaries had net operating loss carry forwards of $105,668,004 and $690,821 which will expires in various years through 2019. Management believes it is more likely than not that the Company will not realize these potential tax benefits as these operations will not generate any operating profits in the foreseeable future. As a result, a valuation allowance was provided against the full amount of the potential tax benefits.
(b)
Deferred tax assets and deferred tax liabilities
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities as of September 30, 2013 and, 2014 are presented below:
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
15.
Income Taxes, Deferred Tax Assets and Deferred Tax Liabilities (continued)
As of September 30, 2013 and 2014, the Company had no material unrecognized tax benefits which would favorably affect the effective income tax rates in future periods and does not believe that there will be any significant increases or decreases of unrecognized tax benefits within the next twelve months. No interest or penalties relating to income tax matters have been imposed on the Company during the years ended September 30, 2013 and 2014, and no provision for interest and penalties is deemed necessary as of September 30, 2013 and 2014.
According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational errors made by the taxpayer or its withholding agent. The statute of limitations extends to five years under special circumstances, which are not clearly defined. In the case of a related party transaction, the statute of limitations is ten years. There is no statute of limitations in the case of tax evasion.
16.
Share-based Compensation
(i)
Options
The Company grants share options to officers and employees and restricted shares of common stock to its non-employee directors as rewards for their services.
Stock Option Plan
In May 2005, the Board of Directors adopted the China BAK Battery, Inc. 2005 Stock Option Plan (the “Plan”). The Plan originally authorized the issuance of up to 800,000 shares of the Company’s common stock, pursuant to stock options granted under the Plan, or as grants of restricted stock. The exercise price of 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. Fair market value is determined at the discretion of the designated committee on the basis of reported sales prices for the Company’s common stock over a ten-business-day period ending on the grant date. The Plan will terminate on May 16, 2055. On July 28, 2008, the Company’s stockholders approved certain amendments to the Plan, including an amendment increasing the total number of shares available for issuance under the Plan to 1,600,000.
On June 22, 2009, the Compensation Committee of the Company’s Board of Directors recommended and approved the grant of options to purchase 385,640 shares of the Company’s common stock to certain key employees, officers and consultants with an exercise price of $14.05 per share and a contractual life of 7 years. In accordance with the vesting provisions of the grants, the options will become vested and exercisable over five years in twenty equal quarterly installments on the first day of each fiscal quarter beginning on October 1, 2009.
A summary of share option plan activity for these options during the years ended September 30, 2013 and 2014 is presented below:
(1)
The intrinsic values of option at September 30, 2014 was zero since the per share market value of common stock of $2.99 was lower than the exercise price of the option of $14.05 per share.
The weighted average grant-date fair value of options granted on June 22, 2009 was $12.30 per share. The Company recorded non-cash share-based compensation expense of $259,207 and of $65,147 for the years ended September 30, 2013 and 2014, respectively.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
16.
Share-based Compensation (continued)
(i)
Options (continued)
The fair value of the above option awards granted on June 22, 2009 was estimated on the date of grant using the Black-Scholes Option Valuation Model that uses the following assumptions.
As of September 30, 2014, there were no unrecognized compensation costs related to the above non-vested share options.
On April 8, 2010, the Compensation Committee of the Company’s Board of Directors recommended and approved the grant of options to purchase 20,000 shares of the Company’s common stock to certain key management with an exercise price of $12.15 per share and a contractual life of 7.5 years. In accordance with the vesting provisions of the grants, the options will become vested and exercisable in eight equal installments beginning on each quarter after September 30, 2010.
A summary of share option plan activity for these options during the years ended September 30, 2013 and 2014 is presented below:
The weighted average grant-date fair value of options granted on April 8, 2010 was $7.05 per share. The Company recorded non-cash share-based compensation expense of $8,703 and nil for the years ended September 30, 2013 and 2014, respectively, in respect of share options granted on April 8, 2010 which was allocated to research and development expense.
