10QSB/A 1 bak10qsba033105.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB/A Amendment No. 1 [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2005 000-49712 --------- (Commission File Number) CHINA BAK BATTERY, INC. ----------------------- (Exact name of registrant as specified in its charter) Nevada ------ (State or other jurisdiction of Incorporation) 88-0442833 ---------- (IRS Employer Identification No.) BAK Industrial Park No. 1 BAK Street Kuichong Town, Lunggang District Shenzhen, People's Republic of China 518119 ------------------------------------------- (Address of principal executive offices) (Zip Code) (86 755) 897-70060 ------------------ (Issuer telephone number, including area code) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for at least the past 90 days. [X] Yes [ ] No As of May 12, 2005, 40,978,533 shares of the Issuer's $.001 par value common stock were outstanding. Transitional Small Business Disclosure Format: [ ]Yes [X] No Explanatory Statement This Amendment No. 1 (the "Amendment") to the Quarterly Report on Form 10-QSB of China BAK Battery, Inc. (the "Company") for the quarterly period ended March 31, 2005 amends the Quarterly Report on Form 10-QSB for the quarterly period ended March 31, 2005 originally filed on May 16, 2005 (the "Original Filing"). The Company has filed this Amendment to amend Items 1 and 2 of Part I of the Original Filing for the following reasons. As a result of comments received from the Securities and Exchange Commission ("the Commission") in connection with another filing with the Commission by the Company, the Company has amended its consolidated balance sheet as of March 31, 2005, the consolidated statements of operations for the three months and six months ended March 31, 2005, the consolidated statement of changes in stockholders' equity for the six months ended March 31, 2005, the consolidated statements of cash flows for the three months and six months ended March 31, 2005, and extended or modified certain notes to the consolidated financial statements as of such dates and for such periods to provide additional information to reflect retroactively that 1,152,458 shares of common stock of the Company were outstanding immediately prior to the exchange of shares of the Company's common stock for the outstanding shares of BAK International Co., Ltd. and the resulting recapitalization that occurred on January 20, 2005. The restatement had no effect on total stockholders' equity in the consolidated balance sheet as of March 31, 2005 or the consolidated statements of stockholders' equity for the six months ended March 31, 2005. As a result of further comments from the Commission in connection with such other filing with the Commission by the Company, the Company has amended the consolidated statements of operations for the three months and six months ended March 31, 2005 and 2004 to reclassify depreciation and amortization expense from a separate item in operating expenses into cost of goods sold, selling expenses and general and administrative expenses. The effect of the restatement is to decrease gross profit in each of the periods presented. This restatement had no effect on operating income or net income in any of the periods presented. The Company is also filing this Amendment to provide in Item 3 of Part I its conclusion regarding its reevaluation of its disclosure controls and procedures pursuant to Rules 13a - 15(e) and 15(d) - 15(e) of the Securities Exchange Act of 1934, as amended. Pursuant to Rule 12b-15 under the Securities Exchange Act of 1934, as amended, the complete text of Items 1, 2 and 3 of Part I, as amended are set forth below. The remainder of the Original Filing is reproduced in this Amendment without further amendment. This Amendment speaks as of the date of the Original Filing. This Amendment should be read together with other documents that the Company has filed with the Securities and Exchange Commission subsequent to the filing of the Original Filing. Information in such reports and documents updates and supersedes certain information contained in this Amendment. The filing of this Amendment shall not be deemed an admission that the Original Filing, when made, included any known, untrue statement of material fact or knowingly omitted to state a material fact necessary to make a statement made therein not misleading. TABLE OF CONTENTS PART I - FINANCIAL INFORMATION PAGE ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS...................................1 Consolidated Balance Sheets as of March 31, 2005 (Unaudited) and September 30, 2004 ..........................................1 Consolidated Statement of Operations For the Three Months Ended March 31, 2005 and 2004 (Unaudited)........................3 Consolidated Statement of Operations For the Six Months Ended March 31, 2005 and 2004 (Unaudited)........................4 Consolidated Statements of Stockholders' Equity (Unaudited).........5 Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2004 (Unaudited)........................7 Consolidated Statements of Cash Flows for the Six Months Ended March 31, 2005 and 2004 (Unaudited)........................9 Notes to Consolidated Financial Statements (Unaudited).............11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION............................................23 ITEM 3. CONTROLS AND PROCEDURES............................................29 PART II - OTHER INFORMATION...................................................29 ITEM 6. EXHIBITS...........................................................29 SIGNATURES....................................................................31 i CHINA BAK BATTERY, INC. (Formerly known as Medina Coffee, Inc.) and Subsidiary Consolidated Balance Sheets As of March 31, 2005 and September 30, 2004 (Amounts Expressed in US Dollars) (Unaudited) March 31, September 30, 2005 2004 $ $ ------------- ------------- Assets Restated (Audited) Current Assets Cash 10,886,298 3,212,176 Cash -Restricted 10,555,838 7,120,069 Accounts Receivable, Net 30,717,771 20,999,561 Inventories 12,125,092 29,535,985 Prepaid Expenses 1,517,750 1,330,645 Notes Receivable 244,460 18,122 Accounts Receivable - Related Party 561,989 911,093 ------------- ------------- Total Current Assets 66,609,198 63,127,651 ------------- ------------- Long-Term Assets Property, Plant, & Equipment 22,602,319 19,875,583 Construction in Progress 31,811,026 23,656,190 Land Use Rights 4,029,038 4,029,038 Less Accumulated Depreciation (3,868,270) (2,370,774) ------------- ------------- Long-term Assets, Net 54,574,113 45,190,037 ------------- ------------- Other Assets Other Receivables 149,469 225,972 Intangible Assets, Net 50,056 58,362 ------------- ------------- Total other 199,525 284,334 ------------- ------------- Total Assets 121,382,836 108,602,022 ============= ============= 1 Liabilities and Stockholder's Equity Current Liabilities Accounts Payable 17,810,106 23,570,087 Bank Loans, Short Term 28,876,941 27,304,162 Short Term Loans -- 1,812,316 Notes Payable, Other 25,222,575 20,772,559 Land Use Rights Payable 3,751,028 3,750,756 Construction Costs Payable 2,549,304 6,347,846 Customer Deposits 208,450 369,390 Accrued Expenses 3,388,537 5,247,656 Other Liabilities 436,078 181,223 ------------ ------------ Total Current Liabilities 82,243,019 89,355,995 ------------ ------------ Contingencies and Commitments (Note 6) Stockholders' Equity Capital Stock-$.001 Par Value; 40,978 31,226 100,000,000 Shares Authorized; 40,978,533 and 31,225,642 Shares Issued and outstanding at March 31, 2005 and September 30, 2004, respectively Additional Paid In Capital 27,572,874 12,052,845 Accumulated Comprehensive Income (Loss) (1,669) (144) Reserves 2,323,673 1,724,246 Retained Earnings 9,203,961 5,437,854 ------------ ------------ 39,139,817 19,246,027 ------------ ------------ Total Liabilities and Stockholders' Equity 121,382,836 108,602,022 ============ ============ The accompanying notes are an integral part of these consolidated financial statements. 2 CHINA BAK BATTERY, INC. (Formerly known as Medina Coffee, Inc.) and Subsidiary Consolidated Statements of Operation For the Three Months Ended March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 2005 2004 $ $ ---------- ---------- Restated Restated Revenues, Net of Returns 25,878,407 16,166,081 Cost of Goods Sold 20,310,291 12,663,035 ---------- ---------- Gross Profit 5,568,116 3,503,046 ---------- ---------- Expenses: Selling Expense 1,018,113 405,381 General and Administrative Expenses 723,144 1,452,499 Research and Development 165,770 114,498 Bad Debts Expense 294,252 119,881 ---------- ---------- Total Expenses 2,201,279 2,092,259 ---------- ---------- Operating Income 3,366,837 1,410,787 Other Expense Finance Costs 572,064 107,308 Other Expense 8,759 5,559 ---------- ---------- Net Income Before Provision for Income Taxes 2,786,014 1,297,920 Provision for Income Taxes 219,776 97,394 ---------- ---------- Net Income 2,566,238 1,200,526 ========== ========== Net Income per Share - Basic and Diluted 0.07 0.04 ========== ========== Weighted Average Shares Outstanding 38,811,224 31,225,642 ========== ========== The accompanying notes are an integral part of these consolidated financial statements. 