-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TE/b41c5czYOsKixrIDSe9AzXlCZ0FK7NvILjzpbrh9A4RSeSfnQ5BbtMKpP+cgT k5G7axHajdN/cKBq61bXsA== 0001275287-06-001411.txt : 20060315 0001275287-06-001411.hdr.sgml : 20060315 20060315172543 ACCESSION NUMBER: 0001275287-06-001411 CONFORMED SUBMISSION TYPE: SB-2/A PUBLIC DOCUMENT COUNT: 4 FILED AS OF DATE: 20060315 DATE AS OF CHANGE: 20060315 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHINA BAK BATTERY INC CENTRAL INDEX KEY: 0001117171 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS ELECTRICAL MACHINERY, EQUIPMENT & SUPPLIES [3690] IRS NUMBER: 880442833 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: SB-2/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-122209 FILM NUMBER: 06689199 BUSINESS ADDRESS: STREET 1: BAK INDUSTRIAL PARK, NO. 1 BAK STREET STREET 2: KUICHONG TOWN, LONGGANG DISTRICT CITY: SHENZHEN PEOPLE STATE: F4 ZIP: 518119 BUSINESS PHONE: 86-755-8977-0093 MAIL ADDRESS: STREET 1: BAK INDUSTRIAL PARK, NO. 1 BAK STREET STREET 2: KUICHONG TOWN, LONGGANG DISTRICT CITY: SHENZHEN PEOPLE STATE: F4 ZIP: 518119 FORMER COMPANY: FORMER CONFORMED NAME: MEDINA COFFEE INC DATE OF NAME CHANGE: 20000626 SB-2/A 1 cb5112.txt FORM SB-2/A UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM SB - 2 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 (Amendment No. 7) CHINA BAK BATTERY, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Nevada 88-0442833 (State or other jurisdiction (IRS Employer incorporation or of organization) identification No.) 3692 (Primary Standard Industrial Classification Code Number) BAK Industrial Park, No. 1 BAK Street Kuichong Town, Longgang District Shenzhen People's Republic Of China Ph: (86-755) 8977-0093 - -------------------------------------------------------------------------------- (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) Nevada Agency and Trust Company 50 West Liberty Street, Suite 880 Reno, Nevada 89501 Ph: (775) 322-5623 - -------------------------------------------------------------------------------- (Name, address, including zip code, and telephone number, including area code, of agent for service) With copy to: Robin Bradford Andrews Kurth LLP 1717 Main Street, Suite 3700 Dallas, Texas 75201 Ph: (214) 659-4400 Facsimile: (214) 659-4401 Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement. If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box. [x] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act Registration Statement number of the earlier effective Registration Statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act Registration Statement number of the earlier effective Registration Statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act Registration Statement number of the earlier effective Registration Statement for the same offering. [ ] If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. [ ]
CALCULATION OF REGISTRATION FEE Title of each Class Proposed Proposed of Securities Maximum Maximum Amount of to be Amount to be Offering Price Aggregate Registration registered Registered per share Offering Price Fee - ------------- ------------ -------------- -------------- -------------- Common Stock 12,626,264 $ (1) $ 60,015,179.5 $ 7,063.79(1)
- ---------- (1) A registration fee of $4,338.18 was previously paid with respect to 9,934,762 shares of common stock registered hereby based upon the proposed maximum offering price of $3.71 yielding a proposed maximum aggregate offering price of $36,857,967. An additional registration fee of $2,725.61 also was previously paid with respect to an additional 3,705,154 shares of common stock registered hereby, based upon a proposed maximum offering price of $6.25 yielding an additional maximum aggregate offering price of $23,157,212.50. Some of the shares for which the registration fee has been paid no longer held by selling stock identified in this registration statement and will not be registered hereby. Pursuant to Rule 457 under the Securities Act of 1933, as amended, no refund of the registration fee applicable to those shares will be paid to the registrant. The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said section 8(a), may determine. SUBJECT TO COMPLETION DATED MARCH 13, 2006 12,626,264 Shares CHINA BAK BATTERY, INC. Common Stock ----------------------- This is an offering of 12,625,545 shares of the common stock, $.001 par value per share, of China BAK Battery, Inc. by the selling stockholders identified elsewhere in this prospectus. The shares are being registered to permit public secondary trading of the shares that are being offered by the selling stockholders named in this prospectus. We will not receive any of the proceeds from the sale of the shares. The selling stockholders may, but are not obligated to, offer all or part of their shares for resale from time to time through public or private transactions including underwritten offerings, at either prevailing market prices or at privately negotiated prices. See "Plan of Distribution" below. Our common stock is currently quoted on the Over-the-Counter Bulletin Board under the symbol "CBBT." On March 9, 2006, the last reported sales price on our common stock was $10.00 per share. Investing in our common stock involves risks. See "Risk Factors" beginning on page 3 to read about factors you should consider before buying shares of our common stock. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense. The date of this prospectus is March 13, 2006. ---------------------------------- ABOUT THIS PROSPECTUS You should rely only on the information contained in this document or any other document to which we refer you. Neither we nor the selling stockholders have authorized anyone to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. Neither we nor the selling stockholders are making an offer to sell these securities in a jurisdiction where the offer or sale is not permitted. The information contained in this document is current only as of its date, regardless of the time of delivery of this prospectus or of any sales of shares of common stock. Our business, financial condition, results of operations and prospects may have changed since that date. The information in this prospectus is not complete and may be changed. The selling stockholders may not sell the securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and is not soliciting an offer. TABLE OF CONTENTS PROSPECTUS SUMMARY.............................................................1 RISK FACTORS...................................................................3 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS.............................14 MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND DIVIDEND POLICY....15 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATION AND FINANCIAL CONDITION.................................................................17 OUR BUSINESS..................................................................29 DIRECTORS AND EXECUTIVE OFFICERS..............................................39 PRINCIPAL STOCKHOLDERS........................................................42 CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS..........................43 DESCRIPTION OF OUR COMMON STOCK...............................................44 SELLING STOCKHOLDERS..........................................................44 SHARES ELIGIBLE FOR FUTURE SALE...............................................49 PLAN OF DISTRIBUTION..........................................................49 INDEPENDENT PUBLIC ACCOUNTANTS................................................51 LEGAL MATTERS.................................................................51 EXPERTS.......................................................................51 INTERESTS OF NAMED EXPERTS AND COUNSEL........................................51 DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES...............................................................51 WHERE YOU CAN FIND MORE INFORMATION...........................................51 FINANCIAL STATEMENTS ........................................................F-1 i PROSPECTUS SUMMARY This summary highlights selected information about us and the offering that is contained elsewhere in this prospectus. You should read the entire prospectus before making an investment decision, especially the information presented under the heading "Risk Factors" on page 3 and the financial statements and related notes included elsewhere in this prospectus, as well as the other documents to which we refer you. Except as otherwise indicated by the context, references in this prospectus to "we," "us," or "our" are to the combined business of China BAK Battery, Inc. ("CBBI") and its wholly-owned direct subsidiary, BAK International, Ltd. ("BAK International") and BAK International's wholly-owned subsidiaries, Shenzhen BAK Battery Co., Ltd. ("BAK Battery") and BAK Electronics (Shenzhen) Co., Ltd. ("BAK Electronics"), and in each case does not include the selling stockholders. References to "China" or to the "PRC" are references to the People's Republic of China. All references to "dollars" or "$" refers to United States dollars. Our Business We are engaged in the manufacture, commercialization and distribution of a wide variety of standard and customized lithium ion rechargeable batteries for use in a wide array of applications. We believe that our technologies allow us to offer batteries that are flexibly configured, lightweight and generally achieve longer operating time than many competing batteries currently available. We have focused on manufacturing a family of replacement lithium batteries for cellular telephones. We also supply rechargeable lithium ion batteries for use in various other portable electronic applications, including high-power handset telephones, laptop computers, digital cameras, video camcorders, MP3 players and general industrial applications. Historically, we have manufactured three types of batteries: steel cell, aluminum cell and cylindrical cell. We deliver our products to packing plants operated by third parties where the bare cells are packed in accordance with specifications established by certain manufacturers of cellular telephones and other electronic products. The majority of our income is generated from the sale of steel cells. However, we believe there is growth potential for aluminum and cylindrical cells because of their wide applications. In September 2005 we began producing a fourth type of battery, lithium polymer. Our current growth strategy includes entering into the global original equipment manufacture ("OEM") battery market for cellular telephone brands and portable electronic applications. We have developed a program for producing high power lithium ion battery cells which may allow us inroads into additional battery markets such as those for power tools. We have begun marketing our high power lithium ion battery cells. We have internal research and development facilities engaged primarily in furthering lithium ion related technologies. We operate sales and service branches in Beijing and seven principal coastal cities in the PRC. Our Corporate Information We originally began operations as a Nevada corporation known as "Medina Copy, Inc." We were incorporated in Nevada on October 4, 1999, and subsequently changed our name to "Medina Coffee, Inc." ("Medina Coffee") on October 6, 1999. Medina Coffee commenced operations on December 1, 2002 and was considered a development stage company. Medina Coffee was formed originally for the purpose of building a retail specialty coffee business that sold specialty coffee and espresso drinks through company owned and operated espresso carts. Medina Coffee had incurred operating losses from its inception, and therefore looked to combine with a privately-held company that was profitable or that management considered to have growth potential. On January 20, 2005 we completed a stock exchange transaction with the stockholders of BAK International, which is a Hong Kong company. The exchange was consummated under Nevada law pursuant to the terms of a Securities Exchange Agreement dated effective as of January 20, 2005 by and among Medina Coffee, BAK International and the stockholders of BAK International. Pursuant to the Securities Exchange Agreement, we issued 39,826,075 shares of our common stock, par value $0.001 per share, to the stockholders of BAK International, representing approximately 97.2% of our post-exchange issued and outstanding common stock, in exchange for 100% of the outstanding capital stock of BAK International. Effective February 14, 2005, we changed our name from Medina Coffee, Inc. to China BAK Battery, Inc. Prior to and in connection with the completion of 1 the stock exchange with BAK International, BAK International sold 8,600,433 shares of its common stock to certain of the selling shareholders in a private placement and agreed to register with the SEC the resale by the selling shareholders of the shares of our common stock upon completion of the exchange of the shares of common stock in BAK International held by the selling shareholders for our shares pursuant to the Stock Exchange Agreement. Our corporate headquarters is located at BAK Industrial Park, No. 1 BAK Street, Kuichong Town, Longgang District, Shenzhen, People's Republic of China. Our telephone number there is (86-755) 8977-0093. Registration of Other Shares We have filed with the Securities and Exchange Commission a registration statement on Form SB-2 (file number 333-130247), as amended, registering the resale of 8,531,852 shares of our common stock by certain selling stockholders as described therein. If and when such registration statement is declared effective, the offers and sales of the shares covered by such registration statement by those selling stockholders could occur simultaneously with offers and sales of the shares to which this prospectus relates. See "Risk Factors -- Risk Related to our Common Stock." The Offering Common stock outstanding prior to and to be outstanding after this offering............48,878,396 shares Common stock offered by us...................We are not offering any shares for sale pursuant to this prospectus. Common stock offered by the selling stockholders.................................12,626,264 shares Total shares of common stock offered pursuant to this prospectus..................12,626,264 shares Method of offering...........................The selling shareholders may offer and sell their shares in one or more types of transactions, including in ordinary brokerage transactions, by cross or block trades, in negotiated transactions, by sales "at the market," in underwritten offerings, and in transactions involving options, swaps and other derivatives. See "Plan of Distribution" below. Dividends....................................We have not in the past paid any dividends on our common stock and currently have no plans to do so. Risk Factors.................................See "Risk Factors" beginning on page 3 and other information included in this prospectus for a discussion of factors you should consider before deciding to invest in shares of our common stock. Trading......................................Shares of our common stock trade in the over-the-counter market and are quoted on the OTC Bulletin Board under the symbol "CBBT." 2 RISK FACTORS An investment in our securities involves a high degree of risk. You should carefully consider the following risks and the other information set forth elsewhere in this prospectus, including our financial statements and related notes, before you decide to purchase shares of our common stock. Risks Related to Our Business We have significant short-term debt obligations, which mature in less than one year. Failure to extend those maturities of, or to refinance, that debt could result in defaults, in certain instances, and foreclosures on our assets. At December 31, 2005, we had $72.637 million of short-term loans and notes payable maturing in less than one year, a substantial portion of which is secured by the pledge of certain of our assets. That collateral includes inventory, machinery and equipment, and cash and cash equivalents which, at December 31, 2005, were in the aggregate amount of $42.4 million. Failure to obtain extensions of the maturity dates of, or to refinance, these obligations or to obtain additional equity financing to meet these debt obligations would result in an event of default with respect to such obligations and could result in the foreclosure on the collateral. The sale of such collateral at foreclosure would result in a substantial disruption in our ability to produce products for our customers in the quantities required by customer orders or deliver products in a timely fashion, which could significantly lower our revenues and profitability. We may be able to refinance or obtain extensions of the maturities of all or some of such debt only on terms that significantly restrict our ability to operate, including terms that place limitations on our ability to incur other indebtedness, to pay dividends, to use our assets as collateral for other financings, to sell assets or to make acquisitions or enter into other transactions. Such restrictions may adversely affect our ability to finance our future operations or to engage in other business activities. If we finance the repayment of our outstanding indebtedness by issuing additional equity or convertible debt securities, such issuances could result in substantial dilution to our stockholders. Our indebtedness adversely affects our ability to fund our operations and to compete effectively. The amount of our indebtedness to lenders, which was $72.637 million, as of December 31, 2005, is substantial compared to our assets, stockholders' equity and our operating cash flow. That indebtedness limits our ability to fund our operations through our operating cash flow and to compete effectively. Among other things, our indebtedness: o requires us to dedicate a substantial portion of our cash flow from operations to debt service payments, reducing our working capital and adversely affecting our ability to fund capital expenditures through operating cash flow; o places us at a disadvantage compared with competitors that have proportionately less debt; and o limits our ability to borrow additional funds in the future, if we need them, due to financial and restrictive covenants in our debt agreements. Our manufacturing facilities are not insured against damage or loss. Our operations and financial condition are solely dependent on the success of BAK Battery's operations in China. As is the case with many manufacturing companies in the PRC, we conduct those operations in manufacturing facilities, and using machinery and other related property, that we do not insure against damage or loss. We do not carry business interruption insurance. If we suffer any business interruption or material damage to, or the loss of, any of our manufacturing facilities, due to any cause, the loss would not be offset by any insurance proceeds, and if large enough, that loss could threaten the continued viability of our business. 3 We are and will continue to be under downward pricing pressures on our products from our customers and competitors. We face downward pricing pressures from our customers and competitors, especially in the sales of replacement batteries. To retain our existing customers and gain new ones, we must continue to keep our unit prices low. In view of our need to maintain low prices on our products, our growth, profit margins and net income will suffer if we cannot effectively continue to control our manufacturing and other costs. Our contracts with our customers are generally short-term and do not require the purchase of a minimum amount. Our customers generally do not provide us with firm, long-term volume purchase commitments. Although we enter into manufacturing contracts with our customers who have continuing demand for a certain product, these contracts state terms such as payment method, payment period, quality standard and inspection and similar matters rather than provide firm, long-term commitments to purchase products from us. As a result of the absence of the long term contracts, we could have periods during which we have no or only limited orders for our products, but will continue to have to pay the costs to maintain our work force and our manufacturing facilities and to service our indebtedness without the benefit of current revenues. We consistently face short lead times for delivery of products to customers. Failure to meet delivery deadlines in our production agreements could result in the loss of customers and damage to our reputation and goodwill. We enter into production agreements with our customers prior to commencing production, which reduces our risk of cancellations. However, these production agreements typically contain short lead times for delivery of products, leading to production schedules that can strain our resources and reduce our profit margins on the products produced. Although we have increased our manufacturing capacity, we may lack sufficient capacity at any given time to meet all of our customers' demands if they exceed the production capacity of levels. We strive for rapid response to customer demand, which can lead to reduced purchasing efficiency and increased material costs. If we are unable to sufficiently meet our customers' demands, we may lose our customers. Moreover, failure to meet customer demands may damage our reputation and goodwill. Because of the short lead times in our production agreements, we may not be able to accurately or effectively plan our production or supply needs. We make significant decisions, including determining the levels of business that we will seek and accept, production schedules, component procurement commitments, facility requirements, personnel needs, and other resource requirements, based on our production agreements with our customers. Short lead times of our customers' commitments to their own customers and the possibility of rapid changes in demand for their products reduce our ability to estimate accurately the future requirements of those customers for our products. Because many of our costs and operating expenses are fixed, a reduction in customer demand can harm our gross margins and operating results. We may also occasionally acquire raw materials without having customer orders based on a customer's forecast or in anticipation of an order and to secure more favorable pricing, delivery or credit terms in view of the short lead times we often have under our customers' orders. These purchases can expose us to losses from inventory carrying costs or inventory obsolescence. We have not obtained the certificate of land use right for our BAK Industrial Park. We do not own the tract of property on which we have constructed a new manufacturing plant and related facilities, which facilities are important to our future operations. See "Business-Facilities." We have applied for, but have not obtained, a certificate of land use right for the property and those new facilities. We are negotiating with the PRC government to obtain such a certificate and believe that we will obtain the certificate. If we are unsuccessful in doing so, we could be forced to vacate our current premises, would not be permitted to use the new manufacturing and other facilities we have constructed and could be required to relocate to new facilities. Such an 4 event would cause a severe disruption in our ability to produce our products, resulting in the failure to fill customer orders, the loss of customer revenues and a resulting loss of revenues. We face intense competition from other battery manufacturers, many of whom have significantly greater resources than do we. We are subject to intense competition from manufacturers of traditional rechargeable batteries, such as nickel-cadmium batteries, from manufacturers of rechargeable batteries of more recent technologies, such as nickel-metal hydride and liquid electrolyte, other manufacturers of lithium ion batteries, as well as from companies engaged in the development of batteries incorporating new technologies. Other manufacturers of lithium ion batteries currently include Sanyo Electric Co., Sony Corp., Matsushita Electric Industrial Co., Ltd. (Panasonic), GS Group, NEC Corporation, Hitachi Ltd., LG Chemical Ltd., Samsung Electronics Co., Ltd., BYD Co. Ltd., Tianjin Lishen Battery Joint-Stock Co., Ltd., Henan Huanyu Group and Harbin Coslight Technology International Group Co., Ltd. Several of these existing competitors have greater financial, personnel and capacity resources than we do and, as a result, these competitors may be in a stronger position to respond quickly to market opportunities, new or emerging technologies and changes in customer requirements. Many of our competitors are developing a variety of battery technologies, such as lithium polymer and fuel cell batteries, which are expected to compete with our existing product lines. Other companies undertaking research and development activities of solid-polymer lithium ion batteries have developed prototypes and are constructing commercial scale production facilities. The introduction of new products that are perceived as having more desirable qualities than our products and that gain market acceptance would lead to price erosion for our products, require greater marketing and advertising of our products or require greater research and development costs to develop competing products. If competitors develop manufacturing processes that are more efficient than ours, we may face downward pressure on pricing with resulting reductions in our gross profit for our products. Any such developments may require us to increase our research and development and related expenditures to develop competing technology or more efficient manufacturing processes. We are dependent on a single line of products. Our revenues are derived solely from the sale of our lithium ion batteries. The market for these products is characterized by changing technology and evolving industry standards, often resulting in product obsolescence or short product lifecycles. Although we believe our products are based on state-of-the-art technology, other technologies may become the standard for manufacturers of cellular telephones and other devices that use our batteries. In that instance, our products could be obsolete, requiring us to develop new products that compete effectively with the other products on the market. Our failure to identify and develop a commercially viable number of product lines that are sought by the market could adversely affect our growth opportunities and, ultimately, our viability. Because we do not have a diverse product offering that would enable us to sustain our business while seeking to develop new types of products, our business may not be able to recover if we experience a steep decline in demand for our current product offerings. Our operations depend highly on Mr. Xianqian Li, our President and Chief Executive Officer and a small number of other executives. The success of operations depends greatly on a small number of key managers, including Mr. Li, the President, Chief Executive Officer and Chairman of the Board of Directors of CBBI and the chief executive officer and sole director of BAK International and BAK Battery. The loss of the services of Mr. Li or any of the other senior executives of CBBI or BAK Battery could adversely affect our ability to conduct our business. Although we believe we would be able to find other managers to replace any of these managers, the search for such managers and the integration of such managers into our business will inevitably occur only over an extended period of time. During that time the lack of senior leadership could affect adversely our sales and manufacturing, as well as our research and development efforts. Mr. Li has held his positions with BAK Battery since the inception of its business, and our future growth and success very much depends on his continued involvement with our company. All of our senior managers have an employment agreement with CBBI, BAK International or BAK Battery. 5 Our operations depend on our ability to attract and retain a highly skilled group of managers and other personnel. Because of the highly specialized, technical nature of our business, we must attract and retain a highly skilled group of managers and a sizeable workforce of technically competent employees. Although we do not experience unacceptable attrition among our technical staff and sales force, if we were to lose a substantial portion of such persons, our ability to effectively pursue our business strategy could be materially and negatively affected. Although we believe the pool of managers and workers having the necessary education, training and technical skills to fill any positions that may become open is sufficient for our needs, the labor market for such managers and workers is becoming more competitive and we could have to pay higher salaries and wages and provide greater benefits in order for us to attract the necessary workers. We may not be able to effectively respond to rapid growth in demand for our products and of our manufacturing operations. If we are successful in obtaining rapid market growth of our batteries, we will be required to deliver large volumes of quality products to customers on a timely basis at a reasonable cost to those customers. Meeting such increased demands will require us to expand our manufacturing facilities, to increase our ability to purchases of raw materials, to increase the size of our work force, to expand our quality control capabilities and to increase the scale upon which we produce products. Such demands would require more capital and working capital than we currently have available. We extend relatively long payment terms for accounts receivable. As is customary in the PRC, we extend relatively long payment terms and provide liberal return policies to our customers. As a result of the size of many of our orders, these extended terms adversely affect our cash flow and our ability to fund our operations out of our operating cash flow. In addition, although we attempt to establish appropriate reserves for our receivables, those reserves may not prove to be adequate in view of actual levels of bad debts. The failure of our customers to pay us timely would negatively affect our working capital, which could in turn adversely affect our cash flow. Our customers often place large orders for products, requiring fast delivery, which impacts our working capital. If our customers do not incorporate our products into their products and sell them in a timely fashion, for example, due to excess inventories, sales slowdowns or other issues, they may not pay us in a timely fashion, even on our extended terms. This failure to pay timely may defer or delay further product orders from us, which may adversely affect our cash flows, sales or income in subsequent periods. We may not be able to finance the development of new products. Our future operating results will depend to a significant extent on our ability to continue to provide new products that compare favorably on the basis of cost and performance with the products of our competitors, many of whom have design and manufacturing capabilities and technologies that compete well with our products. We are currently conducting research and development on a number of new products, activities requiring a substantial outlay of capital. To remain competitive, we must continue to incur significant costs in product development, equipment, facilities and invest in research and development of new products. These costs may increase, resulting in greater fixed costs and operating expenses. All of these factors create pressures on our working capital and ability to fund our current and future manufacturing activities and the expansion of our business. Lithium ion batteries pose certain safety risks that could affect our financial condition and results of operations. Due to the high energy density inherent in lithium batteries, our batteries can pose certain safety risks, including the risk of fire. Although through our research, design, development and manufacturing processes we attempt to minimize safety risks related to our batteries, should an accident occur, whether at the manufacturing facilities or from the use of the products, it could result in significant production delays or product liability claims 6 for damages resulting from injuries. As a result of limits imposed in our product liability insurance policy, such losses might not be covered by our insurance policy, and if large enough, could have a material and negative effect on our financial condition and results of operations. We depend on certain suppliers of raw materials for the production of our products, and any disruption with those suppliers could delay product shipments and adversely affect our relationships with customers. Certain materials used in products are available to us only from a limited number of suppliers. We currently maintain volume purchase agreements with our major suppliers. However, any interruption in deliveries from any such supplier could delay our product shipments and adversely affect our relationships with customers. We believe, however, that alternative suppliers could supply raw materials that could replace the materials currently used and that, if necessary, we would be able to redesign our products to make use of such alternatives. We receive a significant portion of our revenues from a small number of customers. Although no customer individually accounted for more than 10% of our revenues for the fiscal year ended September 30, 2005 our five largest customers accounted for approximately 34.51% and 38.98% of our revenues in fiscal 2005 and 2004, respectively. Dependence on a few customers could make it difficult to negotiate attractive prices for our products and could expose us to the risk of substantial losses if a single dominant customer stops purchasing our products. Our business depends on our ability to protect our intellectual property effectively. The success of our business depends in substantial measure on the legal protection of the patents and other proprietary rights in technology we hold. We hold patents in China and have patent applications pending in China and other countries regarding technologies important to our business. If (i) our pending patent applications do not result in the issuance of patents, (ii) the claims allowed under any existing patents are not sufficiently broad to protect our technology, or (iii) any patents issued to us are challenged, invalidated or circumvented, then the resulting ability of third parties to utilize the subject technology will adversely affect on our business. We do not hold similar patents in other countries with respect to these technologies. Consequently, our ability to protect against the unauthorized use of those technologies outside of China is limited. We claim proprietary rights in various unpatented technologies, know-how, trade secrets and trademarks relating to products and manufacturing processes. We protect our proprietary rights in our products and operations through contractual obligations, including nondisclosure agreements. If these contractual measures fail to protect our proprietary rights, any advantage those proprietary rights provided to us would be negated. Monitoring infringement of intellectual property rights is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our intellectual property and know-how, particularly in the PRC and other countries in which the laws may not protect our proprietary rights as fully as the laws of the United States. Accordingly, other parties, including competitors, may duplicate our products using our proprietary technologies. Pursuing legal remedies against persons infringing our patents or otherwise improperly using our proprietary information is a costly and time consuming process that would divert management's attention and other resources from the conduct of our other business, could cause delays and other problems with the marketing and sales of our products, as well as delays in deliveries. Our business may be adversely affected by obsolete inventories as a result of changes in demand for our products and change in life cycles of our products. Risks Related to Doing Business in China Our operations are located in China. Changes in the political and economic policies of the Chinese government may adversely affect our operations. Our business operations may be adversely affected by the political environment in the PRC. The PRC has operated as a socialist state since 1949 and is controlled by the Communist Party of China. In recent years, however, the government has introduced reforms aimed at creating a "socialist market economy" and policies have 7 been implemented to allow business enterprises greater autonomy in their operations. Changes in the political leadership of the PRC may have a significant effect on laws and policies related to the current economic reforms program, other policies affecting business and the general political, economic and social environment in the PRC, including the introduction of measures to control inflation, changes in the rate or method of taxation, the imposition of additional restrictions on currency conversion and remittances abroad, and foreign investment. Moreover, economic reforms and growth in the PRC have been more successful in certain provinces in the PRC than in others, and the continuation or increases of such disparities could affect the political or social stability of the PRC. Although we believe that the economic reform and the macroeconomic measures adopted by the Chinese government have had a positive effect on the economic development of China, the future direction of these economic reforms is uncertain and the uncertainty may decrease the attractiveness of our company as an investment, which may in turn materially adversely affect the price at which our stock trades. The Chinese government exerts substantial influence over the manner in which we must conduct our business activities. The PRC only recently has permitted provincial and local economic autonomy and private economic activities. The government of the PRC has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters. We believe that our operations in China are in compliance with all applicable legal and regulatory requirements. However, the central or local governments of these jurisdictions may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations. Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies or to nationalized ownership of all companies now privately owned, could have a significant effect on economic conditions in the PRC or particular regions thereof, and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures. We currently enjoy a reduced tax rate, and the loss of this benefit may adversely impact our net income. Under PRC laws and regulations our PRC subsidiary BAK Battery enjoys a reduced enterprise income tax rate as a foreign invested enterprise and a high tech enterprise in an economic development zone. As such, under the current tax scheme, we did not owe any tax during the first two years following the time at which we became profitable, which tax-free period ended on December 31, 2003. After that time and through the 2009 calendar year, we have been and will be taxed on our enterprise income, which is equivalent to our net income before provision for income tax, at the rate of 7.5%, which is equal to 50% of the current 15% enterprise income tax rate currently applicable in Shenzhen. If we fail to qualify for a reduced tax program following the end of the 2009 calendar year, we would be required to pay tax at the full tax rate applicable in Shenzhen at that time. We currently benefit from favorable local tax treatment, the loss of which would adversely affect our results of operations. The current enterprise income tax rate in Shenzhen is 15%, which is in addition to the taxes described above. The PRC could change the tax law to raise the enterprise income tax rate applicable in Shenzhen to the standard statutory tax rate in the PRC, which currently is 33%, which change would result in our incurring a substantially increased tax liability and a consequent reduction in our net income. Future inflation in China may inhibit economic activity in China. In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation. During the past ten years, the rate of inflation in China has been as high as 20.7% and China has experienced deflation as low as minus 2.2%. These factors have led to the adoption by the PRC government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. 8 While inflation has been more moderate since 1995, high inflation may in the future cause the PRC government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby adversely affect the market for our products. Any recurrence of severe acute respiratory syndrome, or SARS, or another widespread public health problem, in the PRC could adversely affect our operations. A renewed outbreak of SARS or another widespread public health problem in China, where all of our manufacturing facilities are located and where over 71% of our sales occur and in Shenzhen, where our operations are headquartered, could have a negative effect on our operations. Such an outbreak could have an impact on our operations as a result of: o quarantines or closures of some of our manufacturing facilities offices, which would severely disrupt our operations, o the sickness or death of our key officers and employees, and o a general slowdown in the Chinese economy. Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our operations. Restrictions on currency exchange may limit our ability to receive and use our revenues effectively. Because all of our revenues are in the form of Renminbi, the Chinese currency unit, any restrictions on currency exchanges may limit our ability to use revenue generated in Renminbi to fund any future business activities outside China. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the Renminbi for current account transactions, significant restrictions still remain, including primarily the restriction that foreign-invested enterprises may only buy, sell or remit foreign currencies, after providing valid commercial documents, at those banks authorized to conduct foreign exchange business. In addition, conversion of Renminbi for capital account items, including direct investment and loans, is subject to government approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. If the currency exchange system prevents us from obtaining sufficient foreign currency, we may be unable to fund business activities outside China or otherwise make payments in dollars. Shortages in China in the availability of foreign currency may also restrict our ability to pay dividends. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the Renminbi, especially with respect to foreign exchange transactions. The value of our common stock will be affected by the foreign exchange rate between Dollars and Renminbi. To the extent that we need to convert dollars into Renminbi for our operational needs, should the Renminbi appreciate against the U.S. dollar at that time, our financial position and the price of our common stock may be adversely affected. Conversely, if we decide to convert our Renminbi into dollars for the purpose of paying dividends on our common stock or for other business purposes and the dollar appreciates against the Renminbi, the dollar equivalent of our earnings from our subsidiaries in China would be reduced. Until 1994, the Renminbi experienced a gradual but significant devaluation against most major currencies, including dollars, and there was a significant devaluation of the Renminbi on January 1, 1994 in connection with the replacement of the dual exchange rate system with a unified managed floating rate foreign exchange system. Since 1994, the value of the Renminbi relative to the U.S. Dollar has remained stable and has appreciated slightly against the U.S. dollar. Countries, including the United States, have argued that the Renminbi is artificially undervalued due to China's current monetary policies and have pressured China to allow the Renminbi to float freely in world markets. On July 21, 2005 the PRC government changed its policy of pegging the value of the Renminbi to the dollar. Under the new policy the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of designated foreign currencies. This change in policy has resulted in an approximate 2.0% 9 appreciation in the Renminbi against the dollar. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in further and more significant appreciation of the Renminbi against the dollar. Any significant revaluation of the Renminbi may materially and adversely affect our revenues, cash flow, earnings and financial position, and the value of any dividends payable in dollars. For example, an appreciation of the Renminbi against the dollar would make any Renminbi denominated investment or expenditure more costly to us, to the extent that we use dollars that we must convert into Renminbi for such purpose. We may be unable to enforce our legal rights due to policies regarding the regulation of foreign investments in China. The PRC's legal system is a civil law system based on written statutes, in which system decided legal cases have little value as precedents unlike the common law system prevalent in the United States. The PRC does not have a well-developed, consolidated body of laws governing foreign investment enterprises. As a result, the administration of laws and regulations by government agencies are subject to considerable discretion and variation on the part of the PRC government, including its courts, and may be subject to influence by external forces unrelated to the legal merits of a particular matter. China's regulations and policies with respect to foreign investments are evolving. Definitive regulations and policies with respect to such matters as the permissible percentage of foreign investment and permissible rates of equity returns have not yet been published. As a result, we may not be aware of any violations of these policies and rules until some time after the violation. Statements regarding these evolving policies have been conflicting and any such policies, as administered, are likely to be subject to broad interpretation and discretion and to be modified, perhaps on a case-by-case basis. The uncertainties regarding such regulations and policies present risks that may affect our ability to achieve our business objectives. If we are unable to enforce any legal rights we may have under our contracts or otherwise, our ability to compete with other companies in our industry could be materially and negatively affected. In addition, any litigation in China may be protracted and result in substantial cost and diversion of resources and management attention. You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based upon U.S. laws, including the federal securities laws or other foreign laws against us or our management. Almost all of our current operations are conducted in China. Moreover, all of our current directors and officers are nationals or residents of China. All or a substantial portion of the assets of these persons are located outside the United States and in the PRC. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon these persons. In addition, uncertainty exists as to whether the courts of China would recognize or enforce judgments of U.S. courts obtained against us or such officers and/or directors predicated upon the civil liability provisions of the securities law of the United States or any state thereof, or be competent to hear original actions brought in China against us or such persons predicated upon the securities laws of the United States or any state thereof. Recent PRC regulations relating to acquisitions of PRC companies by foreign entities may create regulatory uncertainties that could restrict or limit our PRC subsidiary BAK Battery's ability to operate, including its ability to pay dividends. The PRC State Administration of Foreign Exchange, or SAFE, issued a public notice in January 2005 concerning foreign exchange regulations on mergers and acquisitions in China. The public notice states that if an offshore company controlled by PRC residents intends to acquire a PRC company, such acquisition will be subject to strict examination by the relevant foreign exchange authorities. The public notice also states that the approval of the relevant foreign exchange authorities is required for any sale or transfer by the PRC residents of a PRC company's assets or equity interests to foreign entities, such as CBBI, for equity interests or assets of the foreign entities. In April 2005, SAFE issued another public notice further explaining the January notice. In accordance with the April notice, if an acquisition of a PRC company by an offshore company controlled by PRC residents has been confirmed by a Foreign Investment Enterprise Certificate prior to the promulgation of the January notice, the PRC 10 residents must each submit a registration form to the local SAFE branch with respect to their respective ownership interests in the offshore company, and must also file an amendment to such registration if the offshore company experiences material events, such as changes in the share capital, share transfer, mergers and acquisitions, spin-off transaction or use of assets in China to guarantee offshore obligations. The April notice also provides that failure to comply with the registration procedures set forth therein may result in restrictions on our PRC resident shareholders and BAK International and BAK Battery, including their ability to distribute profits to CBBI. Pending the promulgation of detailed implementation rules, the relevant government authorities are reluctant to commence processing any registration or application for approval required under the SAFE notices. Our business operations or future strategy could be adversely affected by the interpretations and implementation of the SAFE notices . For example, we may be subject to more stringent review and approval process with respect to our foreign exchange activities, including remittance of dividends to CBBI and the making of foreign-currency-denominated borrowings. Risks Related to our Common Stock The market price for our common stock may be volatile. The market price for our common stock is likely to be highly volatile and subject to wide fluctuations in response to factors including the following: o the lack of depth and liquidity of the market for our common stock, o actual or anticipated fluctuations in our quarterly operating results, o announcements of new products or services by us or our competitors, o changes in financial estimates by securities analysts, o conditions in the lithium ion battery market, o changes in the economic performance or market valuations of other companies involved in lithium ion battery production, o our sales of common stock, o investor perceptions of us and our business, o changes in the estimates of the future size and growth rate of our markets, o announcements by our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments, o additions or departures of key personnel, and o potential litigation, or conditions in the mobile telephone market. In addition, the stock market in general, and the over-the-counter market in particular, have experienced significant price and volume fluctuations that have often been unrelated or disproportionate to the performance of listed companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance. 11 A large portion of our common stock is controlled by a small number of stockholders. 43.4% of our common stock is held by Xiangqian Li, our President and Chief Executive Officer and Chairman of our Board, and 44.6% of our common stock is held by our directors and executive officers, collectively. As a result, our directors and executive officers are able to influence the outcome of stockholder votes on various matters, including the election of directors and extraordinary corporate transactions including business combinations. Furthermore, the current ratios of ownership of our common stock reduce the public float and liquidity of our common stock which can in turn affect the market price of our common stock. Only a limited trading market for our common stock exists. Historically, we have had limited trading in our common stock, in part, as a result of the limited public float in our stock and as a result of our operating history. Unless a substantial number of shares are sold by the selling shareholders and other CBBI shareholders into the open market, an active trading market for shares of our common stock may never develop. Without an active market in our shares, the liquidity of the stock could be limited and prices for the common stock would be depressed. Our common stock is traded in the over-the-counter market through the Over-the-Counter Electronic Bulletin Board. Our common stock may never be included for trading on any stock exchange or through any other quotation system (including, without limitation, the NASDAQ Stock Market). Sales of substantial amounts of our common stock in the market could cause the price to fall. As there is only limited trading activity in our securities, the sale of a substantial amount of our common stock in the market over a relatively short period of time could result in significant fluctuations in the market price of our common stock and could cause our common stock price to fall. In addition to this registration statement, we have filed with the Securities and Exchange Commission a registration statement on Form SB-2 (file number 333-130247), as amended, registering the resale of 8,531,852 shares of our common stock by certain selling stockholders as described therein. If and when such registration statement is declared effective, the offers and sales of the shares covered by such registration statement by those selling stockholders could occur simultaneously with offers and sales of the shares to which this prospectus relates. The sale of any or all of those shares in the open market could adversely affect the liquidity of the shares being offered by this prospectus and the price for shares of our common stock in the open market. Our common stock could be subject to additional regulation as a "penny stock," which may reduce the liquidity of our common stock. If the trading price of our common stock falls below $5.00 per share, the open-market trading of our common stock will be subject to the "penny stock" rules. The "penny stock" rules impose additional sales practice requirements on broker-dealers who sell securities to persons other than established customers and accredited investors (generally those with assets in excess of $1,000,000 or annual income exceeding $200,000 or, together with his or her spouse, $300,000). For transactions covered by these rules, the broker-dealer must make a special suitability determination for the purchase of securities and have received the purchaser's written consent to the transaction before the purchase. Additionally, for any transaction involving a penny stock, unless exempt, the broker-dealer must deliver, before the transaction, a disclosure schedule prescribed by the SEC relating to the penny stock market. The broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative and current quotations for the securities. Finally, monthly statements must be sent disclosing recent price information on the limited market in penny stocks. These additional burdens imposed on broker-dealers may restrict the ability of broker-dealers to sell the common stock and may affect a stockholder's ability to resell the common stock. Stockholders should be aware that, according to SEC Release No. 34-29093, the market for penny stocks has suffered in recent years from patterns of fraud and abuse. Such patterns include (i) control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer; (ii) manipulation of prices 12 through prearranged matching of purchases and sales and false and misleading press releases; (iii) boiler room practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons; (iv) excessive and undisclosed bid-ask differential and markups by selling broker-dealers; and (v) the wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, along with the resulting inevitable collapse of those prices and with consequent investor losses. We are obligated to indemnify our officers and directors for certain losses they suffer. Our Bylaws provide for the indemnification of our directors, officers, employees, and agents, under certain circumstances, against liabilities, attorney's fees and other expenses incurred by them in any litigation to which they become a party arising from their association with or activities on behalf of us to the maximum extent permitted by Nevada law. If we are required to indemnify any persons under this policy, the amounts we would have to pay could be material, and we may be unable to recover any of these funds from any source. We recently adopted amendments to our Bylaws that could entrench our Board of Directors and prevent a change in control. Effective January 20, 2005, we adopted Amended and Restated Bylaws that (i) increased the percentage of stockholders required to call special meetings of stockholders from 10% to 30%, (ii) eliminated a provision allowing stockholders to fill vacancies in the Board if such vacancies were not filled by the Board, (iii) include a new provision providing that no contract or transaction between us and one or more of our directors or officers is void if certain criteria are met and (iv) allow for the amendment of our Bylaws by the Board of Directors rather than our stockholders. Collectively, these provisions may allow our Board of Directors to entrench the current members and prevent a change in control of our company in situations where a change in control would be beneficial to our stockholders. 13 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This prospectus contains certain statements that may be deemed to be "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. In some cases, you can identify forward-looking statements by the use in those Statements of terminology such as "may," "will," "could," "expect," "plan," "intend," "anticipate," "believe," "estimate," "predict," "potential," or "continue," or the negative of such terms or other comparable terminology. The forward-looking statements included in this prospectus address activities, events or developments that we expect or anticipate will or may occur in the future, including: o our ability to maintain our gross profit on our products at certain levels; o our ability to increase sales in the higher profit margin OEM market; o our ability to continue to achieve cost savings through vertical integration of the manufacturing process, increased production efficiencies and low labor costs. Although we believe the expectations expressed in the forward-looking statements included in this prospectus are based on reasonable assumptions within the bounds of our knowledge of our business, a number of factors outside of our control could cause actual results to differ materially from those expressed in any of the forward-looking statements included in this prospectus. Any one, or a combination, of these factors could materially affect our financial performance, business strategy, business operations, plans, goals and objectives. These factors include: o costs of raw materials; o costs of energy, including electricity; o competitive pressures, including the impact on our market of competitive products introduced into the marketplace; o price resistance among consumers to products using our batteries; o changes in the design of products that use rechargeable batteries to require batteries different from those we produce; o changes in the laws and regulations applicable to us and our operations; o rates of taxation applicable to our Chinese operations and our effective rate of taxation in the United States; o cost and availability of capital and debt financing; o product liability claims against us; o the adequacy of our products liability insurance coverage; o casualty losses to our manufacturing and other facilities, which are uninsured; o interest rate fluctuations; o demand for our products by existing and new customers; o inflation; 14 o currency exchange rate fluctuations; o changes in freight rates; o labor costs; and o other capital market, economic and geo-political conditions. Forward-looking statements that we make or that are made by others on our behalf are based on a knowledge of our business and the environment in which we operate, but because of the factors listed above, actual results may differ from those in the forward-looking statements. Consequently, these cautionary statements qualify all of the forward-looking statements we make herein. The results or developments we anticipate may not be realized. Even if substantially realized, those results or developments may not result in the expected consequences for us or affect us, our business or our operations in the ways we expect. We caution readers not to place undue reliance on any of these forward-looking statements in this prospectus, which speak only as of their dates. We assume no obligation to update any of the forward-looking statements. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND DIVIDEND POLICY There is no established public trading market for our common stock, and our common stock is not listed for trading on any securities exchange or the NASDAQ. However, over-the-counter trades in our common stock are quoted on the Over-the-Counter Bulletin Board under the symbol "CBBT." On March 9, 2006, the last reported sales price for our common stock was $10.00 per share. The following table sets forth, for the quarters indicated, the range of closing high and low bid prices of our common stock as reported by the Over-the-Counter Bulletin Board, as adjusted for all previously effected stock splits. These prices do not include retail markup, markdown or commission and may not represent actual transactions. 14 Common Stock --------------------- By Quarter Ended High Low -------------------------------------- -------- -------- FISCAL 2004 -------------------------------------- December 31, 2003 .................... $ 1.01 $ 1.01 March 31, 2004 ....................... $ 1.01 $ 1.01 June 30, 2004 ........................ $ 1.01 $ 1.01 September 30, 2004 ................... $ 1.45 $ 1.02 FISCAL 2005 -------------------------------------- December 31, 2004 .................... $ 3.50 $ 1.25 March 31, 2005 ....................... $ 7.30 $ 2.80 June 30, 2005 ........................ $ 8.50 $ 5.00 September 30, 2005 ................... $ 7.75 $ 6.54 FISCAL 2006 -------------------------------------- December 31, 2005 .................... $ 11.10 $ 5.60 - ----------- In reviewing the foregoing table, it should be noted that the exchange of stock by which CBBI acquired BAK International and its subsidiary BAK Battery occurred on January 20, 2005. As of March 1, 2006, there were 48,878,396 shares of our common stock outstanding held by approximately 139 stockholders of record. We have never paid any cash dividends on our common stock. We do not anticipate paying any cash dividends or making any other cash distributions on our common stock in the foreseeable future. Should we decide in the future to do so, as a holding company, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries. Our operating subsidiaries may be subject, from time to time, to restrictions on their ability to make distributions to us, including as a result of restrictive covenants in loan agreements, restrictions on the conversion of local currency into dollars or other hard currency and other regulatory restrictions. We currently intend to retain future earnings, if any, to finance operations and the expansion of our business. 15 Equity Compensation Plan Information The following table provides information about the securities authorized for issuance under our equity compensation plans. In accordance with the rules of the Commission, the information in the table is presented as of September 30, 2005, the end of our most recently completed fiscal year.
NUMBER OF SECURITIES REMAINING AVAILABLE FOR NUMBER OF SECURITIES TO FUTURE ISSUANCE UNDER EQUITY BE ISSUED UPON EXERCISE WEIGHTED-AVERAGE EXERCISE COMPENSATION PLANS OF OUTSTANDING OPTIONS, PRICE OF OUTSTANDING OPTIONS, (EXCLUDING SECURITIES PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (A)) - ----------------------------------------- ----------------------- ----------------------------- ---------------------------- (a) (b) (c) Equity compensation plans approved by security holders -- -- -- Equity compensation plans not approved by security holders 2,000,000 6.25 2,000,000 Total 2,000,000 6.25 2,000,000
16 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATION AND FINANCIAL CONDITION The following management's discussion and analysis should be read in conjunction with our consolidated financial statements and the notes thereto and the other financial information appearing elsewhere in this item. In addition to historical information, the following discussion contains certain forward-looking information. See "Special Note Regarding Forward Looking Statements" above for certain information concerning those forward looking statements Our financial statements are prepared in US Dollars and in accordance with accounting principles generally accepted ("GAAP") in the United States. See "Exchange Rates" below for information concerning the exchange rates at which Renminbi were converted to US Dollars at various pertinent dates and for pertinent periods. Overview CBBI is a holding company whose Hong Kong-based subsidiary, BAK International, and China-based subsidiaries, BAK Battery and BAK Electronics, focus on the manufacture, commercialization and distribution of a wide variety of standard and customized lithium ion rechargeable batteries for use in cellular telephones, as well as various other portable electronic applications, including high-power handset telephones, laptop computers, power tools, digital cameras, video camcorders, MP3 players, electric bicycles, hybrid/electric motors, and general industrial applications. We manufacture five types of batteries: steel case cell, aluminum case cell, cylindrical case cell, Li-ion polymer cells and industrial batteries, although the majority of our income is generated from the sale of steel case cells. CBBI acquired BAK International and, as a result, BAK International's wholly-owned subsidiary, BAK Battery, on January 20, 2005, by means of an exchange of 39,826,075 shares of CBBI's common stock for all of the outstanding shares of stock of BAK International. However, we have accounted for the transaction as a recapitalization, which resulted in the adoption of the historical consolidated financial statements of BAK International, as prepared in accordance with United States GAAP, as the financial statements of CBBI. See Note 2 to our consolidated financial statements included in this filing for additional information regarding the accounting treatment of the acquisition and its impact on our consolidated financial statements. On September 16, 2005, we consummated the sale of 7,899,863 shares of our common stock to certain accredited investors (as that term is defined in Rule 502 of Regulation D promulgated under the Securities Act of 1933, as amended). We granted certain registration rights to such purchasers, including our covenant to file with the Securities and Exchange Commission within ten days of the date that the registration statement of which this prospectus is a part is declared effective by the Securities and Exchange Commission a registration statement covering the resale of the 7,899,863 shares of our common stock purchased by such purchasers and to use our reasonable best efforts to cause such registration statement to be declared effective by the Securities and Exchange Commission. In connection with the closing of that issuance, CBBI issued warrants to purchase an aggregate of 631,989 shares of common stock at an exercise price of $7.92 per share exercisable for a period ending three years after the date of issuance to certain persons as part of an agreed upon fee. The 631,989 shares of common stock purchasable upon exercise of the warrants will also be covered by the registration statement. If and when such registration statement is declared effective, the offers and sales of the shares covered by such registration statement could occur simultaneously with offers and sales of the shares to which this prospectus relates. See "Risk Factors -- Risk Related to our Common Stock." Certain Accounting Matters Substantially all of our revenue is derived from the sale of battery cells, which we recognize upon shipment or delivery depending upon the sales order. In the event goods are returned, revenue is reduced and the returned goods are placed back in inventory during the period the goods are received by us. Concurrent with the recognition of revenue, we record a warranty reserve for product returns. When determining the amount of such reserves, we estimate the amount of claims based upon our historical experience with product returns and warranty claims. Cost of goods sold consists primarily of raw materials, direct labor and manufacturing overhead. Manufacturing overhead consists primarily of an allocation of purchasing and receiving costs, supplies, utilities, depreciation, factory and equipment repairs and maintenance, and inspection fees. Selling expenses consist primarily of payroll, advertising and promotion, depreciation and travel and entertainment. Marketing or advertising costs are incurred primarily to promote ourselves and our products through printed advertisements in trade publications and to display our products through attendance at industry trade exhibitions. We do not pay slotting fees, engage in cooperative advertising programs, participate in buy-down programs or similar arrangements. No material estimates are required to determine our marketing or advertising costs. 17 General and administrative expenses consist primarily of payroll, professional fees, insurance, payroll taxes and benefits, general office expenses, travel and entertainment, transportation, and depreciation. Net income does not reflect certain annual appropriations to reserve funds in accordance with PRC regulations. These appropriations are reflected in the statement of retained earnings as a reduction in retained earnings. Results of Operations Results of operations for the three months ended December 31, 2005 as compared to the three months ended December 31, 2004. Revenues Revenues increased to $26.1 million for the three months ended December 31, 2005 as compared to $25.1 million for same period of the prior year, an increase of $1.0 million or 3.9%. Our revenues increased during the period as a result of increased sales volume, partially offset by a decline in unit selling prices. Revenues relating to steel case cell batteries increased to $14.6 million from $14.1 million in the prior year period, an increase of $453,000 or 3.2%, due to increased sales volume partially offset by lower selling prices. Revenues from sales of aluminum case cell batteries increased to $8.9 million for the period as compared to $6.6 million in the prior year period, an increase of $2.3 million or 35.2%, primarily due to increased sales volume. We were able to gain market share both domestically and internationally during the period because, in our belief, our production volume and technological advantage gives us an advantage over our competitors with regard to supply ability and cost. We also believe that our gain in market share was due in part to our decision to maintain low pricing, the improved quality of our products and the improvements we made in manufacturing efficiencies. Gross Profit Gross profit for the three months ended December 31, 2005 was $7.1 million or 27.1% of revenues as compared to gross profit of $4.4 million or 17.4% of revenues for the same period of the prior year. The increase in gross profit, as a percentage of revenues, resulted primarily from decreased unit manufacturing costs stemming from a decrease in prices for most raw materials and an increased yield in the manufacturing process. Steel case cell battery selling prices decreased by 3.5% during the period, while the cost of manufacturing steel case cell units decreased by 20.3%, resulting in an overall increase in gross profit from 16.4% to 27.2% of revenues. In the aluminum case cell market, the average unit selling price remained consistent from last year and unit manufacturing costs decreased by 17.6%, thereby increasing gross profit from 13.9% to 25.7% of revenues. While we have historically sold our products primarily into the replacement battery market with lower selling prices and, consequently, lower gross profit margins, we are continuing to pursue a strategy of increasing sales into the higher profit margin OEM segment. Continued vertical integration of the manufacturing process, volume discounts on increasing raw material purchases, increasing production efficiencies, and low labor costs collectively served to reduce manufacturing costs. We believe that we can continue to achieve cost savings from these activities that will help to offset potential replacement battery market selling price decreases during 2006. Some entities include all costs associated with their distribution system in cost of goods sold while other companies may record a portion of their distribution costs in selling expense. Because of this disparity in financial reporting, gross margins between our company and other companies may not be comparable. With the exception of transportation and freight charges which we include under selling expenses, we believe we include most other costs of our distribution system in cost of goods sold. 18 Selling Expenses Selling expenses increased to $1.1 million for the three month period ended December 31, 2005 as compared to $808,000 for the same period of the prior year, an increase of $307,000 or 38.0%. As a percentage of revenues, selling expenses have increased to 4.3% this year, from 3.2% last year, as we increase our staff and advertising to obtain orders to increase utilization of our recent manufacturing capacity expansion. Salaries related to selling efforts increased to $598,000 from $464,000 for the same period of the prior year, an increase of $134,000. We had 80 employees engaged in sales and marketing on December 31, 2005 as compared to 71 on December 31, 2004. As a result of the introduction of a formal and coordinated marketing campaign and increased professional advertisements and exhibitions, advertising expenses increased $37,000 from the same period in the prior year. Transportation, maintenance, travel and entertainment and other related selling and marketing expenses also increased due to the increased selling effort. Marketing or advertising costs consist primarily of promoting ourselves and our products through printed advertisements in trade publications, packaging and displaying our products through attendance of industry trade exhibitions. We do not pay slotting fees, engage in cooperative advertising programs, participate in buydown programs or similar arrangements. No material estimates are required to determine our marketing or advertising costs. General and Administrative Expenses General and administrative expenses increased to $1.5 million for the three months ended December 31, 2005 as compared to $1.2 million for the same period of the prior year, an increase of $321,000 or 27.8%. As a percentage of revenues, general and administrative expenses were 5.6% and 4.6% as of December 31, 2005 and December 31, 2004, respectively. Despite increased general and administrative expense, we believe that general and administrative expenses remain manageable relative to revenues. Professional fees and expenses increased $306,000 from the first quarter of last year, reflecting the additional costs of operating as a public company since January 2005. Benefits, primarily employee pensions, increased $102,000 from the same quarter last year, while insurance increased $76,000 to cover our equipment additions since last year. These increases were partially offset by a $140,000 decrease in salaries due to a lump sum payment made to new hires that completed their probationary period during the three month period ended December 31, 2004. Research and Development Expenses Research and development expenses increased to $241,000 for the three months ended December 31, 2005 as compared to $20,000 for the same period of the prior year, an increase of $221,000 or 1,105%. This increase resulted from a $60,000 grant that partially offset the prior year's expense, with the balance of the increase due to materials and other purchases required to support our increased research and development effort. Bad Debts Bad debts expense totaled $255,000 for the three months ended December 31, 2005 as compared to $51,000 for the same period of the prior year. As a percentage of revenues, bad debts expenses were 1.0% and 0.2% for the three months ended December 31, 2005 and 2004, respectively. The bad debt expense increase is primarily due to the increase in the bad debts reserve from $834,000 or 3.0% of total accounts and notes receivable of $28.2 million at December 31, 2004 to $1.8 million or 3.5% of total accounts and notes receivable of $51.8 million at December 31, 2005. Management believes that the reserve for bad debts as of December 31, 2005 is adequate and will adjust future reserves as we gain more experience with our customers. Operating Income As a result of the above, operating income totaled $4.0 million for the three months ended December 31, 2005 as compared to operating income of $2.4 million for the same period of the prior year, an increase of $1.6 million or 69.9%. 19 As a percentage of revenues, operating income was 15.3% for the three months ended December 31, 2005 as compared to 9.4% for the same period of the prior year. The growth in operating income as a percentage of revenues was substantially due to the increase in gross profit. Finance Costs Finance costs decreased to $385,000 for the three month period ended December 31, 2005 as compared to $390,000 for the same period of the prior year, a decrease of $5,000 or 1.3%. The finance costs decrease is primarily due to the BAK Battery's receipt of the second science and technology development interest subsidy from the Shenzhen Department of Finance amounting $124,000 which has been offset against the interest costs during the period. We had $72.6 million in short term loans and notes payable as of December 31, 2005 as compared to $52.6 million outstanding as of December 31, 2004. Short term loans and notes payable are comprised of various short term bank loans and promissory notes, with interest ranging from 5.022% to 6.138%, and maturities of generally less than twelve months. The funds were used for working capital purposes to support the anticipated increase in revenues in the second quarter of fiscal 2006. Other Expenses (Income) Other income was $309,000 for the three month period ended December 31, 2005 as compared to $16,000 of other expenses for the same period of the prior year, an improvement of $325,000. The other income increase is primarily due to BAK International's short term investment in financial instruments during the period. Net Income Primarily as a result of decreased manufacturing costs during the period, we increased our net income to $3.8 million as compared to $1.8 million for the same period of the prior year, an increase of $2.0 million or 110.2%. Inventory Inventory totaled $36.9 million as of December 31, 2005 as compared to $21.7 million as of September 30, 2005, an increase of $15.2 million. We built finished goods inventory by $9.9 million in preparation for the one week plant closing for the Chinese New Year as well as the anticipated ramp up of sales starting in the second quarter of fiscal 2006. Management expects that the finished goods inventory, approximating two months' sales at December 31, 2005, will be reduced by one-third by March 31, 2006. We were also able to enjoy volume discounts from the increased level of raw material purchases. Notes Receivable We have modified our policy with respect to accounts receivable by allowing customers that have good credit ratings and business relationships with us to transfer a portion of their accounts receivable balances to notes receivable. As a result, notes receivable increased to $9.4 million as of December 31, 2005 from $484,000 as of September 30, 2005, an increase of $8.9 million. All of this increase was attributed to sales made during the month of December 2005 and the corresponding notes receivable are due by June 30, 2006. Management believes that this policy will provide a better way to secure our receivables as well as providing the flexibility for us to discount our notes receivable in the future. Results of operations for the year ended September 30, 2005 as compared to the year ended September 30, 2004. 