The fair value of the above option awards granted on April 8, 2010 was estimated on the date of grant using the Black-Scholes Option Valuation Model that uses the following assumptions.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
16.
Share-based Compensation (continued)
(ii)
Restricted Shares
Pursuant to the Plan and in accordance with the China BAK Battery, Inc. Compensation Plan for Non-Employee Directors, the Compensation Committee of the Company’s Board of Directors recommended and approved the grant of 100,000 restricted shares to the Chief Executive Officer, Mr. Xiangqian Li with a fair value of $14.05 per share on June 22, 2009. In accordance with the vesting schedule of the grant, the restricted shares will vest in twenty equal quarterly installments on the first day of each fiscal quarter beginning on October 1, 2009.
The Company recorded non-cash share-based compensation expense of $91,096 and $23,598 for the years ended September 30, 2013 and 2014, respectively, in respect of the restricted shares granted on June 22, 2009, which was allocated to general and administrative expenses.
As of September 30, 2014, there was no unrecognized stock-based compensation associated with these restricted shares granted to Mr. Xiangqian Li.
As the Company itself is an investment holding company which is not expected to generate operating profits to realize the tax benefits arising from its net operating loss carried forward, no income tax benefits were recognized for such stock-based compensation cost under stock option plan for the years ended September 30, 2013 and 2014.
17.
Net Loss Per Share
The following is the calculation of net (loss) profit per share:
For the year ended September 30, 2014, the outstanding 4,200 stock options and 100,000 restricted shares were anti-dilutive and excluded from diluted (loss) earnings per share.
For the year ended September 30, 2013, the outstanding 156,560 stock options and 100,000 restricted shares were anti-dilutive and excluded from diluted (loss) earnings per share.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
18.
Fair Value of Financial Instruments
ASC Topic 820, Fair Value Measurement and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This topic also establishes a fair value hierarchy, which requires classification based on observable and unobservable inputs when measuring fair value. Certain current assets and current liabilities are financial instruments. Management believes their carrying amounts are a reasonable estimate of fair value because of the short period of time between the origination of such instruments and their expected realization and, if applicable, their current interest rates are equivalent to interest rates currently available. The three levels of valuation hierarchy are defined as follows:
Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.
Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The carrying amounts of financial assets and liabilities, such as cash and cash equivalents, pledged deposits, trade accounts receivable, other receivables, short-term loans, accounts and bills payable and other payables approximate their fair values because of the short maturity of these instruments or the rate of interest of these instruments approximate the market rate of interest.
19.
Commitments and Contingencies
(i)
Capital Commitments
As of September 30, 2013 and 2014, the Company had the following contracted capital commitments:
(ii)
Guarantees
Prior to the disposal of BAK International (Note 1), in order to secure the supplies of certain raw materials and equipment and upon the request of suppliers, the Company had given guarantees of bank borrowings with a maximum obligation period of from one to three years to certain parties to the maximum extent of $31.0 million (including $4.9 million to a related party) as of September 30, 2013. The Company did not given any guarantees after the foreclosure of BAK International.
The Company assessed the performance risk of the guarantees and the fair value of the obligation arising from the guarantees. Except that a net loss arising from loan guarantee of Shenzhen Langjin Technology Development Company Limited of $5,424 was recognized and included in other income (expense) for the year ended September 30, 2013, no obligations in respect of the guarantees were recognized for the years ended September 30, 2013 and 2014.
(iii)
Outstanding Discounted Bills and Transferred Bills
Prior to the disposal of BAK International (Note 1), from time to time the Company factored bills receivable to banks and endorsed the bank acceptance bills received to its suppliers, vendors or other parties for settlement of its liabilities to these creditors. At the time of the factoring and transfer, all rights and privileges of holding the receivables are transferred to the banks and the creditors. The Company removes the assets from its books and records a corresponding expense for the amount of the discount.