3 CHINA BAK BATTERY, INC. (Formerly known as Medina Coffee, Inc.) and Subsidiary Consolidated Statements of Operation For the Six Months Ended March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 2005 2004 $ $ ---------- ---------- Restated Restated Revenues, Net of Returns 51,004,672 31,750,468 Cost of Goods Sold 41,053,745 24,829,526 ---------- ---------- Gross Profit 9,950,927 6,920,942 ---------- ---------- Expenses: Selling Expense 1,825,979 840,418 General and Administrative Expenses 1,874,877 1,955,848 Research and Development 185,791 206,305 Bad Debts Expense 345,487 107,595 ---------- ---------- Total Expenses 4,232,134 3,110,166 ---------- ---------- Operating Income 5,718,793 3,810,776 Other Expense Finance Costs 961,714 157,980 Other Expense 24,879 14,558 ---------- ---------- Net Income Before Provision for Income Taxes 4,732,200 3,638,238 Provision for Income Taxes 363,842 97,394 ---------- ---------- Net Income 4,368,358 3,540,844 ========== ========== Net Income per Share - Basic and Diluted 0.12 0.11 ========== ========== Weighted Average Shares Outstanding 34,976,754 31,225,642 ========== ========== The accompanying notes are an integral part of these consolidated financial statements. 4
CHINA BAK BATTERY, INC. (Formerly Known as Medina Coffee, Inc.) and Subsidiary Consolidated Statements of Changes in Stockholders' Equity For The Six Months Ended March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) Additional Paid-In Number of Par Value Capital Shares $ $ ------------ ------------ ------------ Restated Restated Restated Balance - September 30, 2003 31,225,642 31,226 1,176,927 Capital Contribution -- -- 10,873,899 Net Income (Loss) -- -- -- Transfer to Reserve -- -- -- Deemed Distribution to Shareholders - -- -- -- Intangible Assets Foreign Currency Translation -- -- -- ------------ ------------ ------------ Balance - March 31, 2004 31,225,642 31,226 12,050,826 ------------ ------------ ------------ Balance September 30, 2004 31,225,642 31,226 12,052,845 Recapitalization 1,152,458 1,152 -- Contribution of Cash by Stockholders 8,600,433 8,600 16,991,400 Contribution of Cash from Stockholders Acquiring Shares of BAK International -- -- 11,500,000 Distribution of Cash to Stockholders in Connection with Acquisition of Shares of BAK Battery -- -- (11,500,000) Cost of Raising Capital -- -- (1,471,371) Net Income -- -- -- Transfer to Reserves -- -- -- Foreign Currency Translation -- -- -- ------------ ------------ ------------ Balance - March 31, 2005 40,978,533 40,978 27,572,874 ============ ============ ============ The accompanying notes are an integral part of these consolidated financial statements. 5 CHINA BAK BATTERY, INC. (Formerly Known as Medina Coffee, Inc.) and Subsidiary Consolidated Statements of Changes in Stockholders' Equity For The Six Months Ended March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) - Continued - Comprehensive Retained Income Stockholders Earnings Reserves (Loss) Equity $ $ $ $ ------------ ------------ ------------ ------------ Restated Restated Balance - September 30, 2003 3,630,298 651,583 (49) 5,489,985 Capital Contribution -- -- -- 10,873,899 Net Income (Loss) 3,540,843 -- -- 3,540,843 Transfer to Reserve (514,404) 514,404 -- -- Deemed Distribution to Shareholders - -- -- Intangible Assets (3,866,088) -- -- (3,866,088) Foreign Currency Translation -- -- 49 49 ------------ ------------ ------------ ------------ Balance - March 31, 2004 2,790,649 1,165,987 -- 16,038,688 ------------ ------------ ------------ ------------ Balance September 30, 2004 5,437,854 1,724,246 (144) 19,246,027 Recapitalization (2,824) -- -- (1,672) Contribution of Cash by Stockholders -- -- -- 17,000,000 Contribution of Cash from Stockholders Acquiring Shares of BAK International -- -- -- 11,500,000 Distribution of Cash to Stockholders in Connection with Acquisition of Shares of BAK Battery -- -- -- (11,500,000) Cost of Raising Capital -- -- -- (1,471,371) Net Income 4,368,358 -- -- 4,368,358 Transfer to Reserves (599,427) 599,427 -- -- Foreign Currency Translation -- -- (1,525) (1,525) ------------ ------------ ------------ ------------ Balance - March 31, 2005 9,203,961 2,323,673 (1,669) 39,139,817 ============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements. 6
CHINA BAK BATTERY (Formerly Known as Medina Coffee, Inc.) and Subsidiary Consolidated Statements of Cash Flows For The Three Months Ended March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 2005 2004 $ $ ----------- ----------- Restated Cash Flows from Operating Activities Net Income 2,566,238 1,200,526 Adjustments to reconcile net income to net cash from operating activities: Bad debt expense 294,252 119,881 Depreciation and Amortization 751,075 399,303 Changes in Assets and Liabilities: Accounts Receivable (4,135,125) (3,524,821) Inventory 7,175,667 (6,184,949) Prepaid Expenses (1,108,578) (1,752,136) Accounts Receivable - Related Party (29,309) -- Other Receivables 163,110 -- Note Receivable 211,185 (1,414) Accounts Payable (2,973,007) 6,290,314 Customer Deposits (23,594) (392,609) Accrued Expenses 804,943 3,422,900 Construction Costs Payable (4,545,101) -- Other Liabilities 234,584 (9) Deferred Expenses -- 19,987 ----------- ----------- Net Cash Flows from Operating Activities (613,660) (403,027) ----------- ----------- 7 Cash Flows form Investing Activities Recapitalization 18,328 -- Acquisition of Property and Equipment (1,425,750) (529,714) Construction in Progress (4,784,404) (3,563,523) Investment in Intangible Assets -- -- ----------- ----------- Net Cash Flows from Investing Activities (6,191,826) (4,093,237) ----------- ----------- Cash Flows from Financing Activities Proceeds from Borrowings 27,229,641 10,836,727 Repayment from Borrowings (25,694,732) (6,750,614) Cash Pledged to Bank (2,628,818) (1,226,900) Deemed Distributions to Shareholders - Intangible Assets -- -- Proceeds from Issuance of Capital Stock 15,528,629 -- Contribution of Cash from Stockholders Acquiring Shares of BAK International 11,500,000 -- Distribution of Cash to Stockholders in Connection with Acquisition of Shares of BAK Battery (11,500,000) -- ----------- ----------- Net Cash Flows from Financing Activities 14,434,720 2,859,213 ----------- ----------- Effect of Exchange Rate Changes on Cash -- (58) Net Increase (Decrease) in Cash 7,629,234 (1,637,109) Cash - Beginning of Period 3,257,064 2,511,771 ----------- ----------- Cash - End of Period 10,886,298 874,662 =========== =========== Supplemental Cash Flow Disclosures: Interest Paid 561,508 73,410 =========== =========== Income Taxes Paid 43,156 -- =========== =========== Recapitalization (1,672) -- =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 8
CHINA BAK BATTERY, INC. (Formerly Known as Medina Coffee, Inc.) and Subsidiary Consolidated Statements of Cash Flows For The Six Months Ended March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 2005 2004 $ $ ----------- ----------- Restated Cash Flows from Operating Activities Net Income 4,368,358 3,540,844 Adjustments to reconcile net income to net cash from operating activities: Bad debt expense 345,487 107,595 Depreciation and Amortization 1,497,039 589,080 Changes in Assets and Liabilities: Accounts Receivable (10,063,697) (5,958,976) Inventory 17,410,893 (5,195,713) Prepaid Expenses (187,105) (3,214,680) Accounts Receivable - Related Party 349,104 (506,727) Other Receivables 76,503 (553,286) Note Receivable (226,338) (258,825) Accounts Payable (5,759,981) 9,142,301 Customer Deposits (160,940) (617,508) Accrued Expenses (1,859,119) 3,515,983 Construction Costs Payable (3,798,542) -- Other Liabilities 234,855 60,408 Land Use Right Payable 272 -- Deferred Expenses -- (7,373) ----------- ----------- Net Cash Flows from Operating Activities 2,226,789 643,123 ----------- ----------- Cash Flows form Investing Activities Recapitalization 18,328 -- Acquisition of Property and Equipment (12,882,847) (3,335,334) Construction in Progress 2,010,038 (12,150,348) Investment in Intangible Assets -- (5,685) ----------- ----------- Net Cash Flows from Investing Activities (10,854,481) (15,491,367) ----------- ----------- 9 Cash Flows from Financing Activities Proceeds from Borrowings 48,749,538 20,843,580 Repayment from Borrowings (44,539,060) (11,572,559) Cash