20 Revenues Revenues increased to $101.9 million for the year ended September 30, 2005 as compared to $63.7 million for the prior year, an increase of $38.2 million or 59.9%. Our revenues increased during 2005 primarily as a result of an increase in the number of units sold, with a slight improvement in average unit selling prices. Revenues relating to steel case cells increased to $56.9 million in 2005 from $38.0 million in 2004, an increase of $18.9 million or 49.7%, primarily due to an increase in the number of units sold. Revenues from sales of aluminum case cells increased to $23.7 million for 2005 as compared to $13.1 million in 2004, an increase of $10.6 million or 80.9%, primarily due to increased sales volume. Revenues relating to industrial batteries increased to $20.2 million in 2005 from $12.4 million in 2004, an increase of $7.8 million or 62.9%, primarily due to an increase in the number of units sold.. Although most of our sales were made in China, we were able to gain market share both domestically and internationally during the year because, in our belief, our production volume and technological advantage gives us an advantage over our competitors with regard to supply ability and cost. We also believe that our gain in market share was due in part to our decision to maintain competitive pricing, the improved quality of our products and the improvements we made in production efficiencies. Gross Profit Gross profit for the fiscal year ended September 30, 2005 was $25.7 million or 25.2% of revenues as compared to gross profit of $13.8 million or 21.7% of revenues for the prior fiscal year. The increase in gross profit, as a percentage of revenues, resulted from a combination of decreased unit manufacturing costs and slightly higher average unit selling prices. While our cost of manufacturing steel case cell units decreased by 4.8% in fiscal 2005, selling prices decreased by less than 1.0%, resulting in an overall increase in gross profit from 23.2% to 26.5% of revenues. In the aluminum case cell market, unit manufacturing costs increased by 8.2% in fiscal 2005, while selling prices increased an average of only 6.5%, thereby reducing gross profit from 21.9% to 20.7% of revenues. The 7.0% decrease in unit selling prices for industrial batteries from fiscal 2004 to fiscal 2005, however, was more than offset by a 14.0% improvement in unit manufacturing costs, resulting in an improvement in gross profit from 24.1% to 29.8% of revenues. We did gain market share during the year due to our decision to maintain competitive pricing while improving the quality of our products. Selling Expenses Selling expenses increased to $4.0 million for the year ended September 30, 2005, as compared to $1.9 million for the prior year, an increase of $2.1 million or 114.2%. Salaries related to selling efforts increased to $2.0 million in fiscal 2005 from $830,000 for the prior year, an increase of $1.2 million. An increase in the number of employees in our sales and marketing group and higher average salaries paid to the sales and marketing employees in fiscal 2005 were responsible for this increase. We had 88 employees engaged in sales and marketing as of September 30, 2005 as compared to 67 as of September 30, 2004. In connection with the introduction of a formal and coordinated marketing campaign, advertising expenses increased to $298,000 in fiscal 2005 from $201,200 in 2004, an increase of $96,800. Filing fees, promotion, trademarks, depreciation, and other related selling and marketing expenses increased to $1,725,600 for fiscal 2005 from $476,700 for the prior fiscal year, an increase of $1,248,900, related to increased sales and selling efforts. General and Administrative Expenses General and administrative expenses grew to $5.0 million for the fiscal year ended September 30, 2005 from $3.1 million for the prior fiscal year, an increase of $1.9 million or 61.0%. As a percentage of revenues, general and administrative expenses were 4.9% and 4.9% in fiscal 2005 and 2004, respectively. Despite the increase in general and administrative expenses from fiscal 2004 to fiscal 2005, those expenses remained manageable relative to revenues. Salaries and benefits, including costs of training, increased to $1.4 million in fiscal 2005 from $1.2 million in the prior fiscal year, an increase of $234,000 or 19.8%, primarily as a result of additional employees. We had 500 employees in general and administration positions as of September 30, 2005, as compared to 451 employees as of September 30, 2004. Professional fees increased $224,000 from fiscal 2004 to fiscal 2005, reflecting the additional costs of operating as a public company since January 2005. 21 Research and Development Expenses Research and development expenses increased to $542,000 for the fiscal year ended September 30, 2005 as compared to $329,000 for the prior fiscal year, an increase of $213,000 or 64.7%. New initiatives, such as rechargeable lithium polymer batteries and LiNiCoO2 anode research, depreciation from research and development equipment additions and an increase in patent applications and maintenance contributed to the increase. Bad Debts Bad debt expense totaled $770,000 for the fiscal year ended September 30, 2005 as compared to $327,000 for the prior fiscal year, an increase of $443,000 or 135.5%. As a percentage of revenues, bad debts were 0.8% and 0.5% for fiscal 2005 and fiscal 2004, respectively. We believe that the reserve for bad debts as of September 30, 2005 is adequate, and we will adjust future reserves as we gain more experience with our customers. Operating Income As a result of the foregoing, operating income totaled $15.3 million for the fiscal year ended September 30, 2005 as compared to operating income of $8.1 million for the fiscal year ended September 30, 2004, an increase of $7.2 million or 88.0%, on a 59.9% increase in revenues. As a percentage of revenues, operating income was 15.0% in fiscal 2005 as compared to 12.8% for the prior fiscal year. This increase in operating income as a percentage of revenues was substantially due to the increase in gross margin from fiscal 2004 to fiscal 2005. Finance Costs Finance costs increased to $2.4 million for the fiscal year ended September 30, 2005 as compared to $1.0 million for the prior fiscal year, an increase of $1.4 million or 138.1%. The increase was attributable to the increase in the amount of our short term bank loans in fiscal 2005 compared with that outstanding in fiscal 2004. We had $39.5 million in short-term bank loans as of September 30, 2005, as compared to $27.3 million and $3.5 million outstanding as of September 30, 2004 and 2003, respectively. Short-term bank loans bear interest at annual rates ranging from 4.5% to 6.1%, and maturities are generally less than twelve months. The funds obtained from the increased borrowings were primarily used to fund working capital and to purchase equipment. We expect to replace the short term debt incurred to fund these long-term equipment acquisitions with comparable long-term debt once it formally acquires its certificate of land use right. Provision for Income Taxes We temporarily enjoy favorable tax treatment as a result of locating our main production facilities in the Shenzhen Special Enterprise Zone. In accordance with the relevant income tax laws applicable to enterprises operating in the Shenzhen Special Economic Zone of the PRC, the taxable income of is fully exempt from income tax for 2 years ("tax holiday"), commencing from the first profit making year of operations, followed by a 50% exemption for the immediate next three years ("tax preferential period"), after which the profits of BAK Battery will be taxable at the full reduced rate for New and High Technology Enterprises, currently 15%. In addition, BAK Battery also enjoys the same tax holiday and tax preferential period treatments on the additional investments that were approved during fiscal year 2005. The percentage of taxable income enjoying a tax holiday in 2005 is 55.88%; the 44.12% balance enjoys tax preferential period treatment. We anticipate a tax rate of 7.5% of profits on the original investment portion through the 2006 calendar year, before reverting to the anticipated standard corporate rate of 15% afterward. The additional investment will enjoy the tax holiday through the 2006 calendar year and then be taxed at 7.5% through the 2009 calendar year. Further, on August 11, 2005, BAK Battery was recognized as a Foreign-Invested, Advanced-Technology Enterprise by the Shenzhen government, whereby BAK Battery will enjoy an additional three year tax preferential period for all of its taxable income after the expiration of the original three year tax preferential period. If BAK Battery fails to qualify for a reduced tax program following the end of the 2009 calendar year, BAK Battery will be required to pay tax at the full 15% tax rate of its taxable income applicable to Shenzhen starting in 2010. 22 Income taxes increased to $527,000 for the year ended September 30, 2005, as compared to $394,000 for the previous year. We commenced paying taxes at the annual rate of 7.5% for the final nine months of fiscal 2004, resulting in an effective tax rate of 5.5% for fiscal 2004. Although income taxes were paid at a 7.5% rate for all of 2005 on the original investment portion, no taxes were due in 2005 for the additional investment due to the tax holiday, resulting in a lower overall rate of 4.1%. We have purchased $173,000 of equipment made in China during the year ended September 30, 2005, and will be eligible for a tax credit, equal to 40% of theses purchases, against additional future income tax. Net Income Primarily as a result of increased sales during fiscal 2005, we increased our net income to $12.4 million as compared to $6.7 million for the prior year, an increase of $5.6 million or 83.4%. Results of operations for the year ended September 30, 2004 as compared to the year ended September 30, 2003 Revenues Revenues increased to $63.75 million for the fiscal year ended September 30, 2004 as compared to $20.05 million for the prior fiscal year ended September 30, 2003, an increase of $43.70 million or 218%. Revenues from sales of aluminum case cell batteries were $13.08 million, an increase of $12.8 million, as compared to $280,000 in the prior year. This increase was primarily due to increased volume resulting from additional product offerings and our increased production. Revenues relating to steel case cell batteries increased to $50.41 million from $19.68 million in the prior year, an increase of $30.73 million or 156%. This increase also was due to increased volume of sales as a result of additional product offerings and our increased production. In fiscal year 2004, our customers continued to demand price concessions, while simultaneously demanding greater quality and services from us. In response to these conditions, we acted to contain of costs and provided price reductions. Despite continued pricing pressure resulting in selling price reductions during the year in both aluminum case and steel case markets, we were able to gain market share both domestically and internationally because, in our belief, our production volume and technological advantage gives us an advantage over our competitors with regard to supply ability and cost. Gross Profit Gross profit for the fiscal year ended September 30, 2004 was $13.82 million or 21.7% of revenues as compared to gross profit of $5.52 million or 27.5% of revenues for the prior fiscal year. The reduction in gross profit, as a percentage of revenues, resulted from a combination of reduced unit selling prices and increased unit manufacturing costs stemming from an increase in prices for most raw materials used in the manufacturing process. Steel case cell battery selling prices decreased by 12.4% during fiscal 2004, while our cost of manufacturing steel case cell units decreased by only about 5.5%, resulting in an overall decrease in gross profit from 26.65% to 20.42% of revenues from the sale of steel case cell units in fiscal 2004. In the aluminum case cell market, price reductions averaged 21.9% and unit costs increased by 10.6%, thereby reducing gross profit in our aluminum case products from 21.69% to 19.38% of revenues in fiscal 2004. We did, however, gain market share due in part to our decision to maintain low pricing, the improved quality of our products and the improvements we made in manufacturing efficiencies. Selling Expenses Selling expenses increased to $1.88 million for the year ended September 30, 2004 as compared to $445,800 for the prior year, an increase of $1.43 million or about 321.2%. 23 Salaries related to selling efforts increased to $740,000 from $80,000 for the prior year, an increase of $660,000, primarily as a result of an increase in the number of employees in our sales and marketing group and higher average salaries paid to the sales and marketing employees in fiscal 2004. More sales and marketing group efforts were required to continue gaining market share and to grow revenues. We had 67 employees engaged in sales and marketing as of September 30, 2004 as compared to 51 as of September 30, 2003. In connection with the introduction of a formal and coordinated marketing campaign, marketing expenses increased to $610,000 from $230,000 incurred in the prior year, an increase of $380,000. Transportation, filing fees, promotion, trademarks, and other related selling and marketing expenses increased to $520,000 for fiscal 2004 from $132,000 for the prior fiscal year, an increase of $388,000, related to increased sales and selling efforts. General and Administrative Expenses General and administrative expenses grew to $3.14 million for the fiscal year ended September 30, 2004 as compared to $804,600 for the prior fiscal year, an increase of $2.3 million or 290.4%. As a percentage of revenues, general and administrative expenses were 4.9% and 4.0% in fiscal 2004 and fiscal 2003, respectively. The increase in the general and administrative expenses stemmed from an increase in our infrastructure to support the increased sales levels during fiscal 2004 through facilities expansion and the hiring of additional employees. Despite the increase in general and administrative expenses from fiscal 2003 to fiscal 2004, those expenses remained manageable relative to revenues. Salaries and benefits, including costs of training, increased to $1.27 million in fiscal 2004 from $260,000 as compared to the prior fiscal year, an increase of $1.01 million or 388%, primarily as a result of additional employees. We had 99 employees in machinery and engineering positions as of September 30, 2004, as compared to 27 employees as of September 30, 2003. Increases in office expenses, insurance, professional fees, maintenance, recruitment, and other administrative expenses accounted for the remainder of the increase in this category from fiscal 2003 to fiscal 2004, increases also related to the increased number of employees. Research and Development Expenses Research and development expenses increased to $329,000 for the fiscal year ended September 30, 2004 as compared to $117,000 for the prior fiscal year, an increase of $212,000 or 182%. The increase in our research and development staff to 107 as of September 30, 2004 from 58 as of September 30, 2003 was the primary factor accounting for the increase in this category. New initiatives, such as rechargeable lithium polymer batteries research and development, and an increase in patent applications and maintenance required incremental staff hiring contributed to the increase. Bad Debts Bad debt expense totaled $327,000 for the fiscal year ended September 30, 2004 as compared to $448,000 for the prior fiscal year, a decrease of $121,000 or 27%. As a percentage of revenues, bad debts were 0.5% and 2.2% for fiscal 2004 and fiscal 2003, respectively. We believe that the reserve for bad debts as of September 30, 2004 was adequate, and we will adjust future reserves as we gain more experience with our customers. Operating Income As a result of the foregoing, operating income totaled $8.15 million for the fiscal year ended September 30, 2004 as compared to operating income of $3.70 million for the fiscal year ended September 30, 2003, an increase of $4.45 million or 120%. As a percentage of revenues, operating income was 12.8% in fiscal 2004 as compared to 18.5% for the prior fiscal year. This reduction in operating income as a percentage of revenues was substantially due to the reduction in levels of gross profit from fiscal 2003 to fiscal 2004. 24 Finance Costs Finance costs increased to $1.01 million for the fiscal year ended September 30, 2004 as compared to $123,000 for the prior fiscal year, an increase of $887,000 or 721%. The increase was attributable to the increase in the amount of our outstanding debt in fiscal 2004 compared with that outstanding in fiscal 2003. We had $49.89 million in short-term loans and notes payable as of September 30, 2004 as compared to $9.58 million outstanding as of September 30, 2003. Short-term loans and notes payable are comprised of various short-term bank loans and promissory notes, bearing interest at rates ranging from 4.54% to 5.84%, and maturities of generally less than twelve months. The funds obtained from the increased borrowings were used to construct our new manufacturing facilities and to purchase associated equipment, which resulted in $40.31 million of capital costs. The remaining proceeds of the borrowing were used for working capital purposes. Provision for Income Taxes We enjoy a temporary favorable tax treatment as a result of locating our main production facilities in the Shenzhen Special Enterprise Zone. We anticipate a tax rate of 7.5% of profits through the 2009 calendar year before reverting to the anticipated standard corporate rate of 15%. Taxes increased to $394,000 for the year ended September 30, 2004 as compared to no taxes for the previous year. We commenced paying taxes at the annual rate of 7.5% in 2004, two years after we first had net income; however, because these taxes are based on a calendar year we only paid taxes for the final nine months of fiscal 2004, resulting in an effective tax rate of 5.5% for fiscal 2004. Net Income Primarily as a result of increased sales during fiscal 2004, we increased our net income to $6.75 million as compared to $3.58 million for the prior year, an increase of $3.17 million or about 89%. Liquidity and Capital Resources We have historically financed our liquidity requirements from a variety of sources, including short term borrowings under bank credit agreements, promissory notes and issuance of capital stock. As of December 31, 2005, we had cash and cash equivalents of $36.3 million, as compared to $52.4 million as of September 30, 2005. Included in cash and cash equivalents are cash deposits that are pledged to banks in the amount of $24.9 million and $19.4 million at December 31, 2005 and September 30, 2005, respectively. Typically, banks will require borrowers to maintain deposits of approximately 20% to 100% of the outstanding loan balances. The individual bank loans have maturities ranging from 5 to 12 months which coincides with the periods the cash remains pledged to the banks. We had a working capital surplus of $17.9 million as of December 31, 2005, as compared to $20.0 million as of September 30, 2005, a decrease of $2.1 million. This decrease was primarily attributable to the $4.0 million increase in notes payable to finance the construction of the BAK Industrial Park and the acquisition of equipment. We had short term borrowings maturing in less than one year of $72.6 million as of December 31, 2005, as compared to $69.1 million as of September 30, 2005, an increase of $3.5 million. We currently expect to be able to extend the maturities of our short-term debt once we formally acquire our certificate of land use right. If we are not able to do so, we will have to refinance such short-term debt as it becomes due or to repay that debt to the extent we have cash available from operations or from the proceeds of additional issuances of capital stock. As of December 31, 2005, the principal outstanding under our credit facilities and lines of credit were as follows: 25 Maximum Amount Amount Available Borrowed --------- --------- (In thousands) Comprehensive Credit Facilities: Agricultural Bank of China .................. $ 30,978 $ 29,158 Shenzhen Development Bank ................... 18,587 13,630 Shenzhen Commercial Bank .................... 6,196 4,337 China Minsheng Bank ......................... 4,956 4,956 Construction Bank of China .................. 6,196 6,196 --------- --------- Subtotal - Credit Facilities $ 66,913 58,277 ========= --------- Lines of Credit: Agricultural Bank of China .................. 4,264 Shenzhen Development Bank ................... 212 Shenzhen Commercial Bank .................... 4,942 China Minsheng Bank ......................... 4,942 --------- Subtotal - Other Borrowings 14,360 --------- Total Principal Outstanding $ 72,637 ========= Lines of credit are outside of comprehensive credit facilities and are therefore shown separately. We refinanced our short-term debt during fiscal 2005 at annual interest rates of 4.5% to 6.1%, payable monthly, and for terms of six to twelve months. These debt arrangements are generally guaranteed by BAK International, Mr. Xiangqian Li, our Director, Chairman of the Board, President, and Chief Executive Officer, and Jilin Provincial Huaruan Technology Company Limited by Shares, a PRC company ("Huaruan Technology"). Pursuant to the refinancing, we deposited $19.4 million of restricted cash, and pledged $7.7 million of inventory and $9.8 million of equipment and machinery as security for our comprehensive credit facility with Shenzhen Development Bank ("Credit Facility"). In addition, Mr. Li pledged 19,053,887 of his shares of our common stock to guarantee our obligations under the Credit Facility. Furthermore, if at any point during the term of the Credit Facility (i) our liabilities exceed 70% of our assets, (ii) our sales revenue declines by 10% from their levels for the prior calendar year or (iii) our net asset value declines by 10% compared to the same point during the prior calendar year, all outstanding debt, including interest and penalties due thereunder, will accelerate and become immediately due and payable. We are currently in compliance with these financial tests. The indebtedness to Shenzhen Commercial Bank is guaranteed by Mr. Li and by an unaffiliated third party guarantor. During the three months ended December 31, 2005, we refinanced two of our credit facilities totalling $3.8 million, and entered into two new credit facilities totalling $3.7 million with existing lenders. The four new facilities provide for monthly interest payments at fixed annual interest rates from 5.022% to 6.138%, with principal repayments at maturities during the second calendar quarter of 2006. On January 11, 2006, BAK Battery repaid in full its loan from the Agricultural Bank of China, originally entered into on July 29, 2005 for up to $6,178,942 and maturing January 29, 2006. The principal balance at the time of repayment was $6,178,942. On February 22, 2006, BAK Battery renewed its outstanding loan from China Construction Bank in the amount of $3,726,847 under an Application Letter for Drawing for Bank Loan Facility. The new loan agreement provides for a term of six months, with interest accruing at an annual rate of 5.481%, payable monthly, and principal payable at maturity. The principal and interest terms of the loan renewal are the same as those terms under the original loan. In the future, we may be unable to obtain the same or similar terms for any refinancing of our short-term indebtedness, or be unable to renew our credit facilities on acceptable terms. If we fail to obtain debt or equity financing to meet our debt obligations, or fail to obtain extensions of maturity dates of these obligations as they become due, our overall liquidity and capital resources will be adversely affected. As of December 31, 2005, principal, interest and rental payments due under our contractual obligations were as follows:
(In thousands) Payments Due --------------------------------------------------------- Less than More than Total 1 Year 1-3 Years 3-5 Years 5 Years --------- --------- --------- --------- --------- Bank Loan, Short Term $ 39,032 $ 39,032 -- -- -- Notes Payable 33,605 33,605 -- -- -- Operating Leases 192 95 $ 97 -- -- Capital Leases -- -- -- -- -- --------- --------- --------- --------- --------- Total Payments Due $ 72,829 $ 72,732 $ 97 -- -- --------- --------- --------- --------- ---------
On September 30, 2004, contrary to relevant PRC laws and regulations, BAK Battery borrowed $1,812,316 from Changzhou Lihai Investment Consulting Co., Ltd., an unaffiliated party. BAK Battery subsequently repaid this loan on October 11, 2004. Management believes that the risk to BAK Battery, due to this loan arrangement, is very limited. On January 18, 2005, BAK International completed a private offering of 8,600,433 shares of its common stock for gross offering proceeds of $17.0 million or $1.98 per share. Investors in the offering participated in the subsequent exchange transaction with CBBI, and received 8,600,433 restricted shares of CBBI's common stock, along with attendant registration rights. Net proceeds from the financing of $15.7 million were used as follows: $4.3 million to expand production facilities, $1.8 million to enhance existing products and to research and develop new product offerings, and $9.6 million for working capital purposes. On September 16, 2005, CBBI sold 7,899,863 shares of its common stock for gross offering proceeds of $43.4 million or $5.50 per share. Net proceeds from that transaction of $40.3 million will be used to purchase equipment and for working capital. We have completed the construction of 174,784 square meters of new facilities comprised of manufacturing facilities, warehousing and packaging facilities, dormitory space and administrative offices at the BAK Industrial Park. Of that space, 107,388 square meters are new manufacturing facilities. We have completed construction and put into use an additional administrative area, production facility, four manufacturing facilities, a warehouse and packaging facility, two dormitories and one dining hall. At present, we have no significant payment obligations related to these facilities, although we continue to make payments regarding the construction of the facility as costs arise. We do not own the tract of property on which we constructed the new manufacturing plant and related facilities. We have applied for, but have not obtained, a certificate of land use right for the property and those new facilities. After formal receipt of our land use right, we anticipate being able to extend the maturity of some or all of our short-term debt. We are also seeking additional capital from other sources in order to meet our capital requirements for expansion and ongoing liquidity needs. We may be unable to obtain this additional capital or may be able to obtain additional capital only on terms unfavorable to us and our existing stockholders. The additional capital could include debt or equity financing, which could be dilutive to existing stockholders. If we are unable to secure such financing, we may not be able to complete all of our planned capital expansion. Off-Balance Sheet Transactions In the ordinary course of business practices in China, we enter into transactions with banks or other lenders where we guarantee the debt of other parties. These parties may be related to or unrelated to CBBI. Conversely, CBBI's debt with lenders may also be guaranteed by other parties which may be related or unrelated to CBBI. Under generally accepted accounting principles, these transactions may not be recorded on the balance sheet of CBBI or may be recorded in amounts different than the full contract or notional amount of the transaction. Our primary off balance sheet arrangements would result from our loan guaranties in which BAK Battery would provide contractual assurance of the debt, or guarantee the timely re-payment of principal and interest of the guaranteed party. Typically, no fees are received for this service. Thus in those transactions, BAK Battery would have a contingent obligation related to the guaranty of payment in the event the underlying loan is in default. 26 Transactions described above require accounting treatment under FASB Interpretation 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others ("FIN 45"). Under that standard, CBBI would be required to recognize the fair value of guarantees issued or modified after December 31, 2002 for non-contingent guaranty obligations, and also a liability for contingent guaranty obligations based on the probability that the guaranteed party will not perform under the contractual terms of the guaranty agreement. We had contingent guaranty obligations at December 31, 2005 requiring recognition or disclosure under FIN 45. We had guaranteed the timely re-payment of principal and interest of two parties to a bank. The maximum amount of our exposure for those guaranties at December 31, 2005 was $6.3 million. On January 11, 2006, we guaranteed an additional $619,000 for one of these parties to a bank. Between January 9, 2006 and March 7, 2006, we discounted an additional $10.8 million of notes receivable, increasing our maximum exposure for guarantees to $17.7 million on that date. No revenue, expenses or cash flows arose from these arrangements at anytime. Interest Rate Risk We are exposed to interest rate risk primarily with respect to our short-term bank loans. Although the interest rates, based on the banks' prime rates, are fixed for the terms of the loans, the terms are typically five to twelve months and interest rates are subject to change upon renewal. There were no changes in interest rates for short-term bank loans renewed during the three months ended December 31, 2005. A hypothetical 1.0% increase in the annual interest rates for all of our credit facilities at December 31, 2005 would decrease net income before provision for income taxes by $98,000 or 2.5% for the three months ended December 31, 2005. Management monitors the banks' prime rates in conjunction with our cash requirements to determine the appropriate level of debt balances relative to other sources of funds. We have not entered into any hedging transactions in an effort to reduce our exposure to interest rate risk. Foreign Exchange Risk While our reporting currency is the U.S. Dollar, approximately 75% of our consolidated revenues and 90% of consolidated costs and expenses are denominated in Renminbi ("RMB"), with the balance denominated in U.S. Dollars. Substantially all of our assets are denominated in RMB except for cash, of which 34% is denominated in U.S. Dollars. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between U.S. Dollars and RMB. If the RMB depreciates against the U.S. Dollar, the value of our RMB revenues, earnings and assets as expressed in our U.S. Dollar financial statements will decline. We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk. Critical Accounting Policies In preparing our consolidated financial statements in conformity with accounting principles generally accepted in the United States, we use statistical analysis, estimates and projections that affect the reported amounts and related disclosures and may vary from actual results. We consider the following accounting policies to be both those that are most important to the portrayal of our financial condition and require the most subjective judgment. If actual results differ significantly from management's estimates and projections, there could be an effect on our financial statements. Revenue Recognition, Returns and Warranties. Revenue from sales of our products is recognized upon shipment or delivery, depending on the terms of the sales order, provided that persuasive evidence of a sales arrangement exists, title and risk of loss have transferred to the customer, the sales amount is fixed and determinable, sales and value-added tax laws have been complied with, and collection of the revenue is reasonably assured. 27 We reduce revenue based upon estimates of future credits to be granted to customers. Credits are granted for reasons such as product returns due to quality issues, including product warranties claims, volume-based incentives, and other special pricing arrangements. Management utilizes its historical experience to estimate the allowance for product returns and warranty claims and revises those estimates periodically based on changes in actual experience, market conditions and contract terms. In addition, management monitors collectability of accounts receivable primarily through review of the accounts receivable aging. When facts and circumstances indicate the collection of specific amounts from specific customers is at risk, we assess the impact on amounts recorded for bad debts and, if necessary, record a charge in the period such determination is made. Inventory Valuation Allowances. Inventory is valued net of allowances for unsalable or obsolete raw materials, work-in-process and finished goods. Allowances are determined by comparing inventory levels of individual materials and parts to historical usage rates, current backlog and estimated future sales, and by analyzing the age of inventory, in order to identify specific components of inventory that are judged unlikely to be sold. In addition to this specific identification process, statistical allowances are calculated for remaining inventory based on historical write-offs of inventory for salability and obsolescence reasons. Inventory is written-off in the period in which the disposal occurs. Actual future write-offs of inventory for salability and obsolescence reasons may differ from estimates and calculations used to determine valuation allowances due to changes in customer demand, customer negotiations, technology shifts and other factors. Changes in Accounting Standards In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 151, "Inventory Costs, an amendment of ARB No. 43, Chapter 4," ("SFAS 151") which became effective for us on October 1, 2005. This standard clarifies that abnormal amounts of idle facility expense, freight, handling costs and wasted material should be expensed as incurred and not included in inventory. In addition, this standard requires that the allocation of fixed production overhead costs to inventory be based on the normal capacity of the production facilities. We do not believe the impact of the adoption of SFAS 151 has been be material. Exchange Rates The financial records of BAK International, BAK Battery and BAK Electronics are maintained in Renminbi ("RMB" or "Yuan"). In order to prepare our financial statements and to state other amounts set forth in this Management's Discussion and Analysis ("MD&A"), we have translated amounts in Renminbi into amounts in US Dollars. The amounts of our assets and liabilities on our balance sheets are translated using the closing exchange rate as of the date of the balance sheet. Revenues, expenses, gains and losses are translated using the average exchange rate prevailing during the period covered by such financial statements. Adjustments resulting from the translation, if any, are included in our cumulative other comprehensive income (loss) in our stockholders' equity section of our balance sheet. All other amounts stated in this MD&A, that were originally booked in Renminbi and translated into US Dollars, were translated using the closing exchange rate on the date of recognition. Year to year comparative amounts included in this MD&A are based on the amounts for the years or date compared included in the financial statements for the years discussed. Consequently, the exchange rates at which the amounts in those comparisons were computed varied from year to year. 28 The exchange rates used to translate amounts in Renminbi into US Dollars in connection with the preparation of our financial statements or otherwise stated in this MD&A were as follows:
RMB per US Dollar ----------------- 2005 2004 ----------------- Balance sheet items as of December 31 8.0702 8.2765 Amounts included in the statement of operations, statement of changes in stockholders' equity and statement of cash flows for the three months ended December 31 8.0827 8.2765 Balance sheet items as of September 30 8.0920 8.2767 Amounts included in the statement of operations, statement of changes in stockholders' equity and statement of cash flows for the years ended September 30 8.2413 8.26688
Renminbi are not readily convertible into US Dollars in the foreign exchange markets. The foreign exchange rate between the RMB and the US Dollar had been stable at approximately RMB 8.28 to US$1.00 for the last few years. On July 21, 2005, the Central Bank of China announced that it would allow the Yuan to move to a flexible exchange rate with a maximum daily variance against the US Dollar of 0.3%. No provision has been made in the accompanying financial statements for the change in currency policy, nor has any determination been made, as to the potential impact, this may have on our future operations. As a result, the stated exchange rates may not accurately reflect the amount in US Dollars into which Renminbi could be actually converted at the date or during the periods reflected in the foregoing table. OUR BUSINESS Overview CBBI conducts its operations through its China-based indirect subsidiaries, BAK Battery and BAK Electronics. Both CBBI and BAK International are holding companies and do not conduct any revenue generating activities except through BAK Battery and BAK Electronics. We focus on the manufacture, commercialization and distribution of a wide variety of standard and customized lithium ion rechargeable batteries for use in a wide array of applications. We also have internal research and development facilities engaged primarily in furthering lithium ion related technologies. We believe that our technologies allow us to offer batteries that are flexibly configured, lightweight and generally achieve longer operating time than many competing batteries currently available. We have focused on manufacturing a family of replacement lithium batteries for cellular telephones. We also supply rechargeable lithium ion batteries for use in various other portable electronic applications, including high-power handset telephones, laptop computers, digital cameras, video camcorders, MP3 players and general industrial applications. Historically, we have manufactured three types of batteries: steel cell, aluminum cell and cylindrical cell. We deliver our products to packing plants operated by third parties where the bare cells are packed in accordance with specifications established by certain manufacturers of cellular telephones and other electronic products. The majority of our income is generated from the sale of steel cells. However, we believe there is growth potential for aluminum and cylindrical cells because of their wide applications. In September 2005 we began producing a fourth type of battery, lithium polymer. Our current growth strategy includes entering into the global original equipment manufacture ("OEM") battery market for mobile phone and portable electronic applications. We have developed a program for producing high power lithium ion battery cells which will allow us inroads into additional battery markets such as those for power tools. We have begun marketing our high power lithium ion battery cells. We operate sales and service branches in Beijing, Shanghai, Qingdao, Xiamen, Quanzhou, Zhuhai, Fuzhou and Guangzhou in the PRC. 29 History We originally began operations as a Nevada corporation known as "Medina Copy, Inc." We were incorporated in Nevada on October 4, 1999 and subsequently changed our name to "Medina Coffee, Inc." ("Medina Coffee") on October 6, 1999. Medina Coffee commenced operations on December 1, 2002 and was considered a development stage company. Medina Coffee was formed originally for the purpose of building a retail specialty coffee business that sold specialty coffee and espresso drinks through company owned and operated espresso carts. Medina Coffee had incurred operating losses from its inception and therefore looked to combine with a privately-held company that was profitable or that management considered to have growth potential. On January 20, 2005, we completed a stock exchange transaction with the stockholders of BAK International. The exchange was consummated under Nevada law pursuant to the terms of a Securities Exchange Agreement dated effective as of January 20, 2005 by and among Medina Coffee, BAK International and the stockholders of BAK International. Pursuant to the Securities Exchange Agreement, we issued 39,826,075 shares of our common stock, par value $0.001 per share, to the stockholders of BAK International, representing approximately 97.2% of our post-exchange issued and outstanding common stock, in exchange for 100% of the outstanding capital stock of BAK International. Effective February 14, 2005, we changed our name from "Medina Coffee, Inc." to "China BAK Battery, Inc." BAK Battery was formed in August, 2001 to manufacture and sell a variety of standard and customized lithium ion rechargeable batteries for use in a number of applications, although primarily in cellular telephones. It commenced revenue producing operations in June 2002. BAK International was incorporated in Hong Kong on December 29, 2003 under the Companies Ordinance at BATCO International Limited (and subsequently changed its name to BAK International Limited on November 3, 2004) for the purpose of acquiring all of the equity ownership interests in BAK Battery, a transaction which it completed in January 18, 2005. Our recent business activities include: o In June 2002, BAK Battery began operations with initial monthly output of approximately 220,000 units. o It received government authorization in October 2002 to establish a Postdoctoral Workstation, the establishment of which serves as recognition by the PRC government of the strong capabilities of our in-house research team. With our research and development facilities we are focusing our research efforts on liquid lithium ion batteries, high power lithium ion batteries, solid-polymer lithium ion batteries, and cylindrical and rectangular lithium ion batteries. o In March 2003, monthly output of the BAK Battery steel case battery cell reached approximately 2.4 million units. o In September 2003, BAK Battery was granted International Organization for Standardization 14001: 1996, an environmental management system certification, as well as International Organization for Standardization 9001: 2000, a quality management system certification, by Beijing Zhonjing Quality Certification Co., Ltd, an independent third party which issues such standardization certifications in the PRC. o As of September 2004, BAK Battery established a sales and service network to cover six principal coastal cities and Beijing in the PRC. o Following the completion of the new steel case cell production facility located in Shenzhen, PRC in May 2005, BAK Battery's total monthly capacity for all battery types rose to 22 million units. As of September 2005, our total monthly output for all battery types was approximately 18 million units. The opening of our new steel case cell production facility also allowed us to increase the production of aluminum case cells by making available a production line previously dedicated to steel cell production. Our ability to continue to grow our manufacturing capacity will depend upon the development and expansion of semi-automated manufacturing lines requiring less manual labor efforts when compared to previous more labor intensive manufacturing processes. 