The Company's outstanding discounted and transferred bills as of September 30, 2013 and 2014 are summarized as follows:
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
19.
Commitments and Contingencies (continued)
(iv)
Litigation
From time to time, the Company may become involved in various lawsuits and legal proceedings, which arise, in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these, or other matters, may arise from time to time that may harm our business. Other than the legal proceeding set forth below, the Company is currently not aware of any such legal proceedings or claims that the Company believe will have an adverse effect on our business, financial condition or operating results:
China BAK Battery, Inc. has been named as a second defendant in the case of Safeco Ins. Co. of Am. v. Hewlett-Packard Co. et al., filed in the Superior Court of the State of California, County of Ventura. It is an action for negligence and strict product liability. The plaintiff (“Safeco”) alleges that a product manufactured by the Company was used in a Hewlett Packard laptop, which malfunctioned and caused fire damage in the home of a consumer (the plaintiff's insured). The total damages sought are $126,978, plus interest and fees. On September 24, 2014, Safeco, Defendant Hewlett Packard and the Company agreed to release all claims against each other arising out of the incident described above. Safeco and Hewlett Packard dismissed their complaints against the Company with prejudice. Pursuant to the settlement agreement, the Company dismissed with prejudice its cross-complaint against Hewlett Packard. Further, pursuant to the settlement agreement, Safeco has agreed to indemnify and defend the Company for any further actions/ claims against the Company relating to this incident.
An individual named Steven R. Ruth filed suit against China BAK Battery, Inc. in United States District Court for the Western District of Texas in 2013 alleging breach of contract. The company did not receive notice of this lawsuit and the plaintiff sought a default judgment, which the court granted in January 2014. Accordingly, the court entered judgment in favor of Mr. Ruth in the amount of $553,773.51 inclusive of costs and attorneys’ fees (the “First Judgment”).
Subsequent to the entry of the First Judgment, Mr. Ruth has made efforts to have the judgment enforced in Canada. On September 19, 2014, Mr. Ruth also filed a second complaint in the United States District Court for the Western District of Texas. On November 12, 2014, a second default judgment was entered against the Company in the amount of $553,773.51 for the First Judgment plus an additional $7,550 in attorneys’ fees. The second judgment is inclusive of the amounts ordered in the First Judgment. BAK International thereafter agreed to indemnify the Company from any expenses, losses and damages that were incurred and will incur to the Company due to the lawsuit filed by Mr. Ruth.
20.
Concentrations and Credit Risk
(a)
Concentrations
The Company had two customers that individually comprised 10% or more of net revenue for the years ended September 30, 2013 and 2014 as follows:
* Comprised less than 10% of net revenue for the respective year.
The Company had three customers that individually comprised 10% or more of accounts receivable as of September 30, 2013 and 2014 as follows:
** Comprised less than 10% of accounts receivable as of the respective year end date.
After the disposal of BAK International (Note 1) and prior to the completion of the new manufacturing site in Dalian, the Company continued its business and continued to generate revenues from sale of batteries via subcontracting the production to BAK Tianjin, a former subsidiary. From July 1, 2014 to September 30, 2014, the Company purchases inventories of $3.3 million from BAK Tianjin.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
20.
Concentrations and Credit Risk (continued)
(b)
Credit Risk
Financial instruments that potentially subject the Company to a significant concentration of credit risk consist primarily of cash and cash equivalents and pledged deposits. As of September 30, 2013 and 2014, substantially all of the Company’s cash and cash equivalents and pledged deposits were held by major financial institutions located in the PRC, which management believes are of high credit quality.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
21.
Segment Information
The Company used to engage in one business segment, 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 manufactured five types of Li-ion rechargeable batteries: aluminum-case cell, battery pack, cylindrical cell, lithium polymer cell and high-power lithium battery cell. The Company’s products are sold to packing plants operated by third parties primarily for use in mobile phones and other electronic devices. Starting from the three months ended December 31, 2013 and until June 30, 2014, the Company was also engaged in the business segment of property lease and management (see Note 1). Net revenues from continuing operations for the years ended September 30, 2013 and 2014 were as follows:
Net revenues by product:
Net revenues by geographic area:
Substantially all of the Company’s long-lived assets are located in the PRC.