Pledged to Bank (3,435,768) (1,226,900) Deemed Distributions to Shareholders - Intangible Assets -- (3,866,088) Proceeds from Issuance of Capital Stock 15,528,629 10,873,899 Contribution of Cash from Stockholders Acquiring Shares of BAK International 11,500,000 -- Distribution of Cash to Stockholders in Connection with Acquisition of Shares of BAK Battery (11,500,000) -- ----------- ----------- Net Cash Flows from Financing Activities 16,303,339 15,051,932 ----------- ----------- Effect of Exchange Rate Changes on Cash (1,525) 49 ----------- ----------- Net Increase (Decrease) in Cash 7,674,122 203,737 Cash - Beginning of Period 3,212,176 670,925 ----------- ----------- Cash - End of Period 10,886,298 874,662 ----------- ----------- Supplemental Cash Flow Disclosures: Interest Paid 874,703 126,208 =========== =========== Income Taxes Paid 138,014 -- =========== =========== Recapitalization (1,672) -- =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 10 CHINA BAK BATTERY, INC. (Formerly Known as Medina Coffee, Inc.) and Subsidiary Notes to Consolidated Financial Statements March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 1. BASIS OF PRESENTATION The condensed consolidated financial statements of China BAK Battery, Inc. (formerly known as Medina Coffee, Inc.) and Subsidiary (the "Company") included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosures normally included in financial statements prepared in conjunction with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the annual audited consolidated financial statements and the notes thereto included in the Company's annual report on Form 10-KSB, and other reports filed with the SEC. The accompanying unaudited interim consolidated financial statements reflect all adjustments of a normal and recurring nature which are, in the opinion of management, necessary to present fairly the financial position, results of operations and cash flows of the Company for the interim periods presented. The results of operations for these periods are not necessarily comparable to, or indicative of, results of any other interim period or for the fiscal year taken as a whole. Factors that affect the comparability of financial data from year to year and for comparable interim periods include non-recurring expenses associated with the Company's registration with the SEC, costs incurred to raise capital and stock awards. The condensed consolidated financial statements are prepared in accordance with generally accepted accounting principles used in the United States of America and include the accounts of BAK International Limited and Shenzhen BAK Battery Co, Ltd. for all periods presented. All significant intercompany balances and transactions have been eliminated on consolidation. 2. RECAPITALIZATION TRANSACTION On January 20, 2005, China BAK Battery, Inc. (formerly known as Medina Coffee, Inc.) and Subsidiary completed a stock exchange transaction with the stockholders of BAK International Limited., a Hong Kong company, or BAK International. The exchange was consummated under Nevada law pursuant to the terms of a Securities Exchange Agreement dated effective as of January 3, 2005 by and among China BAK, BAK International and the stockholders of BAK International. Pursuant to the Securities Exchange Agreement, the Company issued 39,826,075 shares of common stock, par value $0.001 per share, to the stockholders of BAK International (31,225,642 Shares are original shareholders of BAK and 8,600,433 Shares to new investors), representing approximately 97.2% of the China BAK post-exchange issued and outstanding common stock, in exchange 11 CHINA BAK BATTERY, INC. (Formerly Known as Medina Coffee, Inc.) and Subsidiary Notes to Consolidated Financial Statements March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 2. RECAPITALIZATION TRANSACTION (cont'd) for 100% of the outstanding capital stock of BAK International. The Company presently carries on the business of Shenzhen BAK Battery Co., Ltd., a Chinese corporation and BAK International's wholly-owned subsidiary, or BAK Battery. The reverse merger transaction has been accounted for as a recapitalization of BAK International whereby the assets and liabilities and operations of BAK Battery become the assets and liabilities and operations of the Company with no adjustment to the historical basis of the assets and liabilities of BAK International and the operations consolidated. The 1,152,458 shares of China BAK outstanding prior to the stock exchange are accounted for at the net book value at the time of the transaction, approximately negative $1,672. The accompanying financial statements reflect the recapitalization of the stockholders equity as if the transaction occurred as of the beginning of the first period presented. 3. ORGANIZATION AND PRINCIPAL ACTIVITIES BAK International was incorporated in Hong Kong on December 29, 2003 under the Companies Ordinance as BATCO International Limited and subsequently changed its name to BAK International Limited on November 3, 2004. On November 6, 2004 the shareholders of BAK Battery agreed to purchase for a total of $11.5 million in cash 96.8% of the outstanding shares of capital stock of BAK International, in the same proportion as their ownership interest in BAK Battery, and BAK International agreed to purchase for a total of $11.5 million in cash all of the outstanding shares of capital stock of BAK Battery, 31,225,642 shares. Five shareholders of BAK Battery with ownership interests of approximately 1.85% of the 31,225,642 total outstanding shares of BAK Battery elected not to acquire shares in BAK International. The five non participating shareholders of BAK Battery sold their right to acquire their proportional ownership interest in BAK International to other BAK Battery Shareholders as well as seven persons who were not previously shareholders of BAK Battery for cash, and the proportionate interests in BAK International to which the five non participating shareholders were entitled were acquired by their transferees. After the share purchase transactions between BAK International and the shareholders of BAK Battery were complete, there were 31,225,642 shares of BAK International stock outstanding, exactly the same as the number of shares of capital stock of BAK Battery outstanding immediately prior to the share purchases, and the shareholders of BAK International were substantially the same as the shareholders of BAK Battery prior to the share purchases. Consequently, the share purchases between BAK International and the shareholders of BAK Battery has been accounted for as a recapitalization of BAK Battery with no adjustment to the historical basis of the assets and liabilities of BAK Battery and the operations consolidated as though the transaction occurred as of the beginning of the first accounting period presented in these financial statements. 12 CHINA BAK BATTERY, INC. (Formerly Known as Medina Coffee, Inc.) and Subsidiary Notes to Consolidated Financial Statements March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 3. ORGANIZATION AND PRINCIPAL ACTIVITIES (cont'd) Shenzhen BAK Battery Co., Ltd. ("BAK") was founded on August 3, 2001 as a China-based company specializing in lithium ion (known as "Li-ion" or "Li-ion cell") battery cell production, for use in the replacement battery market, primarily for cell phones in the Peoples Republic of China (PRC). On January 20, 2005, BAK International closed a private placement of its securities with unrelated investors whereby it issued an aggregate of 8,600,433 shares of common stock for gross proceeds of $17,000,000. The cash and shares of common stock will be held in escrow until the completion of the reverse merger transaction described in Note 2 and the filing of a registration statement with the Securities and Exchange Commission. In conjunction with this financing, the Chief Executive Officer and major shareholder of the Company agreed to place 2,179,550 shares of the Company's common stock owned by him into an escrow account, of which 50% are to be released to the investors in the private placement if audited net income for the fiscal year ending September 30, 2005 is not at least $12,000,000 and of which 50% are to be released to investors in the private placement if audited net income for the fiscal year ending September 30, 2006 is not at least $27,000,000. The Company changed its year-end from December 31 to September 30, effective from September 30, 2004. In February 2005, the Company changed its name from Medina Coffee Inc. to China BAK Battery, Inc. The Company is subject to the consideration and risks of operating in the PRC. These include risks associated with the political and economic environment, foreign currency exchange