30 Our Business Strategy We seek to maintain and strengthen our position as a provider of lithium ion batteries and related services while increasing the breadth of our product line and improving the quality of our products. In order to achieve our objective, we plan to pursue the key strategies described below. o Continuing to be a cost leader in an increasingly competitive market. We believe we can ensure competitive pricing by integrating a labor intensive production process with high-tech, proprietary manufacturing equipment. We believe our experience in designing and updating key manufacturing equipment and operating such equipment at a low cost gives us a cost advantage over our competitors. o Taking advantage of our ready production capacity and allowing for increased production capacity. We believe our production capacity makes us more reliable, flexible and responsive in terms of fulfilling our customers' requirements than other providers. As such, existing and potential competitors may find it more difficult to compete with our production capabilities. The completion of our new manufacturing facility should only enhance our production capacity. o Enhanced R & D activities. With the completion of our new facility, we will have the space to enhance our existing R&D capabilities through the addition of state of the art equipment and experienced personnel. o Developing our OEM business. We believe that by entering the global OEM market for lithium ion batteries, we will be able to significantly increase revenues. In order to do so, we are currently undergoing certification by a global OEM in the mobile phone industry. To date, most of the certification process is complete, and we anticipate that we will receive certification. o Expanding our product lines to capture new market opportunities. We have developed high power lithium ion battery cells that can be used in power tools. Our product offering is currently undergoing testing by a potential customer. We have begun sales of our high power lithium battery during our fourth quarter of calendar year 2005. In addition, we are beginning to produce lithium polymer battery cells that can be used for various cellular telephones, portable electronic applications, Bluetooth technology, and similar types of technology. Lithium polymer batteries are used for applications similar to those that utilize lithium ion aluminum cell batteries. However, lithium polymer battery cells weigh less and are easier to shape. By entering these markets, we believe we can achieve future revenue growth and improved profit margins. In September 2005 we began production of lithium polymer batteries. Principal Products and Services Lithium Batteries A battery is an electrochemical apparatus used to store and release energy in the form of electricity. The main components of a conventional battery are the anode, cathode, separator and an electrolyte, which can be either a liquid or a solid. The separator acts as an electrical insulator, preventing electrical contact between the anode and cathode inside the battery. During discharge of the battery, the anode supplies a flow of electrons, known as current, to a load or device outside of the battery. After powering the load, the electron flow reenters the battery at the cathode. As electrons flow from the anode to the device being powered by the battery, ions are released from the cathode, cross through the electrolyte and react at the anode. 31 All of the cells that we build are rechargeable through the systems in the devices in which our batteries are used. Several important parameters for describing the performance characteristics of a rechargeable battery are design flexibility, energy density, discharge rate, internal resistance and cycle life. Design flexibility refers to the ability of rechargeable batteries to be designed to fit a variety of shapes and sizes of battery compartments. Thin profile batteries with prismatic geometry provide the design flexibility to fit the battery compartments of today's electronic devices. Energy density refers to the total electrical energy per unit volume stored in a battery. High energy density batteries generally are longer lasting power sources providing longer operating time and necessitating fewer battery recharges. Lithium batteries, by the nature of their electrochemical properties, are capable of providing higher energy density than comparably sized batteries that utilize other chemistries such as Nickel Cadmium (NiCd) and Nickel Metal Hydride (Ni-MH) and, therefore, tend to consume less volume and weight for a given energy content. Long cycle life is a preferred feature of a rechargeable battery because it allows the user to charge and recharge many times before noticing a difference in the performance of the battery. A lithium ion battery with lower internal resistance will provide higher electrical current with less energy consumption, as well as lower internal heat energy as a result of the lower internal resistance. The lower internal heat also makes the battery safer because it is less subject to explosion. A higher discharge rate means a higher electrical current, which in cellular telephones means a longer talking time. In addition to the higher energy density of lithium ion batteries compared to other rechargeable chemistry batteries such as NiCd and Ni-MH, lithium ion batters also provide higher discharge rate and shorter recharge time. Lithium batteries also can be manufactured using lithium sulfur dioxide or lithium thionyl chloride although those other chemistries have not been as widely used. Generally, rechargeable batteries have been replacing non-rechargeable batteries in many of the uses of which our batteries are intended. We manufacture a variety of lithium ion rechargeable batteries. We believe our range of lithium ion rechargeable batteries offer substantial benefits including the ability to design and produce lightweight cells in a variety of custom sizes, shapes and thickness. We produce the following types of rechargeable lithium batteries. o Prismatic lithium ion batteries. These batteries are used in cellular telephones, MP3 players, digital cameras and other portable electronic devices. These batteries can be composed of steel case cells or aluminum case cells. Aluminum case cells are lighter than steel case cells and safer. However, aluminum case cells generally are more expensive to manufacture and therefore have a higher cost. We manufacture a wide variety of steel case cell and aluminum case cell lithium ion prismatic batteries in various sizes and voltage configurations to satisfy customer requirements. o Cylindrical lithium ion battery. These batteries are primarily used in laptop computers, digital cameras and electric razors. These batteries are flexible in design like prismatic batteries, but have a greater energy density. Cylindrical batteries offer better uniformity, which permits them to be used in parallel circuits which increases the electrical current and the resulting working time. However, cylindrical batteries are more expensive to manufacture and therefore have a higher sales price than comparable non-cylindrical batteries. We manufacture 3 types of models ranging in size and voltage requirements to satisfy customer requirements. o Lithium polymer batteries. These batteries are used in cellular telephones, Bluetooth headsets, laptop computers, integrated circuit cards and personal digital assistant devices. Lithium polymer batteries have a polymer electrolyte rather than a liquid electrolyte, which reduces the battery's overall weight and volume. This allows for lighter, more compact battery and more flexibility in design than prismatic or cylindrical lithium ion batteries. However, they are more expensive to manufacture. In September 2005, we began production of lithium polymer batteries in a variety of sizes and voltage configurations. We are continuing to increase our offerings of lithium polymer batteries in order to gain the markets acceptance of these products from BAK Battery. During fiscal 2005, our product mix was 55.89% steel case battery cells, 23.27% aluminum case battery cells, 1.03% cylindrical case battery cells, 0.02% polymer battery cells and 19.79% industrial batteries. 32 Services We have built a sales and service network covering the cities of Shanghai, Qingdao, Xiamen, Quanzhou, Zhuhai, Fuzhou, Guangzhou and Beijing in the PRC. We provided services to support sales to our customers who currently are primarily battery pack manufacturers. Our service motto is "cooperative spirit, rapid reaction" . We provide presale, sales and post sale services. Our presale service is designed to determine our customers' order requirements, including, size, quantity, voltage and delivery date, and plan for the production of batteries to meet these order requirements. We solicit this information through face-to-face meetings and through a written client survey. The information we collect is used to schedule raw materials purchases and production. Our sales service includes the actual order processing, materials purchases, production scheduling and shipment of product. Depending upon our customers' location, we may ship directly using our own transportation facilities, primarily delivery by truck, or we may ship using a third party carrier. We support our sales with post-sales customer support. Our service capabilities include a 24-hour customer response. Our other services include providing battery testing and test reporting; providing training courses regarding quality control and battery usage; gathering customer opinions on our products and services; evaluating customer requirements and fulfilling appropriate requests. We have two strategic policies for sales and service: o We built a sales and service network to cover Beijing, Shanghai, Qingdao, Xiamen, Quanzhou, Zhuhai, Fuzhou and Guangzhou in China. o Our service capabilities include 24-hour customer response. Features Performance standards. Our lithium ion batteries have high capacity, low internal resistance, and a safety guarantee. Certificates or approvals we have received include: EU's CE attestation; Underwriters' Laboratory authentication in the United States; and certificates from the major cellular telephone manufacturers of China, including China Saibao (the CEPREI certification body); Amoi Electronics Co., Ltd.; China Datang (Group) Corporation; Konka Group Co., Ltd.; Tianyu Communication Technology (Kunshan) Co., Ltd.; and Shenzhen Telsda Mobile Communication Industry Development Co., Ltd. Longer usage time and higher discharge rates. We believe our battery has a higher discharge voltage so it can provide a longer talking time for mobile phone users. Our products have a higher discharge capacity than the battery products of certain competitors. Therefore, with the same capacity, our battery can therefore provide a longer talking time. The higher discharge capacity is especially useful for cellular telephones with color screens, which have a high demand on the battery's continuous discharge voltage. Performance at lower temperatures. Our lithium ion batteries perform well from -20 Celsius to +60 Celsius. At a temperature as low as -20 Celsius the batteries release 95% of the battery energy at an 0.2C rate (i.e. discharge all the energy in 5 hours); and over 90% of the battery energy can be discharged at an 1.0C rate. This feature allows improved cell phone battery duration, particularly in northern areas of the PRC. Manufacturing We manufacture all of products from raw materials at our facilities in Shenzhen in the PRC. The battery cells we produce are typically shipped to third parties for final packaging prior to delivery to our customers. The cost of such packaging is not included in our sales price to our customers. We maintain separate production lines for steel case cells, aluminum case cells, cylindrical cells and lithium polymer batteries. Such production lines can be adapted to produce other types of batteries if the demand for a particular type of battery increases or decreases. Our current monthly output capacity is 22 million units. Certain of the materials we utilize may pose safety problems if improperly used. We have designed our batteries to minimize safety hazards both in manufacturing and in use. 33 Depending upon the customer's location, we generally deliver our product to our customers by truck or by shipment from the Port of Hong Kong. We deliver our product to packing plants operated by third parties where cells are packed in accordance with our customer's specifications We primarily utilize electrical supply from the local utility company for heat, light and power to our facilities. As part of our production efficiency, we may enter into a supply agreement with an electrical supplier in order to assure the supply of electrical power to our manufacturing facilities. We have received International Organization for Standardization 9001: 2000, a quality management system certification, and International Organization for Standardization 14001: 1996, an environmental management system certification for all our manufacturing facilities. Suppliers We have built a complete supply chain, putting together a group of material and equipment suppliers, primarily Chinese, except for ENTEK (a separator supplier in the US), from whom we buy on a purchase order basis. During the sales process, our purchasing department prepares a schedule of materials needs for the planned production. The purchasing department then solicits from the suppliers with whom we have established relationships and may have entered into a long-term supply contract. We then enter an order with the selected supplier(s). The order will specify price, settlement date, quantity and the other requirements. We also specify quality standards for the purchase. We have established standards for our suppliers relating to quality, service and various other aspects of supply. We may enter into volume purchase agreements with our major suppliers under which we purchase materials and equipment on a purchase order basis. We have entered into such an agreement with Beijing CITIC Guoan Mengguli Electric Supply Ltd. Co., from whom we purchase the cathode material, Lithium Cobalt Dioxide (LiCoO2). These volume purchase agreements generally only specify nonmaterial terms; the material terms of each purchase are separately determined at the time of purchase order. We believe that alternative suppliers are available to supply materials and equipment if purchases were not available under any volume purchase agreement we may enter into. Cathode material in a lithium ion battery is primarily LiCoO2; LiMnO4 and LiCo1-xNixO2 are also used as cathode materials. Anode material mainly consists of carbon materials such as graphite, sourced primarily in China. The separator material is imported from Japan and the US. There are sufficient supplies of electrolytes in China, and we believe the quality to be very good. The table below describes the key sources of our key materials. As of December 31, 2005, our key material suppliers and key equipment suppliers were as follows: Key Material Suppliers - ------ ------------------ ------------------------------------------------------ Item Materials Main Suppliers - ------ ------------------ ------------------------------------------------------ 1 Case and caps Roofer Group Company, Yijinli technology company Shenzhen Tongli Precision Stamping Products Co., Ltd. - ------ ------------------ ------------------------------------------------------ 2 Cathode materials CITIC Guoan - ------ ------------------ ------------------------------------------------------ 3 Anode materials Shanghai Shan Shan, Changsha graphite - ------ ------------------ ------------------------------------------------------ 4 Aluminum foil Aluminum Corporation of America, Shanghai - ------ ------------------ ------------------------------------------------------ 5 Copper foil Huizhou United Copper Foil - ------ ------------------ ------------------------------------------------------ 6 Electrolyte Zhangjiagang Guotai-Huarong New Chemical Materials Co., Ltd. - ------ ------------------ ------------------------------------------------------ 7 Separator Ube Industries, ENTEK, CELGARD - ------ ------------------ ------------------------------------------------------ 34 Key Equipment Suppliers - ------ -------------------------------- ---------------------------------------- Item Instruments Suppliers - ------ -------------------------------- ---------------------------------------- 1 Coating machine Beijing 706 Factory - ------ -------------------------------- ---------------------------------------- 2 Mixer Guangzhou Hongyun Machine - ------ -------------------------------- ---------------------------------------- 3 Press machine SevenStar Huachuang - ------ -------------------------------- ---------------------------------------- 4 Ultrasonic spot welding machine Zhenjiang Tianhua Machinery and Electrical Co., Ltd. - ------ -------------------------------- ---------------------------------------- 5 Laser seam welder Wuhan Chutian Laser Group - ------ -------------------------------- ---------------------------------------- 6 Vacuum oven Jiangshu Wujiang Songling - ------ -------------------------------- ---------------------------------------- 7 Electrolyte filling machine BAK (internally developed) - ------ -------------------------------- ---------------------------------------- 8 Aging equipment Guangzhou Qingtian Industrial Co., Ltd. - ------ -------------------------------- ---------------------------------------- 9 Testing and sorting equipment Guangzhou Qingtian Industrial Co., Ltd.; Wuhan Kingnuo Electronics Co., Ltd. - ------ -------------------------------- ---------------------------------------- Sales and Marketing Marketing Strategies. We have two key marketing strategies. Our first strategy is to be a leader in the worldwide replacement battery market. We believe we can secure and enhance our market share because of the quality of our products and our ability to maintain high production volume with low production cost. Our second marketing strategy is to enter the global OEM market. To enter into this market we will be required to gain certification from a global OEM, which we are currently seeking and anticipate that we will receive. We believe that our entry into the global OEM market is important to our continued growth because the market for replacement batteries is becoming saturated. Our Current Market. We have developed a sales and service network of our own employees based in the cities of Qingdao, Xiamen, Quanzhou, Zhuhai, Fuzhou, Shanghai, Guangzhou and Beijing in the PRC. We also export our products to the United States, Canada, South Africa, Japan, Singapore, Taiwan, and Hong Kong. From 2001, our annual sales have grown from $3 million to $101.9 million for the year ended September 30, 2005. For the year ended September 30, 2005, 71% of our sales were domestic, while 29% were made internationally. We believe that our share of the domestic replacement battery market for cell phones for 2004 was 60%. Competition Our rechargeable lithium ion batteries compete against other manufacturers of lithium ion batteries. We compete on the basis of the prices at which we sell our products, our ability to supply the quantities of batteries our customers need in accordance with our customers' schedules and the quality of our products. We face competition in the production of rechargeable lithium ion batteries, not only within China, but also from other parts of the world, particularly Japan and Korea. Sony Corp. first commercialized rechargeable lithium ion batteries in 1992. However, Japan's market share of lithium ion battery production has decreased since 2000. We believe we are currently one of the largest lithium ion battery manufacturers in the world, with a monthly output of 22 million units (our current monthly production has reached the monthly output capacity). We also believe we are the second largest manufacturer in the Chinese market. We believe the following are the leading global manufacturers of lithium batteries:: o Japan - Sanyo Electric Co., Sony Corp., Matsushita Electric Industrial Co., Ltd. (Panasonic), GS Group, NEC Corporation and Hitachi Ltd.; o Korea - LG Chemical Ltd. and Samsung Electronics Co., Ltd.; and o China - BYD Co. Ltd., Shenzhen BAK Battery Co., Ltd., Tianjin Lishen Battery Joint-Stock Co., Ltd., Henan Huanyu Group and Harbin Coslight Technology International Group Co., Ltd. 35 We compete with these companies by striving to provide a higher quality product at a lower cost. We believe that by doing business in China we enjoy competitive advantages over similar companies doing business in Japan and Korea, including abundant labor resources, low cost raw materials and better access to China's extensive mobile phone market. We also believe that our production efficiencies as well as our labor costs give us a competitive advantage over other manufacturers in China. Historically, although other entities may attempt to take advantage of the growth of the lithium battery market, the lithium battery industry has certain technological and economic barriers to entry. The development of technology, equipment and manufacturing techniques and the operation of a facility for the automated production of lithium batteries require large capital expenditures, which may deter new entrants from commencing production. Customers We have targeted sales of our lithium ion rechargeable batteries to OEM's and replacement battery pack manufacturers, who resell our batteries in packaging to end users. Due to the demand for replacement cell phone batteries in China, and our proximity to that market, we targeted our domestic market through replacement battery pack manufacturers. Over the past three years, we have developed relationships with key battery pack customers, including SCUD (Fujian) Electronics Co., Ltd., Desay Power Tech. Co., Ltd. and Shenzhen Ya Litong Electronic Co., Ltd. We are also targeting sales of lithium ion batteries to global OEM's. A key to the OEM market is obtaining approval of our products from the OEM's, which we are currently seeking from a global OEM in the mobile phone industry. Our sales are generated primarily from purchase orders. We generally do not have long-term contracts with customers, although we may enter into a letter of intent to express our long term cooperative relationship with the customer. Our ten largest customers, who predominantly are in China, accounted for 53.31% of our sales during the fiscal year ended September 30, 2005. Our 30 largest customers accounted for 78.45% of our sales during the fiscal year ended September 30, 2005, predominantly in China. We do not believe our sales are materially seasonal. Research and Development We operate a state of the art research and development center performing proprietary research that has resulted in 25 issued patents in the PRC, 164 applications for patents filed in the PRC and 4 applications for patents filed outside the PRC as of December 31, 2005. We have not had any patents awarded in any country other than the PRC. We also outsource certain of our research and development matters to ChangChun Applied Chemistry Research Institute of the China Scientific Institute, Tstinghua University, JiLin University, the Electrochemistry Department of XiaMen University and Shenzhen University. In our in-house facility we employ over 100 staff members, led by three government recognized specialists. Upon the approval of the National Ministry of Personnel in October 2002, a Postdoctoral Workstation was established. The establishment of the Workstation serves as recognition by the PRC government of the strong capabilities of our in-house research team. The research and development center focuses research on projects relating to liquid lithium ion batteries, high power lithium ion batteries, solid lithium polymer ion batteries, and cylindrical and rectangular lithium ion batteries. During fiscal 2005 and 2004, we expended $541,735 and $328,779, respectively, on our research and development efforts. We have also invested $930,000 on research and development equipment during fiscal 2005, bringing the total research and development expenditures during fiscal 2005 to $1.5 million. During 2004, our research was aimed at developing new or improved anode raw material and new products. Our research in 2005 was targeted at new or improved cathode raw material and product safety research. Employees The following table summarizes the functional distribution of our employees as of September 30, 2004, September 30, 2005 and December 31, 2005: 36
Department September 30, 2004 September 30, 2005 December 31, 2005 ---------------------------------- ------------------ ------------------ ------------------ Officers 10 11 19 Comprehensive Management 197 146 133 Human Resources 19 18 21 Sales and Marketing 67 88 80 PMS Department 21 13 12 Process Department 46 29 15 Research & Development 107 108 108 Purchasing Department 29 24 25 Financial Department 18 25 31 PMC Department 45 74 87 After Sales Department 33 35 23 Quality Control Department 242 125 125 Investment Banking Department 1 5 5 Information Technology Department 0 10 12 Intellectual Property Department 0 12 9 Mechanical and Electronic Engineering 99 165 165 Law Affairs Department 0 0 8 Packing Department 420 578 595 Manufacturing Department 5,008 5,504 6,777 ---------------------------------- ------------------ ------------------ ------------------ TOTALS 6,362 6,970 8,250
33 None of our personnel are represented under collective bargaining agreements. We consider our relations with our employees to be good. Facilities We currently lease 8,486 square meters in the aggregate for office space, manufacturing facilities, and dormitory space. We lease 3,000 square meters for office space and manufacturing operations pursuant to a lease which runs from June 1, 2003 to June 1, 2008. Our current rent due under that lease is $2,781 a month. We also lease 2,500 square meters for office space and manufacturing facilities pursuant to a lease with a term beginning December 16, 2001 and ending December 15, 2006. We owe lease payments of $2,329 a month during the term of this second lease. We also lease an additional 2,986 square meters for dormitory space pursuant to a lease with a term beginning July 1, 2005, and ending June 30, 2008. We owe lease payments of $2,583 per month under this lease. In addition, currently we have completed construction of 174,784 square meters of new facilities comprised of manufacturing facilities, warehousing and packaging facilities, dormitory space and administrative offices at the BAK Industrial Park. Of that space, 107,388 square meters will be new manufacturing facilities. We have completed construction and put into use an additional administrative area, production facility, four manufacturing facilities, a warehouse and packaging facility, two dormitories and one dining hall. At present, we have no payment obligations related to these facilities, although we continue to make payments relating to the completion of construction of the facility. We do not own the tract of property on which we have constructed the new manufacturing plant and related facilities. We have applied for, but have not obtained, a certificate of land use right for the property and those new facilities. Legal Proceedings We are not a party to any legal proceedings, nor are we aware of any threatened or contemplated proceedings which are expected to result in a material adverse effect on our consolidated financial position or results of operation. 37 Intellectual Property and Proprietary Rights We rely primarily on a combination of copyright laws and contractual restrictions to establish and protect our intellectual property rights. As of December 31, 2005 we had obtained 25 issued patents in the PRC and 164 are in the application process in the PRC, and 4 are in the application process outside the PRC. We require our management and key technical personnel to enter into agreements requiring them to keep confidential all information relating to our customers, methods, business and trade secrets during and after their employment with us. We have very strict control over the core technologies for which we can not apply for patents. Every employee who is related to these proprietary technologies must sign a "special technology non-disclosure agreement". We have also established an internal department to protect property rights. In this department, there are professionals including attorneys, engineers, information managers and archives managers responsible for the application and protection of proprietary rights. We have also developed a series of rules regarding "property right non-disclosure", "property right archives management", "information collection and analysis" and "innovation encouragement". While we actively take steps to protect our proprietary rights, such steps may not be adequate to prevent the infringement or misappropriation of our intellectual property. This is particularly the case in China where the laws may not protect our proprietary rights as fully as in the United States. Infringement or misappropriation of our intellectual property could materially harm our business. BAK Battery has registered the following Internet and WAP domain name www.bak.com.cn (the English version of our website can be found at www.bak.com.cn.en). 38 DIRECTORS AND EXECUTIVE OFFICERS The following table provides information about our executive officers and directors and their respective ages and positions as of December 31, 2005. The directors listed below will serve until our next annual or special meeting of stockholders at which directors are elected: NAME AGE POSITION HELD ---- --- ------------- Xiangqian Li 37 Director, Chairman of the Board, President and Chief Executive Officer Yongbin Han 36 Chief Financial Officer, Secretary and Treasurer Huanyu Mao 54 Chief Operating Officer and Chief Technical Officer Xiangqian Li has served as our Director, Chairman of the Board, President and Chief Executive Officer since January 20, 2005. Mr. Li has been Chairman of Board of Directors and General Manager of BAK Battery since April 2001 and has also served as BAK Battery's general manager since December 2003. Previously, Mr. Li served as (i) Chairman of the Board of Directors and General Manager of Shenzhen BAK Li-ion Battery Co., Ltd. from December 2000 until March 2001; (ii) as Chairman of the Board of Directors and General Manager of Jilin Province Huaruan Technology Company Limited by Stocks ("Huaruan Technology") from March 2001 until June 2001; and (iii) as Chairman of the Board of Directors of Huaruan Technology from January 2001 until June 2003. Prior to 2001 Mr. Li was self employed. Mr. Li graduated from Lanzhou Railway Institute and holds a Bachelors degree in gas engineering. He is pursuing a Doctorate of quantity economics from Jilin University. Yongbin Han has served as our Chief Financial Officer and Secretary since January 20, 2005. Mr. Han is a Chinese certified public accountant and certified tax agent. Mr. Han has been Deputy General Manager of BAK Battery since April 2003. In that capacity he oversees the finance and accounting department. Previously, Mr. Han served as (i) Deputy General Manager of Huaruan Technology from January 2002 until April 2003 and (ii) Department Manager of Zhonghongxin Jianyuan Accounting Firm from July 1995 until July 2001. Mr. Han graduated from Changchun Tax Institute with a Bachelors degree in accounting. Huanyu Mao has served as our Chief Technical Officer since January 20, 2005 and as our Chief Operating Officer since June 30, 2005. Dr. Mao has been Chief Scientist of BAK Battery since September 2004. From 1997 until September 2004 Dr. Mao served as Chief Engineer of Tianjin Lishen Company. Dr. Mao received a Doctorate degree in electrochemistry in conducting polymers from Memorial University of Newfoundland, Canada. By the written consent of holders of a majority of the shares of our common stock, Dr. Huanyu Mao, Mr. Richard Goodner, Mr. Joseph R. Mannes and Mr. Donald A. Preston have been chosen to become directors of CBBI, although their elections will not be effective until the end of the twentieth calendar day after an Information Statement under Section 14(c) of the Securities Exchange Act of 1934, as amended, which includes information relating to the choice of those individuals to become directors, is sent to the stockholders of CBBI. An Information Statement has not been sent to stockholders of CBBI and accordingly, Dr. Mao and Messrs. Goodner, Mannes and Preston are not yet directors of CBBI. Richard Goodner, 59, currently serves as Vice President - Legal Affairs and General Counsel for U.S. Home Systems, Inc., a Nasdaq National Market System publicly traded company and has held that position since June 2003. Prior to working with U.S. Home Systems, Inc., Mr. Goodner was a partner in the law firm of Jackson Walker L.L.P. from 1997 to 2003. Mr. Goodner holds a Bachelor of Arts degree in Economics from Eastern New Mexico University and a law degree from Southern Methodist University. Joseph R. Mannes, 47, currently serves as the Managing Director - Corporate Finance of SAMCO Capital Markets, a division of Penson Financial Services, Inc. and has held this position since 2001. Prior to working with SAMCO Capital Markets, Mr. Mannes served as Vice President, Chief Financial Officer and Secretary of Clearwire Technologies, Inc. from 1998 to 2001. Mr. Mannes holds a Bachelor of Arts degree. in Philosophy and French from Dartmouth College and an M.B.A. in Finance and Accounting from the Wharton School Graduate Division of the University of Pennsylvania. 39 Donald A. Preston, 55, currently serves as Managing Director for Lincoln Financial Advisors, a subsidiary of the Lincoln Financial Group. Mr. Preston has served in this and other management capacities with Lincoln Financial Advisors over the last 20 years. Mr. Preston holds a Bachelor of Business Administration degree in General Business from St. John Fisher College and Chartered Life Underwriter and Chartered Financial Consultant degrees in Financial Planning from American College. Board Composition and Committees The board of directors is currently composed of one member, Xiangqian Li. After the election of the four individuals describe above becomes effective, the board of directors will consist of five members. All Board action requires the approval of a majority of the directors in attendance at a meeting at which a quorum is present. We have purchased officers and directors liability insurance. We currently do not have standing audit, nominating or compensation committees. We intend, however, to establish an audit committee and a compensation committee of the board of directors as soon as practicable. We envision that the audit committee will be primarily responsible for reviewing the services performed by our independent auditors, evaluating our accounting policies and evaluating and administering our system of internal controls over financial reporting. The compensation committee will be primarily responsible for reviewing and approving our salary and benefits policies (including stock options), including compensation of executive officers. Director Compensation At present we do not pay our directors a fee for attending scheduled and special meetings of our board of directors. We intend to reimburse each director for reasonable travel expenses related to such director's attendance at board of directors and committee meetings. As noted above, we intend to expand our board to include "independent" directors. It is anticipated that the appointment of independent members of our board will require us to pay fees comparable to those paid by other public companies in our peer group. Indebtedness of Directors and Executive Officers None of our directors or officers or their respective associates or affiliates is indebted to us. Involvement in Certain Legal Proceedings In the normal course of business, various claims are made against us. At this time, in the opinion of management, there are no pending claims the outcome of which are expected to result in a material adverse effect on our consolidated financial position or results of operations. Family Relationships There are no family relationships among our directors or officers. Executive Compensation The following Summary Compensation Table sets forth all cash compensation paid to our chief executive officer for services rendered in all capacities to us during the noted periods. No executive officers received total annual salary and bonus compensation in excess of $100,000. 40 Summary Compensation Table
Name and Restricted Securities Principal Stock Underlying All Other Position Year Salary Bonus Awards Options Compensation - --------------------------------- -------- -------- -------- ----------- ------------ ------------ Xiangqian Li 2005 $ 8,736 -0- N/A N/A $ 45,730(1) Chairman of the Board, 2004 $ 8,709 -0- N/A N/A N/A President, and Chief Executive Officer 2003 $ 8,699 -0- N/A N/A N/A
- ---------- (1) For use of a company-owned vehicle. Mr. Timothy P. Halter served as our Chief Executive Officer without compensation for nineteen days at the beginning of fiscal 2005, from January 1, 2005 to January 19, 2005. Stock Option Plan In May 2005, our board of directors adopted the China BAK Battery, Inc. 2005 stock option plan. We plan to submit the plan to a stockholder vote within 12 months of its adoption. The plan will be void if it is not approved by our stockholders. Our 2005 stock option plan provides for the grant of "nonqualified" stock options. These nonqualified stock options may be granted to our employees, non-employee directors and advisors and those of any of our subsidiaries or affiliates. However, advisors are only eligible to receive awards if they render bona fide services for us or any of our subsidiaries or affiliates. The exercise price of options granted pursuant to the plan must be at least equal to the fair market value of our common stock on the date of the grant. The plan authorizes the issuance of up to 4,000,000 shares of our common stock. We granted options to purchase 2,000,000 shares to approximately 55 individuals at fair market value on May 16, 2005, including options to purchase 200,000 shares granted to each of Yongbin Han, our Chief Financial Officer, Secretary and Treasurer, and Huanyu Mao, our Chief Operating Officer and Chief Technical Officer. We have 2,000,000 shares of our common stock remaining available for issuance under this plan. The plan will generally terminate on May 16, 2055. Generally, stock options granted under this plan may not be transferred in any manner other than by will or by the laws of descent and distribution and may be exercised during the lifetime of the optionee only by the optionee. However, exceptions can be made to this restriction. Options granted under our 2005 stock option plan expire immediately upon the termination of the optionee's service to us or to a subsidiary or affiliate of ours for misconduct, thirty-one days following termination if the termination is for reasons other than death, disability or cause, or 12 months following termination if the termination is due to death or disability. Upon a change in control, all outstanding stock options under our 2005 stock option plan either may be assumed or substituted for by the successor entity. If the successor entity determines not to assume or substitute for these stock options, the vesting provisions of such stock options will be accelerated, and the stock options will terminate upon the change of control if not previously exercised. Employment, Change of Control and Severance Arrangements BAK Battery has an employment agreement with Mr. Li for a term extending until August 3, 2006. BAK Battery pays Mr. Li a salary in accordance with its principle's; his annual salary for fiscal year 2005 was US$8,736. This employment agreement also provides that we will pay social insurance benefits for Mr. Li, which we also provide to our other management employees. We or Mr. Li may terminate this employment agreement upon thirty days prior written notice. 41 PRINCIPAL STOCKHOLDERS The following table sets forth, as of March 1, 2006, certain information with respect to the beneficial ownership of our common stock by (i) each director and officer of CBBI, (ii) each person known to CBBI to be the beneficial owner of five percent or more of the outstanding shares of common stock of CBBI, and (iii) all directors and officers of CBBI as a group. Unless otherwise indicated, the person or entity listed in the table is the beneficial owner of, and has sole voting and investment power with respect to, the shares indicated. Some of the principal stockholders are selling stockholder's in this offering.