22.
Related Party Transactions
Apart from disclosed elsewhere in these financial statements, the Company had the following transactions with related parties:
Mr. Xiangqian Li, the Company’s CEO, is the ultimate shareholder and a director of this related company.
China BAK Battery, Inc. and subsidiaries
Notes to the consolidated financial statements
As of September 30, 2013 and 2014
(In US$ except for number of shares)
23.
China BAK Battery, Inc (Parent Company)
Under PRC regulations, subsidiaries in PRC (“the PRC subsidiaries”) may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC GAAP. In addition, the PRC subsidiaries are required to set aside at least 10% of their after-tax net profits each year, if any, to fund the statutory general reserve until the balance of the reserves reaches 50% of their registered capital. The statutory general reserves are not distributable in the form of cash dividends to the Company and can be used to make up cumulative prior year losses, if any, and may be converted into share capital by the issue of new shares to shareholders in proportion to their existing shareholdings, or by increasing the par value of the shares currently held by them, provided that the reserve balance after such issue is not less than 25% of the registered capital. As of September 30, 2013, additional transfers of $86,789,695 were required for Shenzhen BAK, BAK Battery, BAK Tianjin and Dalian BAK Trading before the statutory general reserve reached 50% of the registered capital of the PRC subsidiaries. As of September 30, 2014, additional transfers of $15,250,000 were required for Dalian BAK Power and Dalian BAK Trading before the statutory general reserve reached 50% of the registered capital of the PRC subsidiaries. As of September 30, 2013 and 2014, $7,786,157 and nil had been appropriated from retained earnings and set aside for statutory general reserves by the PRC subsidiaries. Dalian BAK Power and BAK Dalian did not have after-tax net profits since its incorporation and therefore no appropriation was made to fund its statutory general reserve as of September 30, 2013 and 2014.
Schedule I of Article 5-04 of Regulation S-X requires the condensed financial information of the registrant (Parent Company) to be filed when the restricted net assets of consolidated subsidiaries exceed 25 percent of consolidated net assets as of the end of the most recently completed fiscal year. For purposes of this test, restricted net assets of consolidated subsidiaries shall mean that amount of the registrant’s proportionate share of net assets of consolidated subsidiaries (after intercompany eliminations) which as of the end of the most recent fiscal year may not be transferred to the parent company by subsidiaries in the form of loans, advances or cash dividends without the consent of a third party (i.e., lender, regulatory agency, foreign government, etc.).
The condensed parent company financial statements have not been prepared in accordance with Rule 12-04, Schedule I of Regulation S-X as the PRC subsidiaries recorded net liabilities as of September 30, 2013 and 2014.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: January 13, 2015
CHINA BAK BATTERY, INC.
By: /s/ Xiangqian Li
Xiangqian Li
Chief Executive Officer
By: /s/ Wenwu Wang
Wenwu Wang
Interim Chief Financial Officer
In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Xiangqian Li
Chairman, Chief Executive Officer and Interim Chief Financial Officer (Principal Executive Officer, Principal Financial and Accounting Officer)
January 13, 2015
Xiangqian Li
/s/ Wenwu Wang
Interim Chief Financial Officer (Principal Financial and Accounting Officer)
January 13, 2015
Wenwu Wang
/s/ Guosheng Wang
Director
January 13, 2015
Guosheng Wang
/s/ Chunzhi Zhang
Director
January 13, 2015
Chunzhi Zhang
/s/ Martha C. Agee
Director
January 13, 2015
Martha C. Agee
/s/ Jianjun He
Director
January 13, 2015
Jianjun He
EXHIBIT INDEX
* Filed herewith