and the legal system in the PRC. The economy of PRC differs significantly from the economies of the "western" industrialized nations in such respects as structure, level of development, gross national product, growth rate, capital reinvestment, resource allocation, self-sufficiency, rate of inflation and balance of payments position, among others. Only recently has the PRC government encouraged substantial private economic activities. The Chinese economy has experienced significant growth in the past several years, but such growth has been uneven among various sectors of the economy and geographic regions. Actions by the PRC government to control inflation have significantly restrained economic expansion in the recent past. Similar actions by the PRC government in the future could have a significant adverse effect on economic conditions in PRC. 13 CHINA BAK BATTERY, INC. (Formerly Known as Medina Coffee, Inc.) and Subsidiary Notes to Consolidated Financial Statements March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 3. ORGANIZATION AND PRINCIPAL ACTIVITIES (cont'd) Many laws and regulations dealing with economic matters in general and foreign investment in particular have been enacted in the PRC. However, the PRC still does not have a comprehensive system of laws, and enforcement of existing laws may be uncertain and sporadic. The Company's operating assets and primary sources of income and cash flows are of interests in the PRC. The PRC economy has, for many years, been a centrally-planned economy, operating on the basis of annual, five-year and ten-year state plans adopted by central PRC governmental authorities, which set out national production and development targets. The PRC government has been pursuing economic reforms since it first adopted its "open-door" policy in 1978. There is no assurance that the PRC government will continue to pursue economic reforms or that there will not be any significant change in its economic or other policies, particularly in the event of any change in the political leadership of, or the political, economic or social conditions in, the PRC. There is also no assurance that the Company will not be adversely affected by any such change in governmental policies or any unfavorable change in the political, economic or social conditions, the laws or regulations, or the rate or method of taxation in the PRC. As many of the economic reforms which have been or are being implemented by the PRC government are unprecedented or experimental, they may be subject to adjustment or refinement, which may have adverse effects on the Company. Further, through state plans and other economic and fiscal measures, it remains possible for the PRC government to exert significant influence on the PRC economy. The Company's financial instruments that are exposed to concentration of credit risk consist primarily of cash and cash equivalents, and accounts receivable from customers. Cash and cash equivalents are maintained with major banks in the PRC. The Company's business activity is primarily with customers in the PRC. The Company periodically performs credit analysis and monitors the financial condition of its clients in order to minimize credit risk. Any devaluation of the Renminbi (RMB) against the United States dollar would consequently have adverse effects on the Company's financial performance and asset values when measured in terms of the United States dollar. Should the RMB significantly devalue against the United States dollar, such devaluation could have a material adverse effect on the Company's earnings and the foreign currency equivalent of such earnings. The Company does not hedge its RMB - United States dollar exchange rate exposure. On January 1, 1994, the PRC government introduced a single rate of exchange as quoted daily by the People's Bank of China (the "Unified Exchange Rate"). No representation is made that the RMB amounts have been, or could be, converted into US$ at that or any rate. This quotation of exchange rates does not imply 14 CHINA BAK BATTERY, INC. (Formerly Known as Medina Coffee, Inc.) and Subsidiary Notes to Consolidated Financial Statements March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 3. ORGANIZATION AND PRINCIPAL ACTIVITIES (cont'd) free convertibility of RMB to other foreign currencies. All foreign exchange transactions continue to take place either through the Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate quoted by the People's Bank of China. Approval of foreign currency payments by the People's Bank of China or other institutions requires submitting a payment application form together with suppliers' invoices, shipping documents and signed contracts. 4. RECENTLY ISSUED ACCOUNTING STANDARDS In November 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 151 "Inventory Costs - an amendment of ARB No. 43, Chapter 4" ("SFAS 151"). This statement amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS 151 requires that those items be recognized as current-period charges. In addition, this Statement requires that allocation of fixed production overheads to costs of conversion be based upon the normal capacity of the production facilities. The provisions of SFAS 151 are effective for fiscal years beginning after June 15, 2005. As such, the Company is required to adopt these provisions at the beginning of the fiscal year ended December 31, 2006. The Company is currently evaluating the impact of SFAS 151 on its consolidated financial statements. In December 2004, the FASB issued SFAS No. 152 "Accounting for Real Estate Time-Sharing Transactions - an amendment of FASB Statements No. 66 and 67" ("SFAS 152"). This statement amends FASB Statement No. 66 "Accounting for Sales of Real Estate" to reference the financial accounting and reporting guidance for real estate time-sharing transactions that is provided in AICPA Statement of Position 04-2 "Accounting for Real Estate Time-Sharing Transactions" ("SOP 04-2"). SFAS 152 also amends FASB Statement No. 67 "Accounting for Costs and Initial Rental operations of Real Estate Projects" to state that the guidance for incidental operations and costs incurred to sell real estate projects does not apply to real estate time-sharing transactions, with the accounting for those operations and costs being subject to the guidance in SOP 04-2. The provisions of SFAS 152 are effective in fiscal years beginning after June 15, 2005. As such, the Company is required to adopt these provisions at the beginning of the fiscal year ended December 31, 2006. The Company is currently evaluating the impact of SFAS 152 on its consolidated financial statements. 15 CHINA BAK BATTERY, INC. (Formerly Known as Medina Coffee, Inc.) and Subsidiary Notes to Consolidated Financial Statements March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 4. RECENTLY ISSUED ACCOUNTING STANDARDS (cont'd) In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets - an amendment of APB Opinion No. 29" ("SFAS 153"). SFAS 153 replaces the exception from fair value measurement in APB Opinion No. 29 for nonmonetary exchanges of similar productive assets with a general exception from fair value measurement for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for all interim periods beginning after June 15, 2005. As such, the Company is required to adopt these provisions at the beginning of the fiscal quarter ended September 30, 2005. The Company is currently evaluating the impact of SFAS 153 on its consolidated financial statements. In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment" ("SFAS 123R"). SFAS 123R revises FASB Statement No. 123 "Accounting for Stock-Based Compensation" and supersedes APB Opinion No. 25 "Accounting for Stock Issued to Employees". SFAS 123R requires all public and non-public companies to measure and recognize compensation expense for all stock-based payments for services received at the grant-date fair value, with the cost recognized over the vesting period (or the requisite service period). SFAS 123R is effective for non-small business issuers for all interim periods beginning after June 15, 2005. SFAS 123R is effective for small business issuers for all interim periods beginning after December 15, 2005. As such, the Company is required to adopt these provisions at the beginning of the fiscal quarter ended September 30, 2005. Retroactive application of the provisions of SFAS 123R to the beginning of the fiscal year that includes the effective date is permitted, but not required. The Company is currently evaluating the impact of SFAS 123R on its consolidated financial statements. 