Amount and Nature of Beneficial Ownership(1) -------------------------------------------- Number Percent of Name of Beneficial Owner of Shares(2) Voting Stock(3) - ------------------------ ------------ --------------- Xiangqian Li 21,233,437(4) 43.4% BAK Industrial Park, No. 1 BAK Street Kuichong Town Longgang District, Shenzhen People's Republic of China Jinghui Wang 3,600,035 7.4% BAK Industrial Park, No. 1 BAK Street Kuichong Town Longgang District, Shenzhen People's Republic of China The Pinnacle Fund, L.P.(5) 2,609,636 5.3% 4965 Preston Park Blvd., Suite 240 Plano, TX 75093 Fenghua Li 2,498,051 5.1% BAK Industrial Park, No. 1 BAK Street Kuichong Town Longgang District, Shenzhen People's Republic of China Huanyu Mao 249,805 * BAK Industrial Park, No. 1 BAK Street Kuichong Town Longgang District, Shenzhen People's Republic of China Yongbin Han 312,256 * BAK Industrial Park, No. 1 BAK Street Kuichong Town Longgang District, Shenzhen People's Republic of China Directors and executive officers as a group (3 persons) 21,795,498 44.6%
- -------------------- *Denotes less than 1% of the outstanding shares of common stock. (1) On March 1, 2006, there were 48,878,396 shares of common stock outstanding and no issued and outstanding preferred stock. Each person named above has the sole investment and voting power with respect to all shares of common stock shown as beneficially owned by the person, except as otherwise indicated below. (2) Under applicable SEC rules, a person is deemed to be the "beneficial owner" of a security with regard to which the person directly or indirectly, has or shares (a) the voting power, which includes the power to vote or direct the voting of the security, or (b) the investment power, which includes the power to dispose, or direct the disposition, of the security, in each case irrespective of the person's economic interest in the security. Under these SEC rules, a person is deemed to beneficially own securities which the person has the right to acquire within 60 days through the exercise of any option or warrant or through the conversion of another security. (3) In determining the percent of voting stock owned by a person on March 1, 2006, (a) the numerator is the number of shares of common stock beneficially owned by the person, including shares the beneficial ownership of which may be acquired within 60 days upon the exercise of options or warrants or conversion of convertible securities, and (b) the denominator is the total of (i) the 48,878,396 shares in the aggregate of common stock outstanding on March 1, 2006, and (ii) any shares of common stock which the person has the right to acquire within 60 days upon the exercise of options or warrants or conversion of convertible securities. Neither the numerator nor the denominator includes shares which may be issued upon the exercise of any other options or warrants or the conversion of any other convertible securities. 42 (4) Mr. Li is a party to an Escrow Agreement pursuant to which he agreed to place 2,179,550 shares of his common stock into escrow for the benefit of certain stockholders in the event we fail to satisfy certain "performance thresholds", as defined in the Escrow Agreement, which Escrow Agreement is incorporated by reference as a material exhibit to the registration statement of which this prospectus is a part and is on file with the SEC. CBBI's net income for the fiscal year ended September 30, 2005 exceeded the "performance threshold" for such period; accordingly, 1,089,775 of the shares placed in escrow by Mr. Li will be released to Mr. Li. Mr. Li is also a party to a Lock-up Agreement pursuant to which he has agreed, except for distributions of his shares of common stock required under the Escrow Agreement, not to transfer his common stock for a period commencing January 20, 2005 and ending 12 months after the date our common stock is listed on either the Nasdaq Stock Market or another national stock exchange or quotation medium. The Lock-up Agreement is incorporated by reference as a material exhibit to the registration statement of which this prospectus is a part and is on file with the SEC. Mr. Li is also a party to a Pledge Agreement pursuant to which he has agreed to pledge 19,053,887 shares of his common stock to Shenzhen Development Bank (Longgang Branch) as security for a comprehensive credit facility of BAK Battery. (5) Barry Kitt has sole voting and investment control over the securities held by The Pinnacle Fund, L.P. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS BAK Battery has several outstanding short term bank notes payable to (i) Agricultural Bank of China (Longgang Branch), (ii) Shenzhen Commercial Bank (Shuibei Branch), (iii) Shenzhen Development Bank (Longgang Branch) and (iv) China Minsheng Bank (Binhai/Shenzhen Branches) and (v) Construction Bank of China (Shenzhen Branch), respectively, the proceeds of which were used primarily to fund the operations of our manufacturing facility located at the BAK Industrial Park and for general working capital requirements. At December 31, 2005, we had aggregate amounts due and payable under these debt arrangements of $72.637 million. The debt arrangements bear interest at rates ranging from 5.022% to 6.138% and have maturity dates ranging from six to twelve months. This indebtedness is generally guaranteed by BAK International, by Xiangqian Li, our director, Chairman of the Board, President and Chief Executive Officer, and by Jilin Provincial Huaruan Technology Company Limited by Shares, a PRC company ("Huaruan Technology"). Mr. Li has also pledged 19,053,887 of his 21,233,437 shares of our common stock to secure certain of our indebtedness. Mr. Li is the controlling shareholder and an executive officer of Huaruan Technology. The indebtedness to Shenzhen Commercial Bank is guaranteed by Mr. Li and by an unaffiliated third party guarantor. None of Mr. Li, Huaruan Technology or the third party guarantor received or is entitled to receive any consideration for the above referenced guarantees, and we are not independently obligated to indemnify any of those guarantors for any amounts paid by them pursuant to any guarantee. On October 18, 2003, we acquired intangible assets, including a patent and other patent rights, from Huaruan Technology, an entity controlled by Xiangqian Li, our President and Chief Executive Officer. The total consideration paid to Huaruan Technology was $3.86 million. The consideration paid to Huaruan Technology was recorded at fair market value. On September 30, 2004, BAK Battery entered into a Financial Advisory Agreement with HFG International, Ltd., a Hong Kong corporation, pursuant to which HFG International agreed to provide BAK Battery with consulting help in implementing an organizational structure that would facilitate accessing the capital markets of the United States. In consideration for these services, HFG International was paid a fee of $400,000 in conjunction with the consummation of BAK Battery's private placement on January 20, 2005. Timothy P. Halter, our former Chief Executive Officer, is the principal shareholder and an executive officer of HFG International. We believe the agreement was on terms at least as favorable to BAK Battery as those that could have been negotiated with an unaffiliated party providing similar services. On June 10, 2004, we issued 99,858 shares of our $ 0.001 par value common stock to Harry Miller, our former President and Chief Executive Officer, in full settlement of a debt in the amount of $49,929 that we owed to Mr. Miller. The price of the transaction was $0.50 per share. The last reported sale price for shares of our common stock prior to that issuance was $0.50 per share. 43 DESCRIPTION OF OUR COMMON STOCK Our authorized capital stock consists of 100,000,000 shares of our common stock, having a par value of $0.001 per share. Each outstanding share of common stock entitles the holder thereof to one vote per share on all matters coming before the shareholders for a vote. Our Articles of Incorporation do not permit cumulative voting for the election of directors, which means that the holders of more than 50% of such outstanding shares voting for the election of directors can elect all of the directors to be elected, if they so choose; in such event, the holders of the remaining shares will not be able to elect any of our directors. Likewise, our Articles of Incorporation do not vary the size of the vote necessary for the stockholders to act on various matters from the size of the vote required by Nevada law, which requires an action by the stockholders on a matter other than the election of directors to be approved if the number of votes cast in favor of the action exceeds the number of votes cast in opposition to the action. The directors of a Nevada corporation are elected at the annual meeting of the stockholders by a plurality of the votes cast at the election. Stockholders do not have preemptive rights to purchase shares in any future issuance of our common stock. The holders of shares of our common stock are entitled to dividends out of funds legally available when and as declared by our board of directors. Our board of directors has never declared a dividend or otherwise authorized any cash or other distribution with respect to the shares of our common stock and does not anticipate declaring a dividend in the foreseeable future. Should we decide in the future to pay dividends, as a holding company, our ability to do so and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries and other holdings and investments. In addition, our operating subsidiaries, from time to time, may be subject to restrictions on their ability to make distributions to us, including as a result of restrictive covenants in loan agreements, restrictions on the conversion of local currency into dollars or other hard currency and other regulatory restrictions. In the event of our liquidation, dissolution or winding up, holders of our common stock are entitled to receive, ratably, the net assets available to stockholders after payment of all creditors. PRC regulations currently permit the payment of dividends only out of accumulated profits as determined in accordance with PRC accounting standards and regulations. Each of BAK International and BAK Battery is also required to set aside a portion of its after-tax profits according to PRC accounting standards and regulations to fund certain reserve funds. Currently, BAK Battery, through BAK International, is the only source of revenues or investment holdings for the payment of dividends. If it does not accumulate sufficient profits under PRC accounting standards and regulations to first fund certain reserve funds as required by PRC accounting standards, we will be unable to pay any dividends. In addition, if future dividends are paid to us by BAK International in Renminbi, fluctuations in the exchange rate for the conversion of Renminbi into dollars may adversely affect the amount of the dividends that are received by the holders of shares of our common stock. Furthermore, any restrictions imposed on the expatriation of Renminbi or other currencies out of the PRC by PRC-based companies would adversely affect our ability to pay dividends. All of the issued and outstanding shares of our common stock are duly authorized, validly issued, fully paid and non-assessable. To the extent that additional shares of our common stock are issued, the relative interests of existing stockholders will be diluted. Our transfer agent is Securities Transfer Corporation, 2591 Dallas Parkway, Suite 102, Frisco, Texas 75034. SELLING STOCKHOLDERS The following table sets forth the names of the selling stockholders and for each selling stockholder the number of shares of common stock beneficially owned as of March 1, 2006, and the number of shares being registered. Except as otherwise indicated in the footnotes to the below table, each selling stockholder acquired its securities in CBBI's stock exchange transaction on January 20, 2005. Furthermore, except as set forth in the footnotes below, none of the selling stockholders has held a position as an officer or director of CBBI, nor has any selling stockholder had a material relationship of any kind with CBBI. All information with respect to share ownership has been furnished by the selling stockholders. The shares being offered are being registered to permit public secondary trading of the shares and each selling stockholder may offer all or part of the shares owned for resale from time to time. A selling stockholder is under no obligation, however, to sell any shares immediately pursuant to this prospectus, nor is a selling stockholder obligated to sell all or any portion of the shares at any time. Therefore, no estimate can be given as to the number of shares of common stock that will be sold pursuant to this prospectus or the number of shares that will be owned by the selling stockholders upon termination of the offering made hereby. We will file a supplement to this prospectus to name successors to any named selling stockholders who are able to use this prospectus to resell the securities registered hereby. 44
PERCENT OF SHARES OF COMMON STOCK SHARES OF COMMON STOCK AFTER COMMON STOCK PERCENT OF TO BE COMPLETION OF SELLING STOCKHOLDERS(2) OWNED(1) COMMON STOCK(3) REGISTERED OFFERING(3) - ---------------------------------------------- ------------ --------------- --------------- ------------- Jinghui Wang 3,600,035 7.4% 1,800,000 3.68% Fenghua Li 2,498,051 5.1% 500,000 4.09% The Pinnacle Fund (3) 2,609,636 4.3% 2,109,636 1.03% Yunfei Li 1,405,153 2.9% 1,405,153 0% Ying Wang 911,545 1.9% 911,545 0% Gary Evans 758,862 1.6% 758,862 0% Halter Financial Group, Inc.(4) 587,754 1.2% 587,754 0% Chinamerica Fund, LP(5) 193,608 * 193,608 0% Westpark Capital L.P.(6) 805,908 1.0% 505,908 * Lake Street Fund, LP(7) 478,083 1.0% 478,083 0% Xuechun Zhang 379,673 * 379,673 0% Xin An 288,367 * 288,367 0% Wanpei Chen 252,954 * 252,954 0% Jayhawk China Fund(8) 427,954 * 252,954 * Xiaohui Wang 224,825 * 224,825 0% Leong Sing Lye 15,177 * 15,177 0% Fred Astman 164,420 * 164,420 0% MidSouth Investor Fund, L.P.(9) 164,420 * 164,420 0% Steve Kircher 68,067 * 68,067 0% Kevin Halter, Jr. 134,062 * 134,062 0% Bellfield Capital Partners LP(10) 101,182 * 101,182 0% Southwell Partners, L.P.(11) 641,182 * 101,182 1.1% David Moy 80,945 * 80,945 0% Yuxin Zhang 74,942 * 74,942 0% Feng Li 67,135 * 67,135 0% Chongying Gong 64,857 * 64,857 0% Ray Chapman 50,591 * 50,591 0% Lighthouse Capital Insurance Company(12) 50,591 * 50,591 0% David Ofman 25,591 * 25,591 0% David A. Spinney 50,591 * 50,591 0% Si Zhang 50,591 * 50,591 0% Scott Hood 37,943 * 37,943 0% Bob Schiesser(13) 37,943 * 37,943 0%
45
PERCENT OF SHARES OF COMMON STOCK SHARES OF COMMON STOCK AFTER COMMON STOCK PERCENT OF TO BE COMPLETION OF SELLING STOCKHOLDERS(2) OWNED(1) COMMON STOCK(3) REGISTERED OFFERING(3) - ---------------------------------------------- ------------ --------------- --------------- ------------- Mark DeSalvo 32,884 * 32,884 0% BOT Holdings, Inc.(14) 25,295 * 25,295 0% Michael Columbos 25,295 * 25,295 0% David L. Ebershoff 25,295 * 25,295 0% Harold E. Gear 25,295 * 25,295 0% Robert O. McDonald(15) 25,295 * 25,295 0% William Rosen 15,295 * 15,295 0% Stephen S. Taylor, Sr. 11,795 * 11,795 0% Harry Gabel 22,766 * 22,766 0% 264646 Alberta Ltd.(16) 17,707 * 17,707 0% Yarek Bartos 17,707 * 17,707 0% Earl Fawcett 17,707 * 17,707 0% Kelly Fraser 17,707 * 17,707 0% Andrew Goodacre 17,707 * 17,707 0% Richard Macdermott 15,177 * 15,177 0% 783036 Alberta Ltd.(17) 12,648 * 12,648 0% Dennis B. Bleackley 12,648 * 12,648 0% Chapel Rock Holdings Ltd.(18) 12,648 * 12,648 0% Stephen Sun Chiao 12,648 * 12,648 0% Donna H. Dodson 12,648 * 12,648 0% James Gilkison 12,648 * 12,648 0% Terral D. Hagman 12,648 * 12,648 0% J.M.C. Investments Ltd.(19) 12,648 * 12,648 0% John Mackay 12,648 * 12,648 0% Steven Perry 12,648 * 12,648 0% Paul Plowman 12,648 * 12,648 0% John B. Trescot 12,648 * 12,648 0% John H. Trescot, Jr. 12,648 * 12,648 0% Jack Coldwell 10,118 * 10,118 0% Richard Dahl 10,118 * 10,118 0% Danich Investments Ltd.(20) 10,118 * 10,118 0% Fabmar Investments Ltd.(21) 10,118 * 10,118 0% Robert Geddes 10,118 * 10,118 0% Dwight L. McLennan 10,118 * 10,118 0% Sandeep G. Aggarwal/Prof. Corp.(22) 10,118 * 10,118 0% Ken Bell 7,589 * 7,589 0% Imtiaz Bhiman 7,589 * 7,589 0% Adam Carpenter 7,589 * 7,589 0% Gary Allard 5,059 * 5,059 0% A. J. Charbonneau 5,059 * 5,059 0% G-Mac Welding Ltd.(23) 5,059 * 5,059 0% Calvin Gabel 5,059 * 5,059 0% Steve Horth 5,059 * 5,059 0% Don A. Leeb 5,059 * 5,059 0% Eric Pedersen 5,059 * 5,059 0% Robert G. & Judith T. Rader(24) 5,059 * 5,059 0% Doug Riopelle and Linda Benham-Riopelle 5,059 * 5,059 0% Gerald Slamko 5,059 * 5,059 0% Steve Tobias 5,059 * 5,059 0% William Tobman 5,059 * 5,059 0% Ann T. Garrett 2,530 * 2,530 0% James B. & Pauline Lisle 2,530 * 2,530 0% Total 17,939,350 36.70% 12,626,264 10.87%
- ---------- * Denotes less than 1% of the outstanding shares of common stock. On March 1, 2006, there were 48,878,396 shares of common stock outstanding and no issued and outstanding preferred stock. All of the shares of common stock being registered pursuant to this registration statement are being registered on behalf of the selling stockholders and were outstanding prior to the filing of this registration statement. Following the offering, there will be 48,878,396 shares of common stock outstanding and no issued and outstanding preferred stock. (1) Each person named in the selling stockholder above has the sole investment and voting power with respect to all shares of common stock shown as beneficially owned by the person, except as otherwise indicated below. Under applicable SEC rules, a person is deemed to be the "beneficial owner" of a security with regard to which the person directly or indirectly, has or shares (a) the voting power, which includes the power to vote or direct the voting of the security, or (b) the investment power, which includes the power to dispose, or direct the disposition, of the security, in each case irrespective of the person's economic interest in the security. Under these SEC rules, a person is deemed to beneficially own securities which the person has the right to acquire within 60 days through the exercise of any option or warrant or through the conversion of another security. None of the selling stockholders who are not natural persons are reporting companies under the Securities Exchange Act of 1934. (2) Assumes that each selling stockholder sells all of the shares of stock, the offer and sale of which is registered pursuant to the registration statement of which this prospectus is a part. In determining the percent of common stock owned by a person on March 1, 2006, (a) the numerator is the number of shares of common stock beneficially owned by the person, including shares the beneficial ownership of which may be acquired within 60 days upon the exercise of options or warrants or conversion of convertible securities, and (b) the denominator is the total of (i) the 48,878,396 shares in the aggregate of common stock outstanding on March 1, 2006, and (ii) any shares of common stock which the person has the right to acquire within 60 days upon the exercise of options or warrants or conversion of convertible securities. Neither the numerator nor the denominator includes shares which may be issued upon the exercise of any other options or warrants or the conversion of any other convertible securities. For purposes of this selling stockholders table, the calculation for determining the percent of common stock owned by a person after completion of the offering is the same, and assumes that no new shares of common stock will be issued by us prior to the completion of the offering. 46 (3) Represents (a) 2,109,636 shares of common stock issued to The Pinnacle Fund, L.P. pursuant to CBBI's stock exchange transaction on January 20, 2005, prior to the consummation of the private placement on September 16, 2005 and (b) 500,000 shares of common stock acquired by The Pinnacle Fund, L.P. in the private placement consummated on September 16, 2005. Barry M. Kitt has sole voting and investment control over the securities held by The Pinnacle Fund, L.P. (4) The shares hereby Halter Financial Group, Inc. were acquired in June 2004 in a private purchase transaction with Harry Miller, the former controlling stockholder of the company. Timothy P. Halter, the sole officer and director of Halter Financial Group, Inc., served as our sole officer and director from June 2004 through January 20, 2005. Mr. Halter also exercises sole investment and voting control over the securities held by Halter Financial Group. (5) BeauJohnson and Christopher Efird have shared voting and investment control over the securities held by Chinamerica Fund, LP. (6) Represents (a) 505,908 shares of common stock issued to Westpark Capital, L.P. pursuant to CBBI's stock exchange transaction on January 20, 2005, prior to the consummation of the private placement on September 16, 2005 and (b) 300,000 shares of common stock acquired by Westpark Capital, L.P. in the private placement consummated on September 16, 2005. Patrick J. Brosnahan has sole voting and investment control over the securities held by Westpark Capital, L.P. (7) Scott Hood and Fred Astman have shared voting and investment control over the securities held by Lake Street Fund, LP. (8) Represents (a) 252,954 shares of common stock issued to Jayhawk China Fund (Cayman), Ltd. pursuant to CBBI's stock exchange transaction on January 20, 2005, prior to the consummation of the private placement on September 16, 2005 and (b) 175,000 shares of common stock acquired by Jayhawk China Fund (Cayman), Ltd. in the private placement consummated on September 16, 2005. Kent McCarthy has sole voting and investment control over the securities held by Jayhawk China Fund (Cayman), Ltd. (9) Buzz Heidtke has sole voting and investment control over the securities held by MidSouth Investor Fund, L.P. (10) Dave Brigante has sole voting and investment control over the securities held by Bellfield Capital Partners LP. (11) Wilson Jaeggli has sole voting and investment control over the securities held by Southwell Partners, L.P. 47 (12) David E. Richardson has sole voting and investment control over the securities held by Lighthouse Capital Insurance Company. (13) Mr. Schiesser is an affiliate of Canaccord Capital Corporation, a licensed broker/dealer in Canada. Mr. Schiesser purchased the securities to be registered in the ordinary course of business and had no agreements or understandings, directly or indirectly, with any person to distribute his securities at the time of purchase. (14) Tom Brinkerhoff has sole voting and investment control over the securities held by BOT Holdings, Inc. (15) Mr. McDonald is an affiliate of Capital West Securities, a licensed broker/dealer. Mr. McDonald purchased the securities to be registered in the ordinary course of business and had no agreements or understandings, directly or indirectly, with any person to distribute his securities at the time of purchase. (16) Victor Walls has sole voting and investment control over the securities held by 264646 Alberta Ltd. (17) Ralph Miller has sole voting and investment control over the securities held by 783036 Alberta Ltd. (18) Wayne Hucik and Susan Hucik have shared voting and investment control over the securities held by Chapel Rock Holdings Ltd. (19) Brian Carpenter and Jeanne Carpenter have shared voting and investment control over the securities held by JMC Investments Ltd. (20) Dan Remenda has sole voting and investment control over the securities held by Danich Investments Ltd. (21) Eugene Fabro and Adrienne Fabro have shared voting and investment control over the securities held by Fabmar Investments Ltd. (22) Sandeep G. Aggarwal has sole voting and investment control over the securities held by Sandeep G. Aggarwal/Prof. Corp. (23) Grant McNaughton and Donna McNaughton have shared voting and investment control over the securities held by G-Mac Welding Ltd. (24) Hold as trustees for the Rader Living Trust. 48 SHARES ELIGIBLE FOR FUTURE SALE Upon completion of the offering, we will have 48,878,396 shares of common stock outstanding. A current stockholder who is our "affiliate," defined in Rule 144 as a person who directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, us, will be required to comply with the resale limitations of Rule 144. Purchasers acquiring shares from the selling shareholders in one or more transactions to which this prospectus relates, other than persons who are our affiliates, may resell their shares immediately. Sales by affiliates will be subject to the volume and other limitations of Rule 144, including certain restrictions regarding the manner of sale, notice requirements, and the availability of current public information about us. The volume limitations generally permit an affiliate to sell, within any three-month period, a number of shares that does not exceed the greater of one percent of the outstanding shares of common stock or the average weekly trading volume during the four calendar weeks preceding his sale. A person who ceases to be an affiliate at least three months before the sale of restricted securities beneficially owned for at least two years may sell the restricted securities under Rule 144 without regard to any of the Rule 144 limitations. PLAN OF DISTRIBUTION The 12,626,264 shares being offered by the selling stockholders may be sold or distributed from time to time by the selling stockholders or their transferees directly to one or more purchasers or through brokers, dealers, or underwriters who may act solely as agents or may acquire shares as principals. Such sales or distributions may be made at prevailing market prices, at prices related to such prevailing market prices, or at variable prices negotiated between the sellers and purchasers that may vary. The distribution of the shares may be effected in one or more of the following methods: o ordinary brokerage transactions, including long or short sales, o transactions involving cross or block trades, or otherwise in the over-the-counter market, o purchases by brokers, dealers, or underwriters as principals and subsequent resale by the purchasers for their own accounts pursuant to this prospectus in the open market or in underwritten offerings of those shares, o sales "at the market" to, or through, market makers or into an existing market for the shares, o sales not involving market makers or established trading markets, including direct sales to purchasers or sales effected through agents, o transactions involving options, swaps, or other derivatives, whether exchange-listed or otherwise, or o transactions involving any combination of the foregoing or any other legally available means. 49 In addition, a selling stockholder may enter into hedging transactions with one or more broker-dealers who may engage in short sales of shares in the course of hedging the positions they assume with the selling stockholder. A selling stockholder may also enter into options or other transactions with one or more broker-dealers requiring the delivery of the shares by such broker-dealers with the possibility that such shares may be resold thereafter pursuant to this prospectus. A broker, dealer, underwriter, or agent participating in the distribution of the shares may receive compensation in the form of discounts, concessions, or commissions from the selling stockholders and/or purchasers of the shares for whom such person may act as an agent, to whom such person may sell as principal, or both; and such compensation as to a particular person may be in excess of customary commissions. The selling stockholders and any broker-dealers acting in connection with the sale of the shares being registered may be deemed to be underwriters within the meaning of Section 2(11) of the Securities Act of 1933, as amended, or the Securities Act, and any profit realized by them on the resale of shares as principals may be deemed underwriting compensation under the Securities Act. We know of no existing arrangements between any of the selling stockholders and any other stockholder, broker, dealer, underwriter, or agent relating to the sale or distribution of the shares, nor can we presently estimate the amount, if any, of such compensation. Although we will receive no proceeds from the sale of shares pursuant to this prospectus, we have agreed to bear the costs and expenses of the registration of the shares, including legal and accounting fees, and such costs and expenses are estimated to be approximately $213,000. We have informed the selling stockholders that while they are engaged in a distribution of the shares included in this prospectus they will be required to comply with certain anti-manipulative rules contained in Regulation M under the Exchange Act. With certain exceptions, Regulation M prohibits any selling stockholder, any affiliated purchaser, and any broker-dealer or other person who participates in such distribution from bidding for or purchasing, or attempting to induce any person to bid for or purchase, any security that is the subject of the distribution until the entire distribution is complete. Regulation M also prohibits any bids or purchases made in order to stabilize the price of a security in connection with the distribution of that security. 50 INDEPENDENT PUBLIC ACCOUNTANTS There have been no changes in and/or disagreements with Schwartz Levitsky Feldman L.L.P., independent registered public accounting firm, on accounting and financial disclosure matters. LEGAL MATTERS Certain legal matters in this offering, including the legality of the common stock offered pursuant to this prospectus, will be passed upon for us and the selling stockholders by Schreck Brignone, 300 South Fourth Street, Suite 1200, Las Vegas, NV 89101. EXPERTS Our financial statements included in this prospectus have been audited by Schwartz Levitsky Feldman L.L.P., independent registered public accounting firm, as stated in the opinion, which has been rendered upon the authority of said firm as experts in accounting and auditing. INTERESTS OF NAMED EXPERTS AND COUNSEL No "Expert" or "Counsel" as defined by Item 509 of Regulation S-B promulgated pursuant to the Securities Act, whose services were used in the preparation of this Form SB-2, was hired on a contingent basis or will receive a direct or indirect interest in us. DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES Our Amended and Restated Bylaws, filed as Exhibit 3.3 hereto, provide that we must indemnify our directors to the fullest extent permitted under Nevada law and may indemnify, if so authorized by our board of directors, our officers and any other person whom we have the power to indemnify against liability, reasonable expense or other matter whatsoever. The effect of these provisions is potentially to indemnify our directors and officers from all costs and expenses of liability incurred by them in connection with any action, suit or proceeding in which they are involved by reason of their affiliation with us. Insofar as indemnification for liabilities arising under the Securities Act of 1933 (the "Act") may be permitted to directors, officers and controlling persons of the small business issuer pursuant to the foregoing provisions, or otherwise, we have been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. Our Amended and Restated Bylaws also permit us to maintain insurance on behalf of our company and any person whom we have the power to indemnify. WHERE YOU CAN FIND MORE INFORMATION We have filed a registration statement on Form SB-2 with the Securities and Exchange Commission under the Securities Act of 1933 with respect to the shares of common stock being offered by means of this prospectus. This prospectus, which is a part of the registration statement, does not contain all of the information set forth in the registration statement, or the exhibits which are part of the registration statement. You should refer to the registration statement and its exhibits for additional information that is not contained in this prospectus. Whenever we make reference in this prospectus to any of our contracts, agreements or other documents, you should refer to the exhibits attached to the registration statement for copies of the actual contract, agreement or other document. 51 We are subject to the informational requirements of the Securities Exchange Act of 1934, as amended, and we are required to file reports, any proxy statements and other information with the Securities and Exchange Commission. You can read our Securities and Exchange Commission files, including this registration statement, over the Internet at the Securities and Exchange Commission's web site at http://www.sec.gov. You may also read and copy any documents we file with the Securities and Exchange Commission at its public reference facility at 450 Fifth Street, N.W., Washington, D.C. 20549. You may also obtain copies of the documents at prescribed rates by writing to the Public Reference Section of the Securities and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the operation of the public reference facilities. 52 CHINA BAK BATTERY, INC. CONSOLIDATED FINANCIAL STATEMENTS TABLE OF CONTENTS December 31, 2005 Consolidated Financial Statements (Unaudited) Consolidated Balance Sheets as of December 31, 2005 and September 30, 2005 F-1 Consolidated Statements of Operations for The Three Months Ended December 30, 2005 and 2004 F-2 Consolidated Statements of Cash Flows for The Three Months Ended December 30, 2005 and 2004 F-3 Notes to Consolidated Financial Statements F-4 - F-7 September 30, 2005 and 2004 Consolidated Financial Statements Report of Independent Registered Public Accounting Firm F-8 Consolidated Balance Sheets as of September 30, 2005 and 2004 F-9 Consolidated Statements of Operations for the Years Ended September 30, 2005 and 2004 F-10 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended September 30, 2005 and 2004 F-11 Consolidated Statements of Cash Flows for the Years Ended September 30, 2005 and 2004 F-12 Notes to Consolidated Financial Statements F-13 - F-39
F-i CHINA BAK BATTERY, INC. Consolidated Balance Sheets As of December 31, 2005 and September 30, 2005 (Amounts expressed in US Dollars, except number of shares)
December 31, 2005 September 30, 2005 ------------------ ------------------ $ $ Unaudited Assets ------- Current Assets Cash 11,368,998 33,055,784 Cash -Restricted 24,891,394 19,392,280 Accounts Receivable, Net 40,650,896 43,379,754 Inventories 36,885,868 21,696,226 Prepaid Expenses 1,748,264 1,448,119 Notes Receivable 9,365,328 484,028 Accounts Receivable - Related Party 21,588 271,873 ------------------ ------------------ Total Current Assets 124,932,336 119,728,064 ------------------ ------------------ Long-Term Assets Property, Plant, & Equipment 72,067,498 52,160,610 Construction in Progress 5,198,860 17,804,181 Land Use Rights 3,255,562 3,246,791 Less Accumulated Depreciation (7,085,873) (5,873,954) ------------------ ------------------ Long-term Assets, Net 73,436,047 67,337,628 ------------------ ------------------ Other Assets Other Assets 546,585 566,703 Intangible Assets, Net 52,325 53,379 ------------------ ------------------ Total Other Assets 598,910 620,082 ------------------ ------------------ Total Assets 198,967,293 187,685,774 ================== ================== Liabilities and Stockholders' Equity ------------------------------------ Current Liabilities Accounts Payable 22,159,947 17,836,561 Bank Loans, Short Term 39,032,490 39,545,230 Notes Payable 33,605,163 29,577,308 Land Use Rights Payable 2,970,563 2,962,560 Construction Costs Payable 3,899,249 5,241,883 Customer Deposits 1,329,579 655,065 Accrued Expenses 3,494,288 3,196,594 Other Liabilities 512,718 712,506 ------------------ ------------------ Total Current Liabilities 107,003,997 99,727,707 ------------------ ------------------ CONTINGENCIES AND COMMITMENTS (NOTE 5) Stockholders' Equity Capital Stock-$.001 Par Value; 100,000,000 Shares Authorized; 48,878,396 Shares Issued and Outstanding 48,878 48,878 Additional Paid In Capital 68,012,808 68,012,808 Accumulated Comprehensive Income 579,854 362,728 Reserves 4,274,047 3,688,989 Retained Earnings 19,047,709 15,844,664 ------------------ ------------------ Total Stockholders' Equity 91,963,296 87,958,067 ------------------ ------------------ Total Liabilities and Stockholders' Equity 198,967,293 187,685,774 ================== ==================
The accompanying notes are an integral part of these financial statements. F-1 CHINA BAK BATTERY, INC. Consolidated Statements of Operations For The Three Months Ended December 31, 2005 and 2004 (Amounts expressed in US Dollars, except number of shares) (Unaudited)
2005 2004 ------------------ ------------------ $ $ Revenues, Net of Returns 26,103,750 25,126,265 Cost of Goods Sold 19,024,027 20,743,021 ------------------ ------------------ Gross Profit 7,079,723 4,383,244 ------------------ ------------------ Expenses: Selling 1,115,297 808,276 General and Administrative 1,472,431 1,151,756 Research and Development 241,333 20,020 Bad Debts 255,488 51,235 ------------------ ------------------ Total Expenses 3,084,549 2,031,287 ------------------ ------------------ Operating Income 3,995,174 2,351,957 Other Expenses (Income): Finance Costs 384,889 389,650 Other Expenses (Income) (308,822) 16,120 ------------------ ------------------ Net Income Before Provision for Income Taxes 3,919,107 1,946,187 Provision for Income Tax 131,004 144,067 ------------------ ------------------ Net Income 3,788,103 1,802,120 ================== ================== Net Income Per Common and Common Equivalent Share: Basic 0.08 0.06 ================== ================== Diluted 0.08 0.06 ================== ================== Weighted Average Shares Outstanding: Basic 48,878,396 31,225,642 ================== ================== Diluted 49,242,404 31,225,642 ================== ==================
The accompanying notes are an integral part of these financial statements. F-2 CHINA BAK BATTERY, INC. Consolidated Statements of Cash Flows For The Three Months Ended December 31, 2005 and 2004 (Amounts expressed in US Dollars) (Unaudited)
2005 2004 ------------------ ------------------ $ $ Cash Flows from (used for) Operating Activities Net Income 3,788,103 1,802,120 Adjustments to Reconcile Net Income to Net Cash from Operating Activities: Bad Debts Expense 255,488 51,235 Depreciation and Amortization 1,213,116 754,727 Writedown of Inventory 460,275 - Changes in Assets and Liabilities: Accounts Receivable 2,512,194 (5,947,411) Inventories (15,592,023) 10,235,226 Prepaid Expenses (300,145) 921,473 Notes Receivable (8,881,301) (437,523) Accounts Receivable - Related Party 250,286 378,413 Other Assets 20,118 (67,767) Accounts Payable 4,323,386 (2,786,974) Land Use Rights Payable (768) 272 Construction Costs Payable (1,342,634) 746,559 Customer Deposits 674,514 (137,346) Accrued Expenses 297,695 (2,664,062) Other Liabilities (199,788) 271 ------------------ ------------------ Net Cash Flows from (used for) Operating Activities (12,521,484) 2,849,213 ------------------ ------------------ Cash Flows from (used for) Investing Activities Acquisition of Property, Plant and Equipment (19,906,888) (1,300,986) Construction in Progress 12,605,321 (3,370,433) ------------------ ------------------ Net Cash Flows used for Investing Activities (7,301,567) (4,671,419) ------------------ ------------------ Cash Flows from (used for) Financing Activities Proceeds from Borrowings 27,529,782 21,519,898 Repayment of Borrowings (24,014,667) (18,844,328) Cash Pledged To Bank (5,499,114) (806,951) ------------------ ------------------ Net Cash Flows from (used for) Financing Activities (1,983,999) 1,868,619 ------------------ ------------------ Effect of Exchange Rate Changes on Cash 120,264 (1,525) ------------------ ------------------ Net Increase (Decrease) in Cash (21,686,786) 44,888 Cash - Beginning of Period 33,055,784 3,212,176 ------------------ ------------------ Cash - End of Period 11,368,998 3,257,064 ================== ================== Supplemental Cash Flow Disclosures: Interest Paid 425,214 313,195 ================== ================== Income Taxes Paid 195,491 94,858 ================== ==================
The accompanying notes are an integral part of these financial statements. F-3 CHINA BAK BATTERY, INC. Notes to Consolidated Financial Statements December 31, 2005 and 2004 (Amounts expressed in US Dollars) (Unaudited) 1. BASIS OF PRESENTATION The condensed consolidated financial statements of China BAK Battery, Inc. and Subsidiaries (the "Company") included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosures normally included in financial statements prepared in conjunction with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the annual audited consolidated financial statements and the notes thereto included in the Company's annual report on Form 10-KSB, and other reports filed with the SEC. The accompanying unaudited interim consolidated financial statements reflect all adjustments of a normal and recurring nature which are, in the opinion of management, necessary to present fairly the financial position, results of operations and cash flows of the Company for the interim periods presented. The results of operations for these periods are not necessarily comparable to, or indicative of, results of any other interim period or for the fiscal year taken as a whole. Factors that affect the comparability of financial data from year to year and for comparable interim periods include non-recurring expenses associated with the Company's registration with the SEC, costs incurred to raise capital and stock awards. The condensed consolidated financial statements are prepared in accordance with generally accepted accounting principles used in the United States of America and include the accounts of BAK International Limited ("BAK International"), Shenzhen BAK Battery Co, Ltd. ("BAK") and BAK Electronics (Shenzhen) Co., Ltd. for all periods presented. All significant intercompany balances and transactions have been eliminated on consolidation. On January 10, 2006, BAK International completed the formation of a new wholly owned China-based subsidiary, BAK Electronic (Shenzhen) Co., Ltd., focused on the manufacture, research, development and distribution of polymer lithium ion rechargeable batteries for use in cellular telephones as well as various other portable electronic devices, including high-power handset telephone, laptop computers, digital cameras, video camcorders, MP3 players, MP4 players and general industrial applications. F-4 CHINA BAK BATTERY, INC. Notes to Consolidated Financial Statements December 31, 2005 and 2004 (Amounts expressed in US Dollars) (Unaudited) 2. CASH - RESTRICTED The Company's cash - restricted at December 31, 2005 is summarized as follows:
$ Time deposits pledged as collateral for letter of credit facilities 5,978,762 Cash pledged as a guarantee for notes payable 18,912,632 ---------- Total cash - restricted 24,891,394 ==========
3. INVENTORIES The Company's inventories at December 31, 2005 and September 30, 2005 are summarized as follows: December 31 September 30 2005 2005 ----------- ------------ $ $ Raw materials 13,283,872 9,284,299 Work in progress 4,058,111 2,738,069 Finished goods 19,543,885 9,673,858 ----------- ------------ Total inventories 36,885,868 21,696,226 =========== ============ 4. BANK DEBTS As of December 31, 2005, the Company had several short-term loans, notes payable and letter of credit facilities with banks with a total outstanding balance of $72,637,653. The loans were used primarily to support operating activities, carried interest rates ranging from 5.022% to 6.138%, and have maturity dates ranging from 5 to 12 months. The Company is required to pledge cash, inventories and equipment in order to secure these short-term bank loans and notes payable, summarized as follows at December 31, 2005: $ Cash-restricted 24,891,394 Inventories 7,682,585 Equipment 9,846,100 ---------- Total assets pledged 42,420,079 ========== F-5 CHINA BAK BATTERY, INC. Notes to Consolidated Financial Statements December 31, 2005 and 2004 (Amounts expressed in US Dollars) (Unaudited) 5. CONTINGENCIES AND COMMITMENTS A. Contingent Liabilities 1. Land Use and Ownership Certificate: According to relevant PRC laws and regulations, a land use right certificate, along with government approvals for land planning, project planning, and construction need to be obtained before construction of building is commenced. An ownership certificate shall be granted by the government upon application under the condition that the aforementioned certificate and government approvals are obtained. BAK has not yet obtained the land use right certificate and government approvals relating to the construction of BAK Industrial Park (the Company's operating premises). However, BAK has applied to obtain the land use right certificate of approval. The local government of Kuichong Township of Longgang District of Shenzhen has, however, granted permission for BAK to commence the construction of the new production plant pending a decision from the bureau of city planning. The Company anticipates that it will receive the approval from the bureau of city planning in 2006. Management believes, under the condition that BAK is granted a land use right certificate and related approvals, there should be no legal barriers for BAK to obtain an ownership certificate for the premises presently under construction in BAK Industrial Park. However, in the event that BAK fails to obtain the land use right certificate relating to BAK Industrial Park and/or the government approvals required for the construction of BAK Industrial Park, there is the risk that the buildings constructed need to be vacated as illegitimate constructions. However, management believes that this possibility while present is very remote. As a result, no provision has been made in the financial statements for this potential occurrence. The Company does not currently insure its manufacturing facilities since it has not yet received its land use right certificate. The Company intends to procure such insurance once it has received the certificate. 2. Guarantees The Company's guarantees at December 31, 2005 are summarized as follows: $ Guaranteed for Shenzhen Tongli, a non-related party 3,618,250 Guaranteed for Shenzhen Zhengda, a non-related party 1,239,127 Notes receivable discounted 1,397,308 --------- Total guarantees 6,254,685 ========= F-6 CHINA BAK BATTERY, INC. Notes to Consolidated Financial Statements December 31, 2005 and 2004 (Amounts expressed in US Dollars) (Unaudited) 5. CONTINGENCIES AND COMMITMENTS (cont'd) A. Contingent Liabilities (cont'd) 2. Guarantees (cont'd) The Company discounts notes and accounts receivable from time to time with banks. At the time of the discounting, all rights and privileges of holding the note are transferred to the banks. The Company removes the asset from its books and records a corresponding expense for the amount of the discount. The Company remains contingently liable on a portion of the amount outstanding in the event the note maker defaults. No provision has been made in the consolidated financial statements for these contingencies. B. Capital Commitments BAK has commitments under construction contracts for the construction of factory, office, and employee residence buildings, amounting to $1,209,726 at December 31, 2005. 6. SUBSEQUENT EVENTS A. On January 11, 2006, the Company repaid in full one of its loans with a principal balance of $6.2 million at December 31, 2005. B. On January 11, 2006, the Company guaranteed an additional $619,563 to a bank for Shenzhen Tongli, a non-related party. C. On February 22, 2006, the Company renewed its $3,717,380 loan with China Construction Bank for a term of six months, with interest accruing at an annual rate of 5.481%, payable monthly, and principal payable at maturity. D. Between January 9, 2006 and March 7, 2006, the Company discounted an additional $10,800,766 of notes receivable, increasing the Company's maximum exposure for guarantees to $17.7 million on that date. F-7 Schwartz Levitsky Feldman llp CHARTERED ACCOUNTANTS TORONTO, MONTREAL, OTTAWA REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders of China BAK Battery, Inc. (Formerly known as Medina Coffee, Inc.) and Subsidiaries We have audited the accompanying consolidated balance sheet of China BAK Battery, Inc. as of September 30, 2005 and 2004 and the related consolidated statements of changes in stockholders' equity, operations and cash flows for each of the two years ended September 30, 2005 and 2004 (all expressed in United States dollars). These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the Standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of China BAK Battery, Inc. as of September 30, 2005 and 2004 and the results of its operations and its cash flows for each of the two years ended September 30, 2005 and 2004, in conformity with accounting principles generally accepted in the United States of America. As described in Notes 7 and 14 the Company has not yet obtained final approval from the relevant authorities for the acquisition of land use rights to the property which it occupies. However, the Company has commenced construction of its facilities on the property and has reflected the costs incurred to date as long-term assets on the balance sheet described as "property and equipment - building", "construction in process" and "land use rights", with the expectation that approval will be obtained within the next fiscal year. The Company may be at risk as more fully set out in the notes mentioned above should the application be rejected. The accompanying consolidated financial statements do not include any adjustments that might result should its application not be approved. The comparative figures for the year ended September 30, 2004 have been restated as more fully described in notes 7 and 21 to the consolidated financial statements. /s/ Schwartz Levitsky Feldman llp "SCHWARTZ LEVITSKY FELDMAN LLP" Toronto, Ontario, Canada December 28, 2005, except for notes 20 a), b) and c) and 21 as to which the date is January 12, 2006, note 20 d) as to which the date is January 30, 2006, and notes 20 e) and f) as to which the date is March 14, 2006 Chartered Accountants 1167 Caledonia Road Toronto, Ontario M6A 2X1 Tel: 416 785 5353 Fax: 416 785 5663 F-8 CHINA BAK BATTERY, INC. Consolidated Balance Sheets As of September 30, 2005 and 2004 (Amounts expressed in US Dollars, except number of shares)
September 30, September 30, 2005 2004 $ $ Restated Assets ------ Current Assets Cash 33,055,784 3,212,176 Cash - Restricted 19,392,280 7,120,069 Accounts Receivable, Net 43,379,754 20,999,561 Inventories 21,696,226 29,535,985 Prepaid Expenses 1,448,119 1,330,645 Notes Receivable 484,028 18,122 Accounts Receivable - Related Party 271,873 911,093 ------------- ------------- Total Current Assets 119,728,064 63,127,651 ------------- ------------- Long-Term Assets Property, Plant and Equipment 52,160,610 19,875,583 Construction in Progress 17,804,181 23,656,190 Land Use Rights 3,246,791 4,029,038 Less Accumulated Depreciation (5,873,954) (2,370,774) ------------- ------------- Long-Term Assets, Net 67,337,628 45,190,037 ------------- ------------- Other Assets Other Assets 566,703 225,972 Intangible Assets, Net 53,379 58,362 ------------- ------------- Total Other Assets 620,082 284,334 ------------- ------------- Total Assets 187,685,774 108,602,022 ============= ============= Liabilities and Stockholders' Equity ------------------------------------ Current Liabilities Accounts Payable 17,836,561 23,570,087 Bank Loans, Short Term 39,545,230 27,304,162 Short-Term Loans -- 1,812,316 Notes Payable 29,577,308 20,772,559 Land Use Rights Payable 2,962,560 3,750,756 Construction Costs Payable 5,241,883 6,347,846 Customer Deposits 655,065 369,390 Accrued Expenses 3,196,594 5,247,656 Other Liabilities 712,506 181,223 ------------- ------------- Total Current Liabilities 99,727,707 89,355,995 ------------- ------------- CONTINGENCIES AND COMMITMENTS (NOTE 14) Stockholders' Equity Common Stock - $.001 Par Value; 100,000,000 Shares Authorized; 48,878,396 and 31,225,642 shares issued and outstanding at September 30, 2005 and 2004, respectively 48,878 31,226 Additional Paid In Capital 68,012,808 12,052,845 Accumulated Comprehensive Income (Loss) 362,728 (144) Reserves 3,688,989 1,724,246 Retained Earnings 15,844,664 5,437,854 ------------- ------------- Total Stockholders' Equity 87,958,067 19,246,027 ------------- ------------- Total Liabilities and Stockholders' Equity 187,685,774 108,602,022 ============= =============
The accompanying notes are an integral part of these consolidated financial statements. F-9 CHINA BAK BATTERY, INC. Consolidated Statements of Operations For the Years Ended September 30, 2005 and 2004 (Amounts expressed in US Dollars, except number of shares) 2005 2004 $ $ Restated Revenues, Net of Returns 101,921,583 63,746,202 Cost of Goods Sold 76,234,834 49,921,818 ----------- ----------- Gross Profit 25,686,749 13,824,384 ----------- ----------- Expenses: Selling 4,023,582 1,877,878 General and Administrative 5,027,154 3,141,125 Research and Development 541,735 328,779 Bad Debts Expense 769,807 326,990 ----------- ----------- Total Expenses 10,362,278 5,674,772 ----------- ----------- Operating Income 15,324,471 8,149,612 Other Expenses Finance Costs 2,395,137 1,006,056 Other Expenses 28,117 2,916 ----------- ----------- Net Income Before Provision for Income Tax 12,901,217 7,140,640 ----------- ----------- Provision for Income Tax 526,840 394,333 ----------- ----------- Net Income 12,374,377 6,746,307 =========== =========== Net Income Per Common and Common Equivalent Share: Basic 0.32 0.22 =========== =========== Diluted 0.32 0.22 =========== =========== Weighted Average Shares Outstanding: Basic 38,288,874 31,225,642 =========== =========== Diluted 38,405,401 31,225,642 =========== =========== The accompanying notes are an integral part of these consolidated financial statements. F-10 CHINA BAK BATTERY, INC. Consolidated Statements of Changes in Stockholders' Equity For the Years Ended September 30, 2005 and 2004 (Amounts expressed in US Dollars, except number of shares)
Accumulated Other Additional Comprehensive Number of Common Paid In Income Retained Stockholders' Shares Stock Capital (Loss) Reserves Earnings Equity - ----------------------------------------------------------------------------------------------------------------------------------- $ $ $ $ $ $ Restated Restated Restated Balance - September 30, 2003 31,225,642 31,226 1,176,927 (49) 651,583 3,630,298 5,489,985 - ----------------------------------------------------------------------------------------------------------------------------------- Net Income -- -- -- -- -- 6,746,307 6,746,307 Foreign Currency Translation -- -- -- (95) -- -- (95) - ----------------------------------------------------------------------------------------------------------------------------------- Total Comprehensive Income -- -- -- -- -- -- 6,746,212 - ----------------------------------------------------------------------------------------------------------------------------------- Contribution of Cash by Stockholders -- -- 10,875,918 -- -- -- 10,875,918 Transfer to Reserves -- -- -- -- 1,072,663 (1,072,663) -- Deemed Distribution to Shareholder - Intangible Assets -- -- -- -- -- (3,866,088) (3,866,088) - ----------------------------------------------------------------------------------------------------------------------------------- Balance - September 30, 2004 31,225,642 31,226 12,052,845 (144) 1,724,246 5,437,854 19,246,027 - ----------------------------------------------------------------------------------------------------------------------------------- Net Income -- -- -- -- -- 12,374,377 12,374,377 Foreign Currency Translation -- -- -- 362,872 -- -- 362,872 - ----------------------------------------------------------------------------------------------------------------------------------- Total Comprehensive Income -- -- -- -- -- -- 12,737,249 - ----------------------------------------------------------------------------------------------------------------------------------- Recapitalization 1,152,458 1,152 -- -- -- (2,824) (1,672) Shares Issued for Proceeds of $17.0 Million 8,600,433 8,600 16,991,400 -- -- -- 17,000,000 Shares Issued for Proceeds of $43.4 Million 7,899,863 7,900 43,441,347 -- -- -- 43,449,247 Contribution of Cash by Stockholders Acquiring Shares of BAK International Limited -- -- 11,500,000 -- -- -- 11,500,000 Distribution of Cash to Stockholders in Connection with Acquisition of Shares of China BAK Battery, Inc. -- -- (11,500,000) -- -- -- (11,500,000) Cost of Raising Capital -- -- (4,472,784) -- -- -- (4,472,784) Transfer to Reserves -- -- -- -- 1,964,743 (1,964,743) -- - ----------------------------------------------------------------------------------------------------------------------------------- Balance - September 30, 2005 48,878,396 48,878 68,012,808 362,728 3,688,989 15,844,664 87,958,067 ===================================================================================================================================
The accompanying notes are an integral part of these consolidated financial statements. F-11 CHINA BAK BATTERY, INC. Consolidated Statements of Cash Flows For the Years Ended September 30, 2005 and 2004 (Amounts expressed in US Dollars)
2005 2004 $ $ Restated Cash Flows from (used for) Operating Activities Net Income 12,374,377 6,746,307 Adjustments to Reconcile Net Income to Net Cash from Operating Activities: Bad Debt Expense 769,807 326,990 Depreciation and Amortization 3,511,079 1,732,707 Changes in Assets and Liabilities: Accounts Receivable (22,380,193) (14,543,660) Inventories 7,309,304 (21,542,204) Prepaid Expenses (117,474) (605,800) Notes Receivable (465,906) (18,122) Account Receivable - Related Party 639,220 -- Other Assets (340,731) -- Accounts Payable (5,733,526) 18,405,499 Land Use Rights Payable (5,949) -- Construction Costs Payable (1,105,963) 6,347,846 Customer Deposits 285,675 (286,001) Accrued Expenses (2,051,063) 3,464,904 Other Liabilities 531,283 60,408 ------------ ------------ Net Cash Flows from (used for) Operating Activities (6,780,060) 88,874 ------------ ------------ Cash Flows from (used for) Investing Activities Acquisition of Property, Plant and Equipment (32,285,027) (14,906,846) Construction in Progress 5,852,009 (23,379,077) Intangible Assets (1,584) (47,285) ------------ ------------ Net Cash Flows used for Investing Activities (26,434,602) (38,333,208) ------------ ------------ Cash Flows from (used for) Financing Activities Proceeds from Borrowings 120,005,439 57,740,719 Repayment of Borrowings (100,771,939) (17,429,652) Cash Pledged To Bank (12,272,211) (6,299,377) Loans to Related Parties -- (235,840) Deemed Distribution to Shareholder - Intangible Assets -- (3,866,088) Proceeds from Issuance of Capital Stock 55,976,464 10,875,918 Contribution of Cash from Stockholders Acquiring Shares of BAK International Limited 11,500,000 -- Distribution of Cash to Stockholders in Connection with Acquisition of Shares of China BAK Battery, Inc. (11,500,000) -- ------------ ------------ Net Cash Flows from Financing Activities 62,937,753 40,785,680 ------------ ------------ Effect of Exchange Rate Changes on Cash 120,517 (95) Net Increase in Cash 29,843,608 2,541,251 Cash - Beginning of Period 3,212,176 670,925 ------------ ------------ Cash - End of Period 33,055,784 3,212,176 ============ ============ Supplemental Cash Flow Disclosures: Interest Paid 1,932,257 1,007,287 ============ ============ Income Taxes Paid 487,808 -- ============ ============ Recapitalization 1,152 -- ============ ============
The accompanying notes are an integral part of these consolidated financial statements. F-12 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 1. PRINCIPAL ACTIVITIES AND ORGANIZATION China BAK Battery, Inc. (the "Company" or "China BAK") is a holding company whose Hong Kong-based subsidiary, BAK International Limited ("BAK International") and China-based subsidiary, Shenzhen BAK Battery Co., Ltd. ("BAK" or "Shenzhen BAK") focus on the manufacture, commercialization and distribution of a wide variety of standard and customized lithium ion (known as "Li-ion" or "Li-ion cell") rechargeable batteries for use in cellular telephones, as well as various other portable electronic applications, including high-power handset telephones, laptop computers, power tools, digital cameras, video camcorders, MP3 players, electric bicycles, hybrid/electric motors, and general industrial applications. BAK was founded on August 3, 2001 as a China-based company whose products primarily target the cell phone market in the Peoples Republic of China (PRC). BAK International was incorporated in Hong Kong on December 29, 2003 under the Companies Ordinance as BATCO International Limited, and subsequently changed its name to BAK International Limited on November 3, 2004. On November 6, 2004, the stockholders of BAK agreed to purchase, for a total of $11.5 million in cash, 96.8% of the outstanding shares of capital stock of BAK International, in the same proportion as their ownership interest in BAK, and BAK International agreed to purchase, for a total of $11.5 million in cash, all of the 31,225,642 outstanding shares of capital stock of BAK. Five stockholders of BAK, with ownership interests of approximately 1.85% of the 31,225,642 total outstanding shares of BAK, elected not to acquire shares in BAK International. The five nonparticipating stockholders of BAK sold their right to acquire their proportional ownership interest in BAK International to other BAK stockholders as well as seven persons who were not previously stockholders of BAK for cash, and the proportionate interests in BAK International to which the five nonparticipating stockholders were entitled were acquired by their transferees. After the share purchase transactions between BAK International and the stockholders of BAK were complete, there were 31,225,642 shares of BAK International stock outstanding, exactly the same as the number of shares of capital stock of BAK outstanding immediately prior to the share purchases, and the stockholders of BAK International were substantially the same as the stockholders of BAK prior to the share purchases. Consequently, the share purchases between BAK International and the stockholders of BAK have been accounted for as a recapitalization of BAK with no adjustment to the historical basis of the assets and liabilities of BAK, and the operations were consolidated as though the transactions occurred as of the beginning of the first accounting period presented in these consolidated financial statements. As more fully described in Note 2, on January 20, 2005, the Company completed a stock exchange transaction with the stockholders of BAK International, whereby 100% of the stock of BAK International was exchanged for 97.2% of the post-exchange stock of the Company. F-13 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 1. PRINCIPAL ACTIVITIES AND ORGANIZATION (cont'd) Also on January 20, 2005, BAK International closed a private placement of its securities with unrelated investors whereby it issued an aggregate of 8,600,433 shares of common stock for gross proceeds of $17,000,000. In conjunction with this financing, the Chairman and major stockholder of the Company agreed to place 2,179,550 shares of the Company's common stock owned by him into an escrow account, of which 50% are to be released to the investors in the private placement if audited net income for the fiscal year ended September 30, 2005 is not at least $12,000,000, and the remaining 50% are to be released to investors in the private placement if audited net income for the fiscal year ending September 30, 2006 is not at least $27,000,000. China BAK was originally incorporated as Medina Coffee, Inc. on October 4, 1999. The Company changed its name from Medina Coffee, Inc. to China BAK Battery, Inc. on February 14, 2005. The Company changed its year-end from December 31 to September 30 effective from September 30, 2004. The Company is subject to the consideration and risks of operating in the PRC. These include risks associated with the political and economic environment, foreign currency exchange and the legal system in the PRC. The economy of PRC differs significantly from the economies of the "western" industrialized nations in such respects as structure, level of development, gross national product, growth rate, capital reinvestment, resource allocation, self-sufficiency, rate of inflation and balance of payments position, among others. Only recently has the PRC government encouraged substantial private economic activities. The Chinese economy has experienced significant growth in the past several years, but such growth has been uneven among various sectors of the economy and geographic regions. Actions by the PRC government to control inflation have significantly restrained economic expansion in the recent past. Similar actions by the PRC government in the future could have a significant adverse effect on economic conditions in the PRC. Many laws and regulations dealing with economic matters in general, and foreign investment in particular, have been enacted in the PRC. However, the PRC still does not have a comprehensive system of laws, and enforcement of existing laws may be uncertain and sporadic. The Company's operating assets and primary sources of income and cash flows are from interests in the PRC. The PRC economy has, for many years, been a centrally-planned economy, operating on the basis of annual, five-year and ten-year state plans adopted by central PRC governmental authorities, which set out national production and development targets. The PRC government has been pursuing economic reforms since it first adopted its "open-door" policy in 1978. There is no assurance that the PRC government will continue to pursue economic reforms or that there will not be any significant change in its economic or other policies, particularly in the event of any change in the political leadership of, or the political, economic or social conditions in, the PRC. There is also no assurance that the Company will not be adversely affected by any such change in governmental policies or any unfavorable change in the political, economic or social conditions, the laws or regulations, or the rate or method of taxation in the PRC. F-14 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 1. PRINCIPAL ACTIVITIES AND ORGANIZATION (cont'd) As many of the economic reforms which have been or are being implemented by the PRC government are unprecedented or experimental, they may be subject to adjustment or refinement, which may have adverse effects on the Company. Further, through state plans and other economic and fiscal measures, it remains possible for the PRC government to exert significant influence on the PRC economy. The Company's financial instruments that are exposed to concentration of credit risk consist primarily of cash and cash equivalents, and accounts receivable from customers. Cash and cash equivalents are maintained with major banks in the PRC. The Company's business activity is primarily with customers in the PRC. The Company periodically performs credit analyses and monitors the financial condition of its customers in order to minimize credit risk. Any devaluation of the Renminbi (RMB) against the United States dollar would consequently have adverse effects on the Company's financial performance and asset values when measured in terms of the United States dollar. Should the RMB significantly devalue against the United States dollar, such devaluation could have a material adverse effect on the Company's earnings and the foreign currency equivalent of such earnings. The Company does not hedge its RMB - United States dollar exchange rate exposure. On January 1, 1994, the PRC government introduced a single rate of exchange as quoted daily by the People's Bank of China (the "Unified Exchange Rate"). On July 21, 2005, the PRC government reformed the exchange rate system into a managed floating exchange rate system based on market supply and demand with reference to a basket of currencies. No representation is made that the RMB amounts have been, or could be, converted into US dollars at that or any rate. This quotation of exchange rates does not imply free convertibility of RMB to other foreign currencies. All foreign exchange transactions continue to take place either through the Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate quoted by the People's Bank of China. Approval of foreign currency payments by the People's Bank of China or other institutions requires submitting a payment application form together with suppliers' invoices, shipping documents and signed contracts. 2. RECAPITALIZATION TRANSACTION On January 20, 2005, the Company completed a stock exchange transaction with the stockholders of BAK International. The exchange was consummated under Nevada law pursuant to the terms of a Securities Exchange Agreement by and among China BAK, BAK International and the stockholders of BAK International. Pursuant to the Securities Exchange Agreement, the Company issued 39,826,075 shares of common stock, par value $0.001 per share, to the stockholders of BAK International (31,225,642 shares to original stockholders of China BAK and 8,600,433 shares to new investors), F-15 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 2. RECAPITALIZATION TRANSACTION (cont'd) representing approximately 97.2% of the China BAK post-exchange issued and outstanding common stock, in exchange for 100% of the outstanding capital stock of BAK International. The Company presently carries on the business of BAK, a Chinese corporation and BAK International's wholly-owned subsidiary. The stock exchange transaction has been accounted for as a recapitalization of the Company whereby the historical financial statements and operations of BAK become the historical financial statements of the Company, with no adjustment to the carrying value of the assets and liabilities. The 1,152,458 shares of China BAK outstanding prior to the stock exchange are accounted for at the $(1,672) net book value at the time of the transaction. The accompanying consolidated financial statements reflect the recapitalization of the stockholders equity as if the transaction occurred as of the beginning of the first period presented. 3. BASIS OF PRESENTATION The consolidated financial statements are prepared in accordance with generally accepted accounting principles used in the United States of America and include the accounts of China BAK Battery, Inc., BAK International Limited and Shenzhen BAK Battery Co, Ltd. for all periods presented. All significant intercompany balances and transactions have been eliminated in consolidation. 