5. BANK DEBTS During the quarter ended March 31, 2005, the Company entered into debt agreements with two separate banks in the aggregate amount of approximately $21,320,000. The loans are to support the working capital needs of the Company. Interest is charged on the debt at rates ranging from 4.75% to 5.22% per annum. The loans contain the personal guaranty of the principal stockholders of the Company. 16 CHINA BAK BATTERY, INC. (Formerly Known as Medina Coffee, Inc.) and Subsidiary Notes to Consolidated Financial Statements March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 6. CONTINGENCIES AND COMMITMENTS A. Contingent Liabilities 1. Land Use and Ownership Certificate: According to relevant PRC laws and regulations, a land use right certificate, along with government approvals for land planning, project planning, and construction need to be obtained before construction of building is commenced. An ownership certificate shall be granted by the government upon application under the condition that the aforementioned certificate and government approvals are obtained. BAK has not yet obtained the land use right certificate and government approvals relating to the construction of BAK Industrial Park (the Company's operating premises). However, BAK has applied to obtain the land use right certificate of approval. Management believes, under the condition that BAK is granted a land use right certificate and related approvals, there should be no legal barriers for BAK to obtain an ownership certificate for the premises presently under construction in BAK Industrial Park. However, in the event that BAK fails to obtain the land use right certificate relating to BAK Industrial Park and/or the government approvals required for the construction of BAK Industrial Park, there is the risk that the buildings constructed need to be vacated as illegitimate constructions. However, management believes that this possibility while present, is very remote. At a result, no provision has been made in the financial statements for this potential occurrence. 2. 2005 - US$ 1,715,399 Guaranteed for Shenzhen Tongli, a non-related party, 2005 - US$ 1,208,153 Guaranteed for Shenzhen Zhengda, a non-related party, 2005 - US$ 3,856,566 Notes Receivable Discounted The Company sells notes and accounts receivable from time to time to banks at a discount. At the time of the sale all rights and privileges of holding the note are transferred to the banks or suppliers. When notes are sold, the Company removes the asset from its book with a corresponding expense for the amount of the discount. The Company remains contingently liable on a portion of the amount outstanding in the event the note maker defaults. The company was contingently liable at March 31, 2005 and 2004 in the amounts of $3,856,566. No provision has been made in the financial statements for these contingencies. 17 CHINA BAK BATTERY, INC. (Formerly Known as Medina Coffee, Inc.) and Subsidiary Notes to Consolidated Financial Statements March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 6. CONTINGENCIES AND COMMITMENTS (cont'd) A. Contingent Liabilities (cont'd) 3. BAK and Development and Construction (Group) Company Limited By Shares ("Changchun Co.") of Changchun Economic & Technology Development District, have entered into a Cross-Guaranty Agreement, dated February 20, 2004 (the "Agreement"), pursuant to which the parties were obligated to guaranty a specified amount of each other's indebtedness to specifically identified lending institutions. As of December 22, 2004, Chang Chu Jingkai had guaranteed indebtedness of the Company to Longgang Division, Shenzhen Branch, Agricultural Bank of China (Agricultural Bank) in the amount of USD$ 24,164,220 (The "BAK Indebtedness"). BAK has not guaranteed any indebtedness of Changchun Co. in accordance with the Agreement. On December 22, 2004, the Company received from Changchun Co. a letter of termination pursuant to which the Agreement was deemed terminated by Changchun Co. and the Company was relieved of all obligations to guaranty any indebtedness of Changchun Co. in the future. The termination of the Agreement in no way effects Changchun Co.'s continuing guaranty of the BAK Indebtedness. 4. Social Insurance of BAK's Employees: BAK is required to cover employees with various types of social insurance. Although all insurances have been purchased for management employees, BAK has not fully covered other employees. Management believes that BAK needs to provide all employees with the required insurance. In the event that any current employee, or former employee, files a complaint with the government, not only will BAK be required to purchase insurance for such employee, but BAK may be subject to administrative fines. As the Company believes that these fines are nominal, no provision for any potential fines has been made in the accompanying financial statement. B. Capital Commitments BAK has commitments under construction contracts for the construction of factory, office, and employee residence buildings, amounting to $1,834,065. These contracts are contemplated to be completed at various dates up to the end of the 2005 calendar year. 18 CHINA BAK BATTERY, INC. (Formerly Known as Medina Coffee, Inc.) and Subsidiary Notes to Consolidated Financial Statements March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 7. RESTATEMENT TO CONSOLIDATED FINANCIAL STATEMENTS a). Based on comments from the Securities and Exchange Commission, the Company amended the consolidated balance sheet as of March 31, 2005, the consolidated statements of operations for the three months and six months ended March 31, 2005, the consolidated statement of changes in stockholders' equity for the six months ended March 31, 2005, the consolidated statements of cash flows for the three months and six months ended March 31, 2005, and extended or modified certain notes to the consolidated financial statements to provide additional information as detailed below. The restatements were made to retroactively reflect that 1,152,458 shares of common stock of Medina Coffee, Inc. were outstanding immediately prior to the share exchange and the resulting recapitalization. (See Note 2). The restatement had no effect on total stockholders equity in the accompanying financial statements. The following table presents the effects of the aforementioned amendment to the consolidated financial statements As of and for the Six Months Ended March 31, 2005 ------------------------------ As previously As restated reported (USD$) (USD$) ------------- ------------- Shares Issued and Outstanding 40,978,533 39,826,075 Common Stock 40,978 39,826 Retained Earnings 9,203,961 9,205,113 Net Income 4,368,358 4,366,686 Weighted Average Shares Outstanding 34,976,754 34,580,756 Net Income per Share 0.12 0.13 Net Cash Flows from Operating Activities 2,226,789 2,253,881 Net Cash Flows from Investing Activities (10,854,481) (10,881,572) 19 CHINA BAK BATTERY, INC. (Formerly Known as Medina Coffee, Inc.) and Subsidiary Notes to Consolidated Financial Statements March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 7. RESTATEMENT TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd) For the Three Months Ended March 31, 2005 ------------------------------- As previously As restated reported (USD$) (USD$) ------------- ------------- Net Income 2,566,238 2,563,191 Weighted Average Shares Outstanding 38,811,224 38,010,428 Net Income per Share 0.07 0.07 Net Cash Flows from Operating Activities (613,660) (595,332) Net Cash Flows from Investing Activities (6,191,826) (6,210,154) The following notes have been extended or modified to provide additional information - notes 2 and 3. b). Based on further comments from the Securities and Exchange Commission, the Company amended the consolidated statements of operations to reclassify depreciation and amortization expense from a separate item in operating expenses into cost of goods sold, selling expenses and general and administrative expenses. The effect of the restatement was to decrease gross profit in each of the years. The restatement had no effect on operating income or net income in any of the years. The following table presents the effects of the aforementioned amendments to the consolidated statements of operations. For the Three Months Ended March 31, 2005 ------------------------------ As previously As restated reported (USD$) (USD$) ------------- ------------- Gross Profit 5,568,116 6,160,443 20 CHINA BAK BATTERY, INC. (Formerly Known as Medina Coffee, Inc.) and Subsidiary Notes to Consolidated Financial Statements March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 7. RESTATEMENT TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd) For the Three Months Ended March 31, 2004 ------------------------------ As previously As restated reported (USD$) (USD$) ------------- ------------- Gross Profit 3,503,046 3,886,503 For the Six Months Ended March 31, 2005 ------------------------------ As previously As restated reported (USD$) (USD$) ------------- ------------- Gross Profit 9,950,927 11,265,371 For the Six Months Ended March 31, 2004 ------------------------------ As previously As restated reported (USD$) (USD$) ------------- ------------- Gross Profit 6,920,942 7,479,201 Depreciation expense is included in the statements of operations as follows: Three Months Ended March 31, 2005 2004 ------------ ------------ $ $ Cost of Goods Sold 592,327 379,232 Selling Expenses 121,159 1,577 General and Administrative Expenses 35,193 18,328 ------------ ------------ Total Depreciation Expense 748,679 399,137 ============ ============ 21 CHINA BAK BATTERY, INC. (Formerly Known as Medina Coffee, Inc.) and Subsidiary Notes to Consolidated Financial Statements March 31, 2005 and 2004 (Amounts Expressed in US Dollars) (Unaudited) 7. RESTATEMENT TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd) Six Months Ended March 31, 2005 2004 ----------- ----------- $ $ Cost of Goods Sold 1,300,186 554,035 Selling Expenses 123,008 4,229 General and Administrative Expenses 65,539 30,356 ----------- ----------- Total Depreciation Expense 1,488,733 588,620 =========== =========== 22 Item 2. Management's Discussion and Analysis or Plan of Operation Results of operations for the three months ended March 31, 2005 as compared to the three months ended March 31, 2004. Revenues Revenues increased to approximately $25.88 million for the three months ended March 31, 2005 as compared to approximately $16.17 million for same period of the prior year, an increase of approximately $9.71 million or 60%. Our revenues increased during the period as a result of inroads made into the aluminum case cell market where revenues increased to approximately $ 6.84 million for the period as compared to approximately $2.36 in the prior year period, an increase of $4.48 million. Revenues relating to steel case batteries increased to approximately $11.4 million from approximately $9.98 million in the prior year period, an increase of approximately $1.42 million or 14 %. Our customers continued to demand price concessions during the second quarter of fiscal 2005, while simultaneously raising the bar with respect to quality and service requirements. In response to these conditions, we relied on the time-tested approach of cost and price containment. The Company was able to gain market share both domestically and internationally during the period because, in our belief, our production volume and technological advantage gives us an advantage over our competitors with regard to supply ability and cost. Gross Profit Gross profit for the three months ended March 31, 2005 was approximately $5.57 million or 21.5% of revenues as compared to gross profit of approximately $3.50 million or 21.7% of revenues for the same period of the prior year. The slight reduction in gross profit, as a percentage of revenues, resulted primarily from a combination of increased unit selling prices and increased unit manufacturing costs stemming from an increase in prices for most raw materials used in the manufacturing process. Steel case cell battery selling prices increased by 6 % during the period, while cost of steel case cell units increased by about 12%, resulting in an overall decrease in gross profit from 23.1% to 18.1% of revenues. In the aluminum case cell market, price increases averaged 1.6% and unit costs increased by 13%, thereby reducing gross profit. As such, gross profits in aluminum case segment decreased from 23.0% to 14.2% of revenues. We did, however, gain market share due in part to our decision to maintain low pricing, the improved quality of our products and the improvements we made in manufacturing efficiencies. Prior to 2004, we sold our products primarily into the replacement battery market (as opposed to the OEM market). Products in the replacement market face lower prices and, consequently, lower gross profit margins. Our profit margins should increase as we move into the OEM segment. Continued vertical integration of the manufacturing process, increasing production efficiencies, and low labor costs collectively served to contain costs and we anticipate that these activities will position us to maintain gross profit margins at or near the 22% range during our current fiscal year. Cost savings realized from the above initiatives will help to offset potential raw material and other price increases during 2005 and beyond. Management continues to focus on cost containment and savings realized based on increased economies 23 of scale in order to maintain gross profit margins near 2004 levels. Some entities include all costs associated with their distribution system in cost of goods sold while other companies may record a portion of their distribution costs in selling expense. Because of this disparity in financial reporting, gross margins between our company and other companies may not be comparable. With the exception of transportation and freight charges which we include under selling expenses, we believe we include most other costs of our distribution system. Selling Expenses Selling expenses increased to approximately $1.0 million for the three month period ended March 31, 2005 as compared to approximately $405,000 for the same period of the prior year, an increase of approximately $613,000 or about 151.1%. Salaries related to selling efforts increased to approximately $530,000 from approximately $134,000 for the same period of the prior year, an increase of approximately $396,000. More sales and marketing efforts were required to continue gaining market share and to grow revenues. We had 76 employees engaged in sales and marketing as of March 31, 2005 as compared to 63 as of March 31, 2004. In connection with the introduction of a formal and coordinated marketing campaign, marketing expenses decreased to approximately $44,000 from approximately $62,000 incurred in the same period of the prior year, an decrease of approximately $18,000. Transportation, filing fees, promotion, trademarks, depreciation and other related selling and marketing expenses increased to approximately $435,000 from approximately $212,000 for the same period of the prior year, an increase of approximately $224,000 Marketing or advertising costs consist primarily of promoting ourselves and our products through printed advertisements in trade publications and displaying our products through attendance and industry trade exhibitions. We do not pay slotting fees, engage in cooperative advertising programs, participate in buydown programs or similar arrangements. No material estimates are required to determine our marketing or advertising costs. General and Administrative Expenses General and administrative expenses decreased to approximately $723,000 for the three months ended March 31, 2005 as compared to approximately $1.5 million for the same period of the prior year, a decrease of approximately $729,000 or 50.2%. As a percentage of revenues, general and administrative expenses were 2.8% and 9.0% as of March 31, 2005 and March 31, 2004, respectively. Despite efforts related to increasing manufacturing facilities, general and administrative expenses remained manageable relative to revenues. Salaries and benefits, increased to approximately $291,000 for the three month period ended March 31, 2005 from approximately $180,000 for the three month period ended March 31, 2004, an increase of approximately $111,000 or 62%. We had 152 employees in machinery and engineering positions as of March 31, 2005, as compared to 32 employees as of the same period for the prior year.This increase, together with an approximately $238,000 increase in professional and consulting fees, were more than offset by an approximately $873,000 reduction in inventory write-downs. 24 Research and Development Expenses Research and development expenses increased to approximately $166,000 for the three months ended March 31, 2005 as compared to approximately $115,000 for the same period of the prior year, an increase of approximately $51,000 or 44%. Increase in research and development staff to 108 as of March 31, 2005 from 91 as of the same period of the prior year was the primary factor accounting for the increase in this category. New initiatives, such as rechargeable lithium polymer batteries research and development, and an increase in patent applications and maintenance required incremental staff hiring contributed to the increase. Bad Debts Bad debt expense totaled approximately $294,000 for the three months ended March 31, 2005 as compared to approximately $120,000 for the same period of the prior year, a increase of $174,000 or 145%. As a percentage of revenues, bad debts were approximately 1.1% and 0.7% for the three months ended March 31, 2005 and 2004, respectively. We believe that the reserve for bad debts as of March 31, 2005 is adequate and will adjust future reserves as we gain more experience with our customers. Operating Income Operating income totaled approximately $3.37 million for the three months ended March 31, 2005 as compared to operating income of approximately $1.41 million for the same period of the prior year, an increase of approximately $1.96 million or 138.6%. As a percentage of revenues, operating income was 13.0% for the three months ended March 31, 2005 as compared to 8.7% for the same period of the prior year. The growth in operating income as a percentage of revenues was substantially due to the increase in gross profit. Finance Costs Finance costs increased to approximately $572,000 for the three month period ended March 31, 2005 as compared to approximately $107,000 for the same period of the prior year, an increase of approximately $465,000 or 435%. We had approximately $54 million in short term loans and notes payable as of March 31, 2005 as compared to approximately $20.7 million outstanding as of March 31, 2004. Short term loans and notes payable are comprised of various short term bank loans and promissory notes, with interest ranging from 4.75% to 5.84 %, and maturities of generally less than twelve months. The increase in interest bearing debt caused the increase in finance costs. The funds were used for working capital purposes based on the increase in revenues. Net Income Primarily as a result of increased sales during the period, we increased our net income to approximately $2.6 million as compared to approximately $1.2 million for the same period of the prior year, an increase of approximately $1.4 million or about 113.8%. 25 Dividends We have not paid out any dividends to date. In determining our dividend policy, our Board of Directors considers current and long term profitability, committed and potential cash requirements, and our overall financial condition. We do not anticipate the payment of any dividends in the future based on the present financial requirements for expansion. Should we decide in the future to pay dividends, as a holding company, our ability to do so and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries and other holdings and investments. In addition, our operating subsidiaries, from time to time, may be subject to restrictions on their ability to make distributions to us, including as a result of restrictive covenants in loan agreements, restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions. Results of operations for the six months ended March 31, 2005 as compared to the six months ended March 31, 2004. Revenues Revenues increased to approximately $51 million for the six months ended March 31, 2005 as compared to approximately $32 million for same period of the prior year, an increase of approximately $19 million or 59%. Our revenues increased during the period as a result of inroads made into the aluminum case cell market where revenues increased to approximately $13.39 million for the period as compared to approximately $4.25 in the prior year period, an increase of $9.14 million. Revenues relating to steel case batteries increased to approximately $25.54 million from approximately $23.67 million in the prior year period, an increase of approximately $1.87 million or 7.9%. Our customers continued to demand price concessions during the second quarter of fiscal 2005, while simultaneously raising the bar with respect to quality and service requirements. In response to these conditions, we relied on the time-tested approach of cost containment and price reductions. Despite continued pricing pressure resulting in selling price reductions during the year in the steel case market, we were able to gain market share both domestically and internationally during the period because, in our belief, our production volume and technological advantage gives us an advantage over our competitors with regard to supply ability and cost. Gross Profit Gross profit for the six months ended March 31, 2005 was approximately $10.0 million or 19.5% of revenues as compared to gross profit of approximately $6.9 million or 21.8% of revenues for the same period of the prior year. The decrease in gross profit, as a percentage of revenues, resulted from a combination of increased unit selling prices, primarily in the aluminum market and increased unit manufacturing costs stemming from an increase in prices for most raw materials used in the manufacturing process. Steel case cell battery selling prices decreased by 4.3% during the period, while cost of steel case cell units increased by about 1.5 %, resulting in an overall decrease in gross profit from 21.2% to 16.1% of revenues. In the aluminum case cell market, price increases averaged 12 % and unit costs increased by 33 %, thereby reducing gross profit. As such, gross profits in aluminum case segment decreased from 25.6% to 12.0% of revenues. We did, however, gain market share due in part to our 26 decision to maintain low pricing, the improved quality of our products and the improvements we made in manufacturing efficiencies. Prior to 2004, we sold our products primarily into the replacement battery market (as opposed to the OEM market). Products in the replacement market face lower prices and, consequently, lower gross profit margins. Our profit margins should increase as we move into the OEM segment. Continued vertical integration of the manufacturing process, increasing production efficiencies, and low labor costs collectively served to contain costs and we anticipate that these activities will position us to maintain gross profit margins at or near the 22% range during our current fiscal year. Cost savings realized from the above initiatives will help to offset potential raw material and other price increases during 2005 and beyond. Management continues to focus on cost containment and savings realized based on increased economies of scale in order to maintain gross profit margins near 2004 levels. Some entities include all costs associated with their distribution system in cost of goods sold while other companies may record a portion of their distribution costs in selling expense. Because of this disparity in financial reporting, gross margins between our company and other companies may not be comparable. With the exception of transportation and freight charges which we include under selling expenses, we believe we include most other costs of our distribution system. Selling Expenses Selling expenses increased to approximately $1.8 million for the six month period ended March 31, 2005 as compared to approximately $840,000 for the same period of the prior year, an increase of approximately $986,000 or about 117.3%. Salaries related to selling efforts increased to approximately $918,000 from approximately $253,000 for the same period of the prior year, an increase of approximately $665,000. More sales and marketing efforts were required to continue gaining market share and to grow revenues. We had 76 employees engaged in sales and marketing as of March 31, 2005 as compared to 63 as of March 31, 2004. Increases in pension expense and depreciation comprised the remainder of the increase. Marketing or advertising costs consist primarily of promoting ourselves and our products through printed advertisements in trade publications and displaying our products through attendance and industry trade exhibitions. We do not pay slotting fees, engage in cooperative advertising programs, participate in buydown programs or similar arrangements. No material estimates are required to determine our marketing or advertising costs. General and Administrative Expenses General and administrative expenses decreased to approximately $1.9 million for the six months ended March 31, 2005 as compared to approximately $2.0 for the same period of the prior year, a decrease of approximately $81,000 or 4.3%. As a percentage of revenues, general and administrative expenses were 3.7% and 6.2% as of March 31, 2005 and March 31, 2004, respectively. Despite 27 efforts related to increasing manufacturing facilities, general and administrative expenses remained manageable relative to revenues. Salaries and benefits pensions increased to approximately $864,000 for the six month period ended March 31, 2005 from approximately $228,000 for the six month period ended March 31, 2004, an increase of approximately $636,000 or 279%. We had 152 employees in machinery and engineering positions as of March 31, 2005, as compared to 32 employees as of the same period for the prior year. This increase, together with a smaller increase in professional and consulting fees, were more than offset by a $1.1 million reduction in inventory write-downs. Research and Development Expenses Research and development expenses decreased to approximately $186,000 for the six months ended March 31, 2005 as compared to approximately $206,000 for the same period of the prior year, a decrease of approximately $20,000 or 10%. The Company engaged in less patent applications in the first quarter of fiscal 2005 and enacted it's new initiatives, such as rechargeable lithium polymer batteries research and development, during the second quarter of 2005. Bad Debts Bad debt expense totaled approximately $345,000 for the six months ended March 31, 2005 as compared to approximately $108,000 for the same period of the prior year, a increase of $237,000 or 219%. As a percentage of revenues, bad debts were approximately 0.7% and 0.3% for the six months ended March 31, 2005 and 2004, respectively. We believe that the reserve for bad debts as of March 31, 2005 is adequate and will adjust future reserves as we gain more experience with our customers. Operating Income Operating income totaled approximately $5.72 million for the six months ended March 31, 2005 as compared to operating income of approximately $3.81 million for the same period of the prior year, an increase of approximately $1.91 million or 50.1%. As a percentage of revenues, operating income was 11.2% for the six months ended March 31, 2005 as compared to 12.0% for the same period of the prior year. The reduction in operating income as a percentage of revenues was substantially due to the increase in selling expense and depreciation / amortization. Finance Costs Finance costs increased to approximately $961,000 for the six month period ended March 31, 2005 as compared to approximately $158,000 for the same period of the prior year, an increase of approximately $803,000 or 508%. We had approximately $54 million in short term loans and notes payable as of March 31, 2005 as compared to approximately $20.7 million outstanding as of March 31, 2004. Short term loans and notes payable are comprised of various short term bank loans and promissory notes, with interest ranging from 4.75 % to 5.84 %, 28 and maturities of generally less than twelve months. The increase in interest bearing debt caused the increase in finance costs. The funds were used for working capital purposes based on the increase in revenues. Net Income Primarily as a result of increased sales during the period, we increased our net income to approximately $4.37 million as compared to approximately $3.54 million for the same period of the prior year, an increase of approximately $828,000 or about 23.4%. Dividends We have not paid out any dividends to date. In determining our dividend policy, our Board of Directors considers current and long term profitability, committed and potential cash requirements, and our overall financial condition. We do not anticipate the payment of any dividends in the future based on the present financial requirements for expansion. Should we decide in the future to pay dividends, as a holding company, our ability to do so and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries and other holdings and investments. In addition, our operating subsidiaries, from time to time, may be subject to restrictions on their ability to make distributions to us, including as a result of restrictive covenants in loan agreements, restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions. Item 3. Controls and Procedures Previously, in connection with our Quarterly Report on Form 10-QSB for the fiscal quarter ended March 31, 2005, filed with the Securities and Exchange Commission (the "Commission") on May 16, 2005, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2005, and concluded that our disclosure controls and procedures were effective as of March 31, 2005. As a result of comments we received from the Commission in connection with another filing with the Commission, we amended our consolidated balance sheet as of March 31, 2005, the consolidated statements of operations for the three months and six months ended March 31, 2005, the consolidated statement of changes in stockholders' equity for the six months ended March 31, 2005, the consolidated statements of cash flows for the three months and six months ended March 31, 2005, and extended or modified certain notes to the consolidated financial statements as of such dates and for such periods to provide additional information to reflect retroactively that 1,152,458 shares of our common stock were outstanding immediately prior to the exchange of shares of our common stock for the outstanding shares of BAK International Co., Ltd. and the resulting recapitalization that occurred on January 20, 2005. The restatement had no effect on total stockholders equity in the consolidated balance sheet as of March 31, 2005 or the consolidated statement of changes in stockholders' equity for the six months ended March 31, 2005. As a result of further comments we received from the Commission in connection with such other filing made with the Commission, we also amended the consolidated statements of operations for the three months and six months ended March 31, 2005 and 2004 to reclassify depreciation and amortization expense from a separate item in operating expenses into cost of goods sold, selling expenses and general and administrative expenses. The effect of the restatement was to decrease gross profit in each of the periods presented. The restatement had no effect on operating income or net income in any of the periods presented. For further details see Note 7 "RESTATEMENT TO CONSOLIDATED FINANCIAL STATEMENTS" to the consolidated financial statements at Part I, Item I. We have discussed the restatements described above with our independent registered public accountants. Our management is implementing the following set of changes: (1) Engaging outside consultants with technical accounting expertise, as needed, to ensure that accounting personnel with adequate experience, skills and knowledge are directly involved in the review and accounting for our complex, non-recurring transactions and those items for which we have restated our financial statements as described above; (2) Additional training of our accounting staff; (3) Involving both internal accounting personnel and outside consultants with technical accounting expertise, as needed, early in the evaluation of the application of generally accepted accounting principles in complex, non-recurring transactions; (4) Documenting to standards established by senior accounting personnel and the principal accounting officer the review, analysis and related conclusions with respect to complex, non-recurring transactions and those items for which we have restated our financial statements as described above; and (5) Requiring senior accounting personnel and the outside consultants with technical accounting expertise to review complex, non-recurring transactions to evaluate and approve the accounting treatment for such transactions and those items for which we have restated our financial statements as described above. The Company began to execute the remediation plans identified above in the fourth quarter of calendar year 2005. The Company engaged outside consultants with technical accounting expertise commencing in October, 2005. There was no change in our internal control over financial reporting during the quarter ended March 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting, other than the changes that are described above. Under the supervision and with the participation of our management, including our Chairman and Chief Executive Officer and our Chief Financial Officer, we reevaluated the effectiveness of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of March 31, 2005. As a result of the restatements described above, our Chairman and Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of March 31, 2005. 29 PART II OTHER INFORMATION Item 6. Exhibits The following documents are filed as part of this report: 31.1 Chief Executive Officer Certification furnished pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Chief Financial Officer Certification furnished pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Chief Executive Officer Certification furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Chief Financial Officer Certification furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 30 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CHINA BAK BATTERY, INC. (Registrant) Date: February 2, 2006 /s/ Li Xiangqian ------------------------------------- Li Xiangqian, Chief Executive Officer Date: February 2, 2006 /s/ Han Yongbin ------------------------------------- Han Yongbin, Chief Financial Officer 31