4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES A. Cash and Cash Equivalents Cash and cash equivalents include cash on hand and any other highly liquid investments purchased with an original maturity of three months or less. The carrying amounts approximate fair value because of the short-term maturity of those instruments. As stated in the following Note 10, a portion of the Company's cash is restricted cash, which has been pledged to a bank to secure short-term bank loans and notes payable. This restricted cash is not as liquid as other cash, and has been separately stated in the attached consolidated financial statements. B. Accounts Receivable In order to determine the fair value of the Company's accounts receivable, the Company records a provision for doubtful accounts to cover estimated credit losses. Management reviews and adjusts this allowance periodically based on historical experience and its evaluation of the collectability of outstanding accounts receivable. The Company evaluates the credit risk of its customers utilizing historical data and estimates of future performance. F-16 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd) C. Inventories Inventories are stated at the lower of cost or net realizable value. Cost is calculated on the moving average basis and includes all costs to acquire and other costs incurred in bringing the inventories to their present location and condition. The Company evaluates the net realizable value of its inventories on a regular basis and records a provision for loss to reduce the computed moving average cost if it exceeds the net realizable value. D. Property, Plant and Equipment Property, plant and equipment are carried at cost. The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized. When assets are retired or disposed, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition. The Company recognizes a scrap value of 5% of the cost basis and depreciation is calculated on a straight-line basis over the estimated useful lives of the assets. The estimated useful lives are as follows: Buildings 30 - 40 years Plant and machinery 5 - 12 years Motor vehicles 8 years Office equipment and furnishings 5 years Leasehold improvements 2 - 5 years E. Intangible Assets Trademarks are carried at cost and are amortized using the straight-line method over the estimated useful lives of 5 years from the date the Company acquired the trademark. Management is of the opinion that no impairment loss is considered necessary at year-end. F. Fair Value of Financial Instruments The carrying value of financial instruments, including cash, receivables, accounts payable, accrued expenses and debt, approximates their fair value at September 30, 2005 and 2004 due to the relatively short-term nature of these instruments. G. Construction in Progress Construction in progress, which represents buildings, machinery and other long-term assets under construction or installation, is stated at cost less any impairment losses, and is not depreciated. Cost consists of the direct costs of purchase, construction and installation. Construction in progress is reclassified to the appropriate category of long-term assets when completed and ready for use. Management is of the opinion that no impairment loss is considered necessary at year-end. F-17 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd) H. Income Taxes The Company accounts for income tax under the provisions of Statement of Financial Accounting Standards No. 109, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Deferred income taxes are provided using the liability method. Under the liability method, deferred income taxes are recognized for all significant temporary differences between the tax and financial statement bases of assets and liabilities. In addition, the Company is required to record all deferred tax assets, including future tax benefits of capital losses carried forward, and to record a "valuation allowance" for any deferred tax assets where it is more likely than not that the asset will not be realized. In accordance with the relevant income tax laws applicable to enterprises operating in the Shenzhen Special Economic Zone of the PRC, the profits of BAK are fully exempt from income tax for 2 years ("tax holiday"), commencing from the first profit making year of operations, followed by a 50% exemption for the immediate next three years ("tax preferential period"), after which the profits of BAK will be taxable at the full reduced rate for New and High Technology Enterprises, currently 15%. In addition, due to the additional capital invested in BAK in 2005, BAK was granted a full tax exemption on 55.88% of its taxable income for calendar years 2005 and 2006, and a 50% tax exemption on 55.88% of its taxable income for calendar years 2007 to 2009. Further, on August 11, 2005, BAK was recognized as a Foreign-Invested, Advanced-Technology Enterprise by the Shenzhen government, whereby BAK will enjoy an additional three year tax preferential period for all of its taxable income after the expiration of the original three year tax preferential period, with a 7.5% tax rate on the remaining 44.12% of its taxable income from 2007 to 2009. If the Company fails to qualify for a reduced tax program following the end of the 2009 calendar year, the Company will be required to pay tax at the full 15% tax rate of its taxable income applicable to Shenzhen starting in 2010. The Company has purchased $173,000 of equipment made in China during the year ended September 30, 2005, and will be eligible for a tax credit, equal to 40% of theses purchases, against additional future income tax generated through the purchase of this new equipment. Had this tax holiday, tax preferential period and tax credit not been available, income tax expense would have increased by $1,408,343 for the year ended September 30, 2005 and $691,763 for the year ended September 30, 2004. I. Government Subsidies Subsidies from the government are recognized at their fair values when received, or when there is reasonable assurance that they will be received, and all required conditions have been complied with. F-18 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd) I. Government Subsidies (cont'd) Revenue from government sponsored grants or subsidies is recognized as research activities are performed or as development milestones are completed under the terms of the agreement. Costs incurred in connection with the performance of activities under these agreements are expensed as incurred. The Company defers revenue recognition related to payments received during the current year for research activities to be performed in the following year. The Company received subsidies from the Long Gang Technology and Science Bureau of $123,500 and $181,000 during the years ended September 30, 2005 and September 30, 2004, respectively. The $123,500 grant, which does not need to be repaid, was awarded to purchase equipment, and was accounted for by reducing equipment cost in the accompanying consolidated financial statements. The $181,000 subsidy was awarded to further the research of LiNiCoO2, an advanced anode material in the Li-on battery cell. This subsidy requires repayment of principal and interest, at the rate of 3% per annum, at the end of its two year term on December 26, 2005. This subsidy was recorded as a liability in the accompanying consolidated financial statements. J. Related Parties Parties are considered to be related if one party has the ability, directly or indirectly, to control the other party, or exercise significant influence over the other party, in making financial and operational decisions. Parties are also considered to be related if they are subject to common control or common significant influence. Related parties may be individuals or corporate entities. K. Impairment of Long-Term Assets In accordance with the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", the Company's policy is to record an impairment loss against the balance of a long-lived asset in the period when it is determined that the carrying amount of the asset may not be recoverable. This determination is based on an evaluation of such factors as the occurrence of a significant event, a significant change in the environment in which the business assets operate, or if the expected future non-discounted cash flows of the business are determined to be less than the carrying value of the assets. If impairment is deemed to exist, the assets are written down to fair value. Management also evaluates events and circumstances to determine whether revised estimates of useful lives are warranted. As of September 30, 2005, management expects its long-lived assets to be fully recoverable. F-19 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd) L. Foreign Currency Translation The Company maintains its books and accounting records in Renminbi ("RMB"), the PRC's currency and the Company's functional currency. Translation of amounts from RMB into United States dollars ("US$") has been made at the following exchange rates for the respective years: September 30, 2005: Balance sheet RMB 8.0920 to US$ 1.00 Operating statements RMB 8.2413 to US$ 1.00 September 30, 2004: Balance sheet RMB 8.27670 to US$ 1.00 Operating statements RMB 8.26688 to US$ 1.00 In translating the consolidated financial statements of the Company from its functional currency, in RMB, into its reporting currency, in United States dollars, balance sheet accounts are translated using the closing exchange rate in effect at the balance sheet date and income and expense accounts are translated using the average exchange rate prevailing during the reporting period. Adjustments resulting from the translation, if any, are included in accumulated comprehensive income (loss) in stockholder's equity in the Company's financial statements. RMB is not readily convertible into United States dollars or other foreign currencies. Prior to July 21, 2005, the foreign exchange rate between the United States dollar and the RMB had been stable at approximately RMB 8.28 to US$1.00 for the last several years. On July 21, 2005, the Central Bank of China announced that it would allow the Yuan (Renminbi) to move to a flexible exchange rate with a maximum daily variance against the US dollar of 0.3%. No provision has been made in the accompanying financial statements for the change in currency policy, nor has any determination been made as to the potential impact this may have on the Company's future operations. No representation is made that RMB amounts could have been, or could be, converted into United States dollars or any other currency at that rate or any other rate. M. Use of Estimates The preparation of consolidated financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect certain reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, at the date of the financial statements, and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F-20 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd) N. Revenue Recognition, Returns and Warranties The Company recognizes revenue when the significant risks and rewards of ownership have transferred pursuant to PRC law, including factors such as when persuasive evidence of an arrangement exists, shipment or delivery, depending upon the sales order, has occurred, the sales price is fixed and determinable, sales and value-added tax laws have been complied with, and collectability is reasonably assured. In the event goods are returned from a customer, revenue is reduced, and the returned goods are placed back into inventory during the period that the returned goods are received by the Company. Concurrent with the recognition of revenue, the Company records a warranty reserve for product returns as a percentage of sales based upon historical experience. O. Employees' Benefits and Pension Obligations Mandatory contributions, based on gross salary payments, are made to the PRC government's health, retirement benefit and unemployment programs at the statutory rates in effect during each period These payments are charged to expense in the same period as the related salary cost. See Note 14. P. Comprehensive Income or Loss The Company has adopted the provisions of Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No. 130 establishes standards for the reporting and display of comprehensive income, its components and accumulated balances in a full set of general purpose consolidated financial statements. SFAS No. 130 defines comprehensive income or loss to include all changes in equity, except those resulting from investments by owners and distributions to owners, including adjustments to minimum pension liabilities, accumulated foreign currency translation, and unrealized gains or losses on marketable securities. Q. Concentrations of Credit Risk Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of trade accounts receivable. The Company performs ongoing credit evaluations with respect to the financial condition of its creditors, but does not require collateral. In order to determine the value of the Company's accounts receivable, the Company records a provision for doubtful accounts to cover probable credit losses. Management reviews and adjusts this allowance periodically based on historical experience and its evaluation of the collectability of outstanding accounts receivable. R. Research and Development Costs Research and development costs are charged to operating expenses when incurred. The amounts charged in 2005 and 2004 were $541,735 and $328,779 respectively. F-21 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd) S. Advertising Costs Advertising costs consist primarily of promoting the Company and the Company's products through printed advertisements in trade publications and displaying the Company's products at industry trade exhibitions. The Company does not pay slotting fees or engage in cooperative advertising programs, buydown programs or similar arrangements. Advertising costs are charged to operations when incurred. Advertising costs included in selling expenses in the accompanying consolidated financial statements were $297,998 and $201,200 in 2005 and 2004, respectively. T. Shipping And Handling Costs Shipping and handling costs represent costs incurred by the Company to ship its products to customers using its own delivery vehicles or under contract with professional carriers For the majority of products, which are sold to customers in the Zhujiang Delta, the Company uses its own delivery vehicles. For sales made to customers overseas, the Company incurs transportation charges for delivery to the Port of Hong Kong. All other transportation charges are paid by the customer. Transportation and freight expenses were $150,937 and $83,981 for 2005 and 2004, respectively, and are included in selling expenses in the accompanying consolidated financial statements. U. Net Income Per Common and Common Equivalent Share Basic and diluted net income per common and common equivalent share are computed by dividing net income by the weighted average number of common shares outstanding for the period, including common share equivalents for the Company's dilutive stock options and warrants. The weighted average common shares outstanding reflect the effects of the share exchange transaction described in Note 2. V. Share-Based Payments The Company accounts for stock options using the intrinsic value method as prescribed by Accounting Principles Board Opinion (APB 25). Pro forma disclosures required under Statement of Financial Accounting Standards (SFAS) 123, "Accounting for Stock-Based Compensation," as if the Company had adopted the fair value-based method of accounting for stock options, are presented below. See Note 19. W. Classification of Operating Costs and Expenses The Company records its operating costs and expenses generally with the following classifications: F-22 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd) W. Classification of Operating Costs and Expenses (cont'd) Cost of Goods Sold ------------------ Cost of goods sold consists primarily of raw materials, direct labor and manufacturing overhead. Manufacturing overhead consists primarily of an allocation of purchasing and receiving costs, supplies, utilities, depreciation, factory and equipment repairs and maintenance and inspection fees. Selling Expenses ---------------- Selling expenses consist primarily of payroll, advertising and promotion, shipping and handling, depreciation and travel and entertainment. General and Administrative Expenses ----------------------------------- General and administrative expenses consist primarily of payroll, professional fees, insurance, payroll taxes and benefits, general office expenses, travel and entertainment, transportation, and depreciation. X. Recently Issued Accounting Standards In November 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 151 "Inventory Costs - an amendment of ARB No. 43, Chapter 4" ("SFAS 151"). This statement amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS 151 requires that those items be recognized as current-period charges. In addition, this Statement requires that allocation of fixed production overheads to costs of conversion be based upon the normal capacity of the production facilities. The provisions of SFAS 151 are effective for fiscal years beginning after June 15, 2005. As such, the Company is required to adopt these provisions at the beginning of the fiscal year ended September 30, 2006. The Company is currently evaluating the impact of SFAS 151 on its consolidated financial statements. In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets - an amendment of APB Opinion No.29" ("SFAS 153"). SFAS 153 replaces the exception from fair value measurement in APB Opinion No. 29 for nonmonetary exchanges of similar productive assets with a general exception from fair value measurement for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for all interim periods beginning after June 15, 2005. The adoption of SFAS 153 did not have a material impact on the Company's financial statements or results of operations In December 2004, the FASB issued SFAS No.123R, "Share-Based Payment" ("SFAS 123R"). SFAS 123R revises FASB Statement No. 123 "Accounting for Stock-Based Compensation" and supersedes APB Opinion No. 25 "Accounting for Stock Issued to Employees". SFAS 123R requires all public and non-public companies to measure and recognize compensation expense for all stock-based payments for services received at the F-23 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 4. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd) X. Recently Issued Accounting Standards (cont'd) grant-date fair value, with the cost recognized over the vesting period (or the requisite service period). SFAS 123R is effective for small business issuers for all interim periods beginning after December 15, 2005. As such, the Company is required to adopt these provisions at the beginning of the fiscal quarter ended March 31, 2006. The Company expects the impact on its consolidated financial statements to be consistent with the fair value disclosures included in Note 19 to the consolidated financial statements. In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3" ("SFAS 154"). SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle. These requirements apply to all voluntary changes and changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. SFAS 154 is effective for fiscal years beginning after December 15, 2005. As such, the Company is required to adopt these provisions at the beginning of the fiscal year ended September 30, 2006. The Company is currently evaluating the impact of SFAS 154 on its consolidated financial statements. 5. ACCOUNTS RECEIVABLE The Company's accounts receivable at September 30, 2005 and 2004 are summarized as follows: 2005 2004 $ $ Accounts receivable 44,973,292 21,763,923 Less: allowance for doubtful accounts 1,593,538 764,362 ---------- ---------- Accounts receivable, net 43,379,754 20,999,561 ========== ========== Accounts receivable reserve activity for the years ended September 30, 2005 and 2004 is summarized as follows: 2005 2004 $ $ Balance, beginning of year 764,362 461,982 Bad debts expense 805,479 302,380 Foreign exchange adjustment 23,697 -- ---------- ---------- Balance, end of year 1,593,538 764,362 ========== ========== F-24 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 6. INVENTORIES The Company's inventories at September 30, 2005 and 2004 are summarized as follows: 2005 2004 $ $ Raw materials 9,284,299 9,934,263 Work in progress 2,738,069 1,872,465 Finished goods 9,673,858 17,729,257 ---------- ---------- Total inventories 21,696,226 29,535,985 ========== ========== F-25 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 7. LONG-TERM ASSETS The Company's long-term assets at September 30, 2005 and 2004 are summarized as follows: 2005 2004 $ $ Building 30,763,727 4,535,876 Machinery 19,920,180 14,242,696 Vehicles 671,177 486,480 Office equipment 459,408 304,773 Leasehold improvements 346,118 305,758 ---------- ---------- Total cost 52,160,610 19,875,583 ---------- ---------- 2005 2004 $ $ Building 427,568 19,024 Machinery 4,838,119 2,006,717 Vehicles 147,061 79,097 Office equipment 119,627 53,402 Leasehold improvements 341,579 212,534 ---------- ---------- Total accumulated depreciation 5,873,954 2,370,774 ---------- ---------- Net book value 46,286,656 17,504,809 Construction in progress 17,804,181 23,656,190 Land use rights 3,246,791 4,029,038 ---------- ---------- Long-term assets, net 67,337,628 45,190,037 ========== ========== Depreciation expense is included in the statements of operations as follows: 2005 2004 $ $ Cost of goods sold 2,901,262 1,635,971 Selling expenses 416,701 8,603 General and administrative expenses 185,217 82,584 ---------- ---------- Total depreciation expenses 3,503,180 1,727,158 ========== ========== F-26 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 7. LONG-TERM ASSETS (cont'd) The Company's construction in progress consisted of the following at September 30, 2005 and 2004: 2005 2004 $ $ Land use fees 1,135,763 1,109,976 Construction costs 11,735,920 18,258,222 Land excavation 2,580,449 2,401,050 Construction materials 2,352,049 790,864 Capitalized research and design -- 143,403 Other indirect costs -- 952,675 ---------- ---------- Total construction in progress 17,804,181 23,656,190 ========== ========== Other indirect costs include road repairs, water and sewer fees, temporary electric fees, environmental fees, equipment rental and other administrative costs. The Company has funded the construction costs with cash flow from operations and proceeds from its share issuances, and as such, no interest expense has been capitalized. The Company anticipates that the construction of their facilities will be completed and placed into service by January 2006. The Company has not yet obtained their certificate of land use right. The bureau of city planning and land resource of Shenzhen have not yet approved the Company's application since the original zoning for the use of the land conflicted with both the city planning for education and biology and its current designation as industrial use. According to the agreement with the local government of Kuichong Township of Longgang District of Shenzhen, the Company has paid $285,000 for the down payment on the land use right and the balance of $2,962,000 is still outstanding. It is anticipated that the outstanding balance will be paid within the next twelve months. The local government of Kuichong Township of Longgang District of Shenzhen had, however, granted permission to the Company to commence the construction of the new production plant pending a decision from the Bureau of City Planning. The Company anticipates that it will receive the approval from the Bureau of City Planning in 2006. See Note 14. F-27 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 8. OTHER ASSETS The Company's other assets at September 30, 2005 and 2004 are summarized as follows: 2005 2004 $ $ Other receivables 160,626 283,937 Long term prepayment 437,683 -- Less: allowance for doubtful accounts (31,606) (57,965) ---------- ---------- Other assets 566,703 225,972 ========== ========== Other receivables reserve activity for the years ended September 30, 2005 and 2004 is summarized as follows: 2005 2004 $ $ Balance, beginning of year 57,965 33,355 Bad debts expense (reversal) (35,672) 24,610 Foreign exchange rate adjustment 9,313 -- ---------- ---------- Balance, end of year 31,606 57,965 ========== ========== 9. INTANGIBLE ASSETS The Company's intangible assets at September 30, 2005 and 2004 are summarized as follows: 2005 2004 $ $ Trademarks, technology and software 65,919 63,904 Less: accumulated amortization (12,540) (5,542) ---------- ---------- Intangible assets, net 53,379 58,362 ========== ========== Amortization expense for the years ended September 30, 2005 and 2004 was $7,899 and $5,549, respectively. F-28 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 10. BANK INDEBTEDNESS AND NOTES PAYABLE As of September 30, 2005 and 2004, the Company had several short-term bank loans with outstanding balances of $39,545,230 and $27,304,162, respectively. The loans were used primarily to support operating activities, carried interest rates ranging from 4.536% to 6.138%, and have maturity dates ranging from 5 to 12 months. Each loan is guaranteed by Jilin Province Huaruan Technology Company, Ltd. ("Huaruan", a corporation owned by Xiangqian Li, BAK's Chairman), Xiangqian Li, BAK International, related parties, and others who are not related. Neither Huaruan, Mr. Li, nor other non-related parties receive any compensation for acting as guarantors. The Company is required to pledge cash, inventories and equipment in order to secure these short-term bank loans and notes payable, summarized as follows at September 30, 2005: Cash-restricted $19,392,280 Inventories 7,661,888 Equipment 9,819,574 ----------- Total assets pledged $36,873,742 ----------- Certain shares of the Company were pledged by Mr. Xiangqian Li in order to secure these short-term bank loans. Notes payable represents customer commitments in the ordinary course of business. The notes can generally be exchanged at a discount for cash with financial institutions. On September 30, 2004, contrary to relevant PRC laws and regulations, the Company borrowed $1,812,316 from Changzhou Lihai Investment Consulting Co., Ltd. The Company subsequently repaid this loan on October 11, 2004. Management believes that the risk to the Company, due to this loan arrangement, is very limited. 11. RESERVES Pursuant to the accounting systems for business enterprises as promulgated by the PRC, the profits of BAK, which are based on their PRC statutory financial statements, are available for distribution in the form of cash dividends only after they have satisfied all PRC tax liabilities, provided for losses in previous years, and made appropriations to reserve funds (as discussed below), as determined at the discretion of the Board of Directors in accordance with the PRC accounting standards and regulations. With the exception of the restriction on distributions and dividends, the Company is not limited or otherwise restricted in making distributions by any other agencies or indentures. As stipulated by the relevant laws and regulations for enterprises operating in the PRC, companies are required to make annual appropriations to two reserve funds, consisting of the statutory surplus and public welfare funds. In accordance with relevant PRC regulations and the articles of association of the respective companies, companies are required to allocate a certain percentage of their profits after taxation, as determined in accordance with the PRC accounting standards applicable to the companies, to the statutory surplus reserve, until such reserve reaches 50% of the registered capital of the companies. F-29 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 11. RESERVES (cont'd) Net income reported in the US GAAP consolidated financial statements differs from that reported in the PRC statutory consolidated financial statements. In accordance with relevant laws and regulations in the PRC, profits available for distribution are based on the statutory consolidated financial statements. If BAK has foreign currency available after meeting its operational needs, BAK may make its profit distributions in foreign currency to the extent foreign currency is available. Otherwise, it is necessary to obtain approval and convert such distributions at an authorized bank. 12. SIGNIFICANT CONCENTRATION The Company grants credit to its customers, generally on an open account basis. The Company's five largest customers accounted for 34.51% of revenues in fiscal 2005, with no customer individually exceeded 10% of consolidated revenues. In fiscal 2004, the five largest customers comprised 38.98% of revenues, with only one customer exceeding 10% of consolidated revenues. 13. RELATED PARTY TRANSACTIONS In October 2003, the Company acquired intangible assets from entities controlled by its Chairman and controlling shareholder for $3,866,088, effectively paid in cash. The consideration paid by the Company in excess of the Chairman's carrying cost of the intangible assets was charged to retained earnings, as a distribution to the Chairman, resulting in the acquired intangible asset being recorded by the Company at the Chairman's original cost basis. Accounts receivable - related party in the consolidated balance sheets consists of short term advances made by the Company to a former shareholder. The advances bore no interest, had no formal repayment terms and were repaid on December 14, 2005. On September 30, 2004, BAK entered into an agreement with HFG International Ltd. ("HFG"), in which HFG provided financial consulting services to the Company, as described below, for a period of one year for a fee of $400,000. Under the agreement, HFG provided the Company with, among other things, advice on the development and implementation of a restructuring plan, resulting in an organizational structure that would facilitate the registration of the Company's securities, assist the Company in engaging qualified professionals to assist in facilitating the Company's plan, assist the Company in identifying potential merger candidates, supervise and train management in preparation for the registration of its securities, assist in the preparation of the necessary documentation and assist the Company with solicitation of equity financing. The fee was paid from the proceeds of the equity capital raised by HFG on behalf of the Company. In January 2005, the Company raised $17,000,000 from qualified investors in a private placement offering. In addition, in September 2005, the Company raised $43,449,247 from qualified investors in F-30 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 13. RELATED PARTY TRANSACTIONS (cont'd) a private placement offering. The fee to HFG was offset against the proceeds from the offerings as a cost of raising capital in 2005. The principal stockholder in HFG was also the former Chief Executive Officer of Medina Coffee, Inc. The fee charged to the Company for the services of HFG was on essentially the same terms as those charged by HFG for financial consulting services performed for HFG's other clients. 14. CONTINGENCIES AND COMMITMENTS A Contingent liabilities 1. Land Use and Ownership Certificate: According to relevant PRC laws and regulations, a land use right certificate, along with government approvals for land planning, project planning, and construction, needs to be obtained before construction of a building is commenced. An ownership certificate shall be granted by the government upon application under the condition that the aforementioned certificate and government approvals are obtained. The Company has not yet obtained the land use right certificate and government approvals relating to the construction of the Company's operating premises, BAK Industrial Park. However, the Company is in the process of applying to obtain the land use right certificate of approval. The local government of Kuichong Township of Longgang District of Shenzhen has, however, granted permission for BAK to commence the construction of the new production plant pending a decision from the Bureau of City Planning. The Company anticipates that it will receive the approval from the Bureau of City Planning in 2006. Management believes, under the condition that the Company is granted a land use right certificate and related approvals, that there should be no legal barriers for the Company to obtain an ownership certificate for the premises presently under construction in BAK Industrial Park. However, in the event that the Company fails to obtain the land use right certificate relating to BAK Industrial Park and the government approvals required for the construction of BAK Industrial Park, there is the risk that the buildings constructed will need to be vacated as illegitimate constructions. However, management believes that this possibility, while present, is very remote. As a result, no provision has been made in the consolidated financial statements for this potential occurrence. The Company does not currently insure its manufacturing facilities since it has not yet received its land use right certificate. The Company intends to procure such insurance once it has received the certificate. F-31 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 14. CONTINGENCIES AND COMMITMENTS (cont'd) A Contingent liabilities 2. Guarantees The Company's guarantees at September 30, 2005 and 2004 are summarized as follows: 2005 2004 $ $ Guaranteed for Shenzhen Tongli, a non-related party 3,603,502 1,208,153 Guaranteed for Shenzhen Zhengda, a non-related party 1,235,788 1,208,153 Notes receivable discounted 484,028 18,122 --------- --------- Total guarantees 5,323,318 2,434,428 ========= ========= The Company factors notes and accounts receivable from time to time to banks. At the time of the factoring, all rights and privileges of holding the note are transferred to the banks. The Company removes the asset from its books and records a corresponding expense for the amount of the discount. The Company remains contingently liable on a portion of the amount outstanding in the event the note maker defaults. No provision has been made in the consolidated financial statements for these contingencies. BAK and Development and Construction (Group) Company Limited By Shares ("Changchun Co.") of Changchun Economic & Technology Development District, entered into a Cross-Guaranty Agreement, dated February 20, 2004 (the "Agreement"), pursuant to which the parties were obligated to guaranty a specified amount of each other's indebtedness to specifically identified lending institutions. On December 22, 2004, the Company received from Changchun Co. a letter of termination pursuant to which the Agreement was deemed terminated by Changchun Co. and the Company was relieved of all obligations to guaranty any indebtedness of Changchun Co. in the future. The termination of the Agreement in no way affects Changchun Co.'s continuing guaranty of the BAK Indebtedness. As of September 30, 2005, ChangChun Jingkai had not guaranteed any indebtedness of the Company. 3. Social Insurance of BAK's Employees As described in Note 4 (O), BAK is required to cover employees with various types of social insurance. Although all insurances have been purchased for management employees, BAK has not fully covered other employees. Owing to the transient nature of most of F-32 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 14. CONTINGENCIES AND COMMITMENTS (cont'd) A Contingent liabilities 3. Social Insurance of BAK's Employees(cont'd) its non-management employees and on the basis of historical experience, management believes that BAK does not need to provide all employees with the required insurance. In the event that any current employee, or former employee, files a complaint with the government, not only will BAK be required to purchase insurance for such employee, but BAK may be subject to administrative fines. As the Company believes that these fines are nominal, no provision for any potential fines has been made in the accompanying financial statements. B. Commitments 1. Capital Commitments BAK has outstanding commitments under construction contracts for the construction of factory, office, employee residence buildings, and equipments amounting to $3,916,021 at September 30, 2005. These contracts are expected to be completed by January 2006. 2. Lease Commitments BAK leases various factory and office space under short term operating leases and is obligated at September 30, 2005 for each of the next three fiscal years as follows: 2006 - $ 95,169 2007 - $ 72,017 2008 - $ 47,716 15. CAPITAL CONTRIBUTIONS During the year ended September 30, 2004, the existing stockholders contributed $10,875,918 in cash to the Company, which has been recorded as an increase to additional paid-in capital in the accompanying consolidated financial statements. On January 20, 2005, the Company completed a stock exchange transaction with the stockholders of BAK International, as more fully described in Note 2. Prior to and in connection with the completion of the stock exchange with BAK International, BAK International sold 8,600,433 shares of its common stock to new investors in a private placement, as more fully described in Note 1. F-33 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 15. CAPITAL CONTRIBUTIONS (cont'd) On September 16, 2005, the Company sold 7,899,863 shares of its common stock to new investors. The Company granted certain registration rights to such purchasers, including the Company's covenant to file with the Securities and Exchange Commission a registration statement covering their shares. Under this transaction, the stockholders contributed $43,449,247 to the Company, which has been recorded as an increase in common stock of $7,900 and an increase in additional paid in capital of $43,441,347 in the accompanying consolidated financial statements. The Company also issued warrants to purchase 631,989 shares of its common stock at an exercise price of $7.92 per share, exercisable for three years after the date of issuance, as a fee to certain persons in connection with this transaction. 16. BUSINESS SEGMENT AND GEOGRAPHIC AREA DATA The Company currently engages in the manufacture, commercialization and distribution of a wide variety of standard and customized lithium ion rechargeable batteries for use in a wide array of applications. The Company manufactures five types of Li-ion rechargeable batteries: steel cell, aluminum cell, cylindrical cell, polymer cell and industrial batteries. The Company's products are sold to packing plants operated by third parties primarily for use in mobile phones and other electronic devices. Revenue and long-term asset components for 2005 and 2004 were as follows:
2005 2004 --------------- -------------- $ % $ % Revenues by Product ($ in millions): Steel cell 56.96 55.89 37.97 59.56 Aluminum cell 23.72 23.27 13.08 20.52 Cylindrical cell 1.05 1.03 .26 .41 Polymer cell .02 .02 -- -- Industrial battery 20.17 19.79 12.44 19.51 ------ ------ ----- ------ Total revenues 101.92 100.00 63.75 100.00 ------ ------ ----- ------ Revenues by Geographic Area ($ in millions): Domestic sales - PRC 72.35 70.99 43.36 68.02 Foreign sales 29.57 29.01 20.39 31.98 ------ ------ ----- ------ Total revenues 101.92 100.00 63.75 100.00 ------ ------ ----- ------ Long-Term Assets ($ in millions) Domestic - PRC 67.34 100.00 45.19 100.00 ------ ------ ----- ------
The above geographic area data consists of revenues based on product shipment destination and long-term assets are based on physical location. F-34 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 17. INCOME TAXES The reconciliation between PRC income taxes at the statutory rate and the Company's provision for income taxes at September 30, 2005 and 2004 are as follows: 2005 2004 $ $ (000's) (000's) Computed tax at the PRC statutory rate of 15% 1,935 1,071 Nondeductible Items -- 15 PRC tax holiday and tax reduction (1,408) (692) ---------- ---------- Current provision for income taxes 527 394 ========== ========== As of September 30, 2005 and 2004, the Company had no deferred tax assets or liabilities and was not liable for any taxes in the United States or any other foreign jurisdictions outside the PRC. 18. WARRANTY RESERVES Warranty reserve activity for the years ended September 30, 2005 and 2004 is summarized as follows: 2005 2004 $ $ Balance, beginning of year 220,503 95,874 Warranty expense 5,948,776 3,507,151 Claims paid (5,826,154) (3,382,522) ---------- ---------- Balance, end of year 343,125 220,503 ========== ========== Warranty expense is included in cost of goods sold and warranty reserves are offset against accounts receivable in the accompanying consolidated financial statements. 19. STOCK-BASED COMPENSATION In May 2005, the Board of Directors adopted the China BAK Battery, Inc. 2005 Stock Option Plan ("Plan"). The Plan authorizes the issuance of up to 4,000,000 shares of the Company's common stock. The exercise price of the options granted, pursuant to the Plan, must be at least equal to the fair market value of the Company's common stock at the date of the grant. The Plan will generally terminate on May 16, 2055. Pursuant to the Plan, the Company issued 2,000,000 options with an exercise price of $6.25 per share on May 16, 2005. In accordance with the vesting provisions of the grants, the options will become vested and exercisable under the following schedule: F-35 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 19. STOCK-BASED COMPENSATION (cont'd) Numbers of Shares % of Shares Issued Initial Vesting Date 800,000 40% July 1, 2007 600,000 30% January 1, 2008 600,000 30% July 1, 2008 --------- --- 2,000,000 100% ========= === The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." This standard provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. Additionally, the standard also requires prominent disclosures in the Company's financial statements about the method of accounting used for stock-based employee compensation, and the effect of the method used when reporting financial results. The Company accounts for stock-based compensation in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation." As permitted by SFAS No.123, the Company continues to measure compensation for such plans using the intrinsic value based method of accounting, prescribed by Accounting Principles Board (APB), Opinion No. 25, "Accounting for Stock Issued to Employees." Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for awards consistent with the method of SFAS No. 123, the Company's net income and net income per common share would have been adjusted to the pro forma amounts indicated below:
2005 2004 ----------- ----------- Net income, as reported $12,374,377 $ 6,746,307 Add: total stock-based compensation expense included in net income, net of related tax effects -- -- Deduct: total stock-based compensation expense determined under the fair value, net of related tax effects (1,068,243) -- ----------- ----------- Pro forma net income $11,306,134 $ 6,746,307 =========== ===========
F-36 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 19. STOCK-BASED COMPENSATION (cont'd) Net income per common share: As reported - Basic $0.32 $0.22 Diluted $0.32 $0.22 Pro forma - Basic $0.30 $0.22 Diluted $0.29 $0.22 For purposes of the disclosure above, the fair value of each option grant in 2005 is estimated on the date of the grant using the Black-Scholes option pricing model, with the following weighted average assumptions: Dividend yield 0.00% Expected volatility 59.85% Risk-free interest rate 4.12% Expected life 6 Years For the year ended September 30, 2004, no stock options were granted. 20. SUBSEQUENT EVENTS A. During November and December 2005, the Company refinanced two of its credit facilities totaling $3.8 million, and entered into two new credit facilities totaling $3.7 million with existing lenders. The four new facilities provide for monthly interest payments at fixed annual interest rates from 5.2% to 6.1%, with principal repayments at maturities during the second calendar quarter of 2006. There were no changes in assets pledged or payment guarantees from September 30, 2005 as a result of these new facilities. On January 11, 2006, the Company repaid in full one of its loans with a principal balance of $6.2 million at September 30, 2005. B. Included in capital commitments at September 30, 2005 (Note 14 (B)(1) is $1,183,000 of equipment that has been purchased by a customer on behalf of the Company. The Company will hold title to the equipment and will reimburse the customer by offsetting the purchase price against future product sales. The Company received equipment totaling $778,750 in November 2005 and an additional $298,000 of equipment in December 2005. The Company expects to receive the remaining $106,250 of equipment in 2006. C. On January 11, 2006, the Company guaranteed an additional $617,894 to a bank for Shenzhen Tongli, a non-related party. D. On January 10, 2006, BAK International completed the formation of a new wholly owned subsidiary, BAK Electronics (Shenzhen) Co., Ltd., focused on the research, development, manufacture and distribution of rechargeable lithium polymer batteries. E. On February 22, 2006, the Company renewed its $3,708,190 loan with China Construction Bank for a term of six months, with interest accruing at an annual rate of 5.481%, payable monthly, and principal payable at maturity. F. Between October 1,2005 and March 7, 2006, the Company discounted an additional $11,714,046 of notes receivable, increasing the Company's maximum exposure for guarantees to $17.7 million on that date. F-37 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 21. RESTATEMENT TO CONSOLIDATED FINANCIAL STATEMENTS A. Based on comments from the Securities and Exchange Commission, the Company amended the consolidated statement of cash flows for the year ended September 30, 2004, as summarized below:
2004 ---- As previously As restated reported (USD$) (USD$) ----------- ------------ Net cash provided from operating activities 88,874 209,689 Net cash provided from investing activities (38,333,208) (38,333,200) Net cash provided from financing activities 40,785,680 40,664,762 Effects of exchange rates changes on cash and cash equivalents (95) --
The restatement had no effect on net income or net income per share. B. Based on additional comments from the Securities and Exchange Commission, the Company amended the consolidated balance sheet as of September 30, 2004 and the consolidated statement of changes in stockholders' equity for the year ended September 30, 2004. The restatement was made to retroactively reflect that 1,152,458 shares of common stock of Medina Coffee, Inc. were outstanding immediately prior to the share exchange and the resulting recapitalization. (See Note 2). The effect of the restatement was to decrease common stock outstanding as of the earliest date presented with a corresponding increase to additional paid in capital. The restatement had no effect on net income, net income per share or total stockholders' equity in the accompanying consolidated financial statements. The following table presents the effects of this amendment to the consolidated financial statements: As of September 30, 2004 ----------------------------- As previously As restated reported (USD$) (USD$) ------------- ------------- Common Stock 31,226 32,378 Additional Paid in Capital 12,052,845 12,051,693 Retained Earnings 5,437,854 5,437,854 As of September 30, 2003 ----------------------------- As previously As restated reported (USD$) (USD$) ------------- ------------- Common Stock 31,226 32,378 Additional Paid in Capital 1,176,927 1,175,298 Retained Earnings 3,630,298 3,630,298 F-38 China BAK Battery, Inc. Notes to Consolidated Financial Statements September 30, 2005 and 2004 (Amounts expressed in US Dollars) 21. RESTATEMENT TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd) C. Based on further comments from the Securities and Exchange Commission, the Company amended the consolidated statement of operations for the year ended September 30, 2004. The restatement was made to reclassify depreciation and amortization expense from a separate item in operating expenses into cost of goods sold, selling expenses and general and administrative expenses. The effect of the restatement was to decrease gross profit. The restatement had no effect on operating income, net income or net income per share. The following table presents the effects of this amendment to the consolidated statement of operations: For the Year Ended September 30, 2004 ----------------------------- As previously As restated reported (USD$) (USD$) ------------- ------------- Gross Profit 13,824,384 15,460,355 F-39 PART II INFORMATION NOT REQUIRED IN PROSPECTUS Indemnification of Directors and Officers Our Amended and Restated Bylaws, filed as Exhibit 3.3 hereto, provide that we must indemnify our directors to the fullest extent permitted under Nevada law and may indemnify, if so authorized by our board of directors, our officers and any other person whom we have the power to indemnify against liability, reasonable expense or other matter whatsoever. The effect of these provisions is potentially to indemnify our directors and officers from all costs and expenses of liability incurred by them in connection with any action, suit or proceeding in which they are involved by reason of their affiliation with us. Our Amended and Restated bylaws also permit us to maintain insurance on behalf of our company and any person whom we have the power to indemnify. We have purchased directors and officers liability insurance. Other Expenses of Issuance and Distribution Expenses incurred or (expected) relating to this Registration Statement and distribution are as follows. The amounts set forth are estimates except for the SEC registration fee. Amount ----------- SEC registration fee $ 6,646.98 Directors and officers insurance premium* $ 72,967.84 Printing and engraving expenses* $ 5,000.00 Professional fees and expenses* $500,000.00 Transfer agent's and registrar's fees ad expenses* $ 1,500.00 Miscellaneous* $ 2,500.00 ----------- Total* $588,614.82 =========== - ------------- *Estimates The Registrant will bear all of the expenses shown above. RECENT SALES OF UNREGISTERED SECURITIES Set forth below is information regarding the issuance and sales of our securities without registration for the past three (3) years from the date of this Registration Statement. On September 16, 2005 we issued an aggregate of 7,899,863 shares of our common stock to certain accredited investors as that term is defined in Rule 502 of Regulation D promulgated under the Securities Act of 1933, as amended, at a purchase price of $5.50 per share. In connection with the closing of that issuance, we issued warrants to purchase an aggregate of 631,989 shares of common stock at an exercise price of $7.92 per share exercisable for a period ending three years after the date of issuance to certain persons as part of an agreed upon fee comprised of such warrants and an aggregate cash payment of 3,258,693.70. The securities were issued in reliance upon the exemption contained in Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 of Regulation D promulgated under the Securities II-1 Act of 1933, as amended. The purchasers were not solicited through any form of general solicitation or advertising. The purchasers represented to us, among other things, that they were acquiring the securities for investment purposes only and not with a view to or for sale in connection with any distribution thereof, that they were accredited investors as that term is defined in Rule 502 of Regulation D promulgated under the Securities Act of 1933, as amended, and appropriate legends were placed upon the securities issued. All purchasers were provided, and acknowledged that they had adequate access to, information about us. On January 20, 2005 we completed a stock exchange transaction with the stockholders of BAK International, Ltd., a Hong Kong company ("BAK International"). The exchange was consummated under Nevada law pursuant to the terms of a Securities Exchange Agreement dated effective as of January 20, 2005 by and among CBBI, BAK International and the stockholders of BAK International. Pursuant to the Securities Exchange Agreement, we issued 39,826,075 shares of our common stock, par value $0.001 per share, to the stockholders of BAK International, representing approximately 97.2% of our post-exchange issued and outstanding common stock, in exchange for 100% of the outstanding capital stock of BAK International. We presently carry on the business of Shenzhen BAK Battery Co., Ltd., a Chinese corporation and BAK International's wholly-owned subsidiary, or BAK Battery. The 39,826,075 shares were issued in 2 separate transactions. The first transaction culminated in the issuance of 31,225,642 to the original shareholders of Shenzhen BAK Battery, Co., Ltd. for an aggregate cash consideration of $11,500,000. This amount approximated the capitalization of Shenzhen BAK Battery, Ltd. at the time of the agreement was entered into. The second transaction culminated in the issuance of 8,600,433 shares for an aggregate cash consideration of $17,000,000. ($15,528,629 net of issuance costs). The foregoing shares were issued in private transactions or private placements intending to meet the requirements of one or more exemptions from registration. In addition to any noted exemption below, we relied upon Regulation D and Section 4(2) of the Securities Act of 1933, as amended (the "Act"). The investors were not solicited through any form of general solicitation or advertising, the transactions being non-public offerings, and the sales were conducted in private transactions where the investor identified an investment intent as to the transaction without a view to an immediate resale of the securities; the shares were "restricted securities" in that they were both legended with reference to Rule 144 as such and the investors identified they were sophisticated as to the investment decision and in most cases we reasonably believed the investors were "accredited investors" as such term is defined under Regulation D based upon statements and information supplied to us in writing and verbally in connection with the transactions. We never utilized an underwriter for an offering of our securities and no sales commissions were paid to any third party in connection with the above-referenced sales. On June 10, 2004, we issued 99,858 shares of our $ 0.001 par value common stock in full settlement of debt, in the amount of $49,929, owed to Harry Miller, our former President and Chief Executive Officer. The price of the transaction was $0.50 per share. The issuance of these shares to Mr. Miller was not registered under the Securities Act of 1933 in reliance on the exemption therefrom contained in Section 4(2) of such act and Regulation D as promulgated thereunder. On May 16, 2005, we granted options to purchase an aggregate of 2,000,000 shares of our common stock to approximately 55 individuals in consideration of services rendered pursuant to our China BAK Battery, Inc. Stock Option Plan, each of which had an exercise price of $6.25 per share. These grants were deemed to be exempt from registration under the Securities Act of 1933 in reliance on Section 4(2) of such act as transactions by an issuer not involving any public offering. The recipients of these grants represented their intentions to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends will be placed on share certificates issued. All recipients had adequate access, through their relationships with the registrant, to information about the registrant. Other than the securities mentioned above, we have not issued or sold any securities without registration for the past three (3) years from the date of this Registration Statement. EXHIBITS Exhibit Number Description - --------- -------------------------------------------------------------------- 3.1 Articles of Incorporation of the Registrant (previously filed as Exhibit 3.1 to our Registration Statement on Form SB-1 (File No. 333-41124) filed with the Commission on July 10, 2000) 3.2 Articles of Amendment (previously filed as Exhibit 3.2 to our Registration Statement on Form SB-1 (File No. 333-41124) filed with the Commission on July 10, 2000) 3.3 Amended and Restated Bylaws (previously filed as Exhibit 3.3 to our Current Report on Form 8-K filed with the Commission on January 21, 2005) 3.4 Bylaws (previously filed as Exhibit 3.3 to our Registration Statement on Form SB-1 (File No. 333-41124) filed with the Commission on July 10, 2000) 4.1 Common Stock Specimen (previously filed as Exhibit 4.1 to our Registration Statement on Form SB-2 (File No. 333-130247) filed with the Commission on December 9, 2005) II-2 5.1 Legal Opinion of Schreck Brignone. (1) 10.1 Securities and Exchange Agreement by and among BAK International, Ltd., Medina Coffee, Inc. and the stockholders of BAK International, Ltd. dated as of January 20, 2005 (previously filed as Exhibit 10.1 to our Current Report on Form 8-K filed with the Commission on January 21, 2005) 10.2 Escrow Agreement by and among Medina Coffee, Inc., the selling stockholders, Xiangqian Li, and Securities Transfer Corporation dated as of January 20, 2005 (previously filed as Exhibit 10.2 to our Current Report on Form 8-K filed with the Commission on January 21, 2005) 10.3 Lock-up Agreement by and between Medina Coffee, Inc. and Xiangqian Li dated as of January 20, 2005 (previously filed as Exhibit 10.3 to our Current Report on Form 8-K filed with the Commission on January 21, 2005) 10.4* Form of Subscription Agreement. (1) 10.5 Summary of Sales Agreement by and between Shenzhen BAK Battery Co., Ltd. and Zhongshan Mingji Battery Co., Ltd. dated as of October 25, 2003 (previously filed as Exhibit 10.5 to our Current Report on Form 8-K filed with the Commission on January 21, 2005) 10.6 Summary of Purchase Agreement by and between Shenzhen BAK Battery Co., Ltd. and Luhua Technology (Shenzhen) Co., Ltd. dated as of April 14, 2004 (previously filed as Exhibit 10.6 to our Current Report on Form 8-K filed with the Commission on January 21, 2005) 10.7 Summary of Purchase Agreement by and between Shenzhen BAK Battery Co., Ltd. and Beijing CITIC Guoan Mengguli Electricity Supply Ltd. Co. dated as of September 30, 2004 (previously filed as Exhibit 10.7 to our Current Report on Form 8-K filed with the Commission on January 21, 2005) 10.8 Intentionally omitted. 10.9 Summary of Related Transaction Agreement by and between Shenzhen BAK Battery Co., Ltd. and Jilin Provincial Huaruan Technology Company Limited by Shares dated as of October 18, 2003 (previously filed as Exhibit 10.18 to our Current Report on Form 8-K filed with the Commission on January 21, 2005) 10.10 Summary of Comprehensive Credit Facility Agreement of Maximum Amount by and between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Agricultural Bank of China dated as of May 20, 2005 (previously filed as Exhibit 10.1 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.11 Summary of Guaranty Contract of Maximum Amount by and between BAK International, Ltd. and Longgang Branch, Agricultural Bank of China dated as of May 20, 2005 (previously filed as Exhibit 10.2 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.12 Guaranty Contract of Maximum Amount by and between Xiangqian Li and Longgang Branch, Agricultural Bank of China dated as of May 20, 2005 (previously filed as Exhibit 10.3 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.13 Summary of Loan Agreement by and between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Agricultural Bank of China dated March 21, 2005 (previously filed as Exhibit 10.4 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.14 Summary of Loan Agreement by and between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Agricultural Bank of China dated March 24, 2005 (previously filed as Exhibit 10.5 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.15 Summary of Loan Agreement by and between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Agricultural Bank of China dated March 25, 2005 (previously filed as Exhibit 10.6 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.16 Summary of Loan Agreement by and between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Agricultural Bank of China dated November 30, 2005 (previously filed as Exhibit 10.16 to our Registration Statement on Form SB-2 (File No. 333-130247) filed with the Commission on December 9, 2005) 10.17 Summary of Loan Agreement by and between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Agricultural Bank of China dated December 5, 2005 (previously filed as Exhibit 10.17 to our Registration Statement on Form SB-2 (File No. 333-130247) filed with the Commission on December 9, 2005) 10.18 Summary of Comprehensive Credit Facility Agreement by and between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Shenzhen Development Bank dated April 7, 2005 (previously filed as Exhibit 10.9 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.19 Guaranty Contract of Maximum Amount Pledge by and between Xiangqian Li and Longgang Branch, Shenzhen Development Bank dated April 28, 2005 (previously filed as Exhibit 10.10 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.20 Summary of Guaranty Contract of Maximum Amount Pledge by and between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Shenzhen Development Bank dated April 28, 2005 (previously filed as Exhibit 10.11 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.21 Summary of Guaranty Contract of Maximum Amount Pledge by and between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Shenzhen Development Bank dated April 11, 2005 (previously filed as Exhibit 10.12 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.22 Personal Guarantee Contract of Maximum Amount by and between Xiangqian Li and Shuibei Division, Shenzhen Commercial Bank dated April 20, 2005 (previously filed as Exhibit 10.13 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.23 Summary of Loan Agreement by and between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Shenzhen Development Bank dated April 28, 2005 (previously filed as Exhibit 10.14 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.24 Summary of Loan Agreement by and between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Shenzhen Development Bank dated May 18, 2005 (previously filed as Exhibit 10.15 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) - ---------- * Confidential treatment has been requested with respect to certain provisions of this agreement. II-3 10.25 Summary of Loan Agreement by and between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Shenzhen Development Bank dated May 27, 2005 (previously filed as Exhibit 10.16 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.26 Summary of Loan Agreement by and between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Shenzhen Development Bank dated June 3, 2005 (previously filed as Exhibit 10.17 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.27 Summary of Loan Agreement by and between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Shenzhen Development Bank dated May 18, 2005 (previously filed as Exhibit 10.18 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.28 Summary of Comprehensive Credit Facility Agreement of Maximum Amount between Shenzhen BAK Battery Co., Ltd. and Shenzhen Branch, China Minsheng Bank dated March 17, 2005 (previously filed as Exhibit 10.21 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.29 Guaranty Contract of Maximum Amount between Jilin Provincial Huaruan Technology Company Limited by Shares and Shenzhen Branch, China Minsheng Bank dated March 5, 2005 (previously filed as Exhibit 10.19 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.30 Summary of Loan Agreement between Shenzhen BAK Battery Co., Ltd. and Shenzhen Branch, China Minsheng Bank dated March 17, 2005 (previously filed as Exhibit 10.22 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.31 Summary of Comprehensive Credit Facility Agreement of Maximum Amount between Shenzhen BAK Battery Co., Ltd. and Shuibei Branch, Shenzhen Commercial Bank dated April 22, 2005 (previously filed as Exhibit 10.23 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.32 Individual Guaranty Contract of Maximum Amount between Xiangqian Li and Shuibei Branch, Shenzhen Commercial Bank dated April 20, 2005 (previously filed as Exhibit 10.33 to our Registration Statement on Form SB-2/A (File No. 333-130247) filed with Commission on November 29, 2005) 10.33 Summary of Guaranty Contract of Maximum Amount between Shenzhen Tongli Hi-tech Co., Ltd. and Agricultural Bank dated July 29, 2005 (previously filed as Exhibit 10.26 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.34 Guaranty Contract by Xiangqian Li in favor of Shenzhen Longgang Branch, Agricultural Bank of China dated July 29, 2005 (previously filed as Exhibit 10.27 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.35 Summary of Guaranty Contract signed by and between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Shenzhen Development Bank dated December 18, 2003 (previously filed as Exhibit 10.28 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.36 Summary of Guaranty Contract of Maximum Amount by Shenzhen BAK Battery Co., Ltd. and Shenzhen Development Bank dated August 30, 2004 (previously filed as Exhibit 10.29 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.37 Summary of Guaranty Contract of Maximum Amount by Shenzhen BAK Battery Co., Ltd. and Shenzhen Commercial Bank dated March 17, 2005 (previously filed as Exhibit 10.30 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.38 China BAK Battery, Inc. Stock Option Plan (previously filed as Exhibit 10.31 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.39 Form of Nonqualified Stock Option Agreement under the China BAK Battery, Inc. Stock Option Plan (previously filed as Exhibit 10.32 to our Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 2005 filed with the Commission on August 19, 2005) 10.40 Form of Securities Purchase Agreement dated September 14, 2005 by and among China BAK Battery, Inc. and the investors signatory thereto (previously filed as Exhibit 10.1 to our Current Report on Form 8-K filed with the Commission on September 15, 2005 and amended on March 9, 2006) 10.41 Form of Registration Rights Agreement dated September 14, 2005 by and among China BAK Battery, Inc. and the investors signatory thereto (previously filed as Exhibit 10.2 to our Current Report on Form 8-K filed with the Commission on September 15, 2005 and amended on March 9, 2006) 10.42 Summary of Comprehensive Credit Facility Agreement between Shenzhen BAK Battery Co., Ltd. and Shenzhen Branch, China Construction Bank dated August 24, 2005 (previously filed as Exhibit 10.45 to our Registration Statement on Form SB-2/A (File No. 333-130247) filed with Commission on November 29, 2005) 10.43 Irrevocable Letter of Guaranty made by Xiangqian Li in favor of Shenzhen Branch, China Construction Bank dated August 19, 2005 (previously filed as Exhibit 10.46 to our Registration Statement on Form SB-2/A (File No. 333-130247) filed with Commission on November 29, 2005) 10.44 Summary of Loan Agreement between Shenzhen BAK Battery Co., Ltd. and Shenzhen Longgang Branch, Agricultural Bank of China dated September 22, 2005 (previously filed as Exhibit 10.47 to our Registration Statement on Form SB-2/A (File No. 333-130247) filed with Commission on November 29, 2005) 10.45 Summary of Loan Agreement between Shenzhen BAK Battery Co., Ltd. and Shenzhen Longgang Branch, Agricultural Bank of China dated September 27, 2005 (previously filed as Exhibit 10.48 to our Registration Statement on Form SB-2/A (File No. 333-130247) filed with Commission on November 29, 2005) 10.46 Guaranty Contract of Maximum Amount made by Shenzhen BAK Battery Co., Ltd. in favor of Longhua Branch, Shenzhen Development Bank dated September 16, 2005 (previously filed as Exhibit 10.49 to our Registration Statement on Form SB-2/A (File No. 333-130247) filed with Commission on November 29, 2005) 10.47 Summary of Loan Agreement between Shenzhen BAK Battery Co., Ltd. and Longgang Branch, Shenzhen Development Bank dated November 1, 2005 (previously filed as Exhibit 10.50 to our Registration Statement on Form SB-2 (File No. 333-130247) filed with the Commission on December 9, 2005) 10.48 Summary of Loan Agreement between Shenzhen BAK Battery Co., Ltd. and Shenzhen Branch, China Construction Bank dated December 1, 2005 (previously filed as Exhibit 10.51 to our Registration Statement on Form SB-2 (File No. 333-130247) filed with the Commission on December 9, 2005) 10.49 Summary of Guaranty Contract of Comprehensive Credit Facility Agreement between BAK International, Ltd. and Shenzhen Branch, China Construction Bank dated December 1, 2005 (previously filed as Exhibit 10.52 to our Registration Statement on Form SB-2 (File No. 333-130247) filed with the Commission on December 9, 2005) II-4 10.50 Summary of Guaranty Agreement by and between Shenzhen Branch, Industrial Bank and Shenzhen High-Tech Investment Service Co. dated as of March 10, 2004 (previously filed as Exhibit 10.17 to our Current Report on Form 8-K filed with the Commission on January 21, 2005) 10.51 Roth Capital Partners LLC Warrant dated September 16, 2005 (previously filed as Exhibit 10.50 to our Annual Report on Form 10-KSB for the fiscal year ended September 30, 2005, filed with the Commission on December 30, 2005) 10.52 Global Hunt Securities LLC Warrant dated September 16, 2005 (previously filed as Exhibit 10.51 to our Annual Report on Form 10-KSB for the fiscal year ended September 30, 2005, filed with the Commission on December 30, 2005) 10.53 Indemnification Agreement of Heritage Management Consultants, Inc. (previously filed as Exhibit 10.52 to our Annual Report on Form 10-KSB for the fiscal year ended September 30, 2005, filed with the Commission on December 30, 2005) 10.54 Summary of Loan Agreement dated January 11, 2006 by and among Shenzhen Tongli Hi-Tech Co., Ltd., Shenzhen Nanshan Branch of Guangdong Development Bank and Shenzhen BAK Battery Co., Ltd. (previously filed as Exhibit 10.57 to our Registration Statement on Form SB-2/A (File No. 333-122209) (filed with the Commission on January 13, 2006) 10.55 Summary of Guaranty Contract dated January 11, 2006 by and between Shenzhen BAK Battery Co., Ltd. and Shenzhen Nanshan Branch of Guangdong Development Bank (previously filed as Exhibit 10.58 to our Registration Statement on Form SB-2/A (File No. 333-122209) (filed with the Commission on January 13, 2006) 10.56 Employment Agreement between Shenzhen BAK Battery, Co., Ltd. and Xiangqian Li dated August 3, 2001 (previously filed as Exhibit 10.53 to our Amendment No. 1 to our Annual Report on Form 10KS-B/A for the fiscal year ended September 30, 2005, filed with the Commission on January 31, 2006) 10.57 Employment Agreement between Shenzhen BAK Battery, Co., Ltd. and Yongbin Han dated April 18, 2003 (previously filed as Exhibit 10.54 to our Amendment No. 1 to our Annual Report on Form 10KS-B/A for the fiscal year ended September 30, 2005, filed with the Commission on January 31, 2006) 10.58 Employment Agreement between Shenzhen BAK Battery, Co., Ltd. and Huanyu Mao dated September 1, 2004 (previously filed as Exhibit 10.55 to our Amendment No. 1 to our Annual Report on Form 10KS-B/A for the fiscal year ended September 30, 2005, filed with the Commission on January 31, 2006) 10.59 Application Letter for Drawing of Bank Loan Facility between Shenzhen BAK Battery Co., Ltd. and Shenzhen Branch, China Construction Bank dated February 22, 2006. (1) 21.1 Subsidiaries of the Registrant (previously filed as Exhibit 21.1 to our Annual Report on Form 10-KSB filed with the Commission on March 31, 2005) 23.1 Consent of Independently Registered Public Accounting Firm. (1) - ---------- (1) Filed herewith. II-5 UNDERTAKINGS The small business issuer will: (1) File, during any period in which it offers or sells securities, a post-effective amendment to this registration statement to: (i) Include in any prospectus required by Section 10(a)(3) of the Securities Act; (ii) Reflect in the prospectus any facts or events which, individually or together, represent a fundamental change in the information in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20 percent change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement; and (iii) Include any additional or changed material information on the plan of distribution. (2) For determining liability under the Securities Act, treat each post-effective amendment as a new registration statement of the securities offered, and the offering of the securities at that time to be the initial bona fide offering. (3) File a post-effective amendment to remove from registration any of the securities that remain unsold at the end of the offering. (4) For determining liability of the undersigned small business issuer under the Securities Act to any purchaser in the initial distribution of the securities, the undersigned small business issuer undertakes that in a primary offering of securities of the undersigned small business issuer pursuant to this registration statement, regardless of the underwriting method used to sell the securities to the purchaser, if the securities are offered or sold to such purchaser by means of any of the following communications, the undersigned small business issuer will be a seller to the purchaser and will be considered to offer or sell such securities to such purchaser: (i) Any preliminary prospectus or prospectus of the undersigned small business issuer relating to the offering required to be filed pursuant to Rule 424; (ii) Any free writing prospectus relating to the offering prepared by or on behalf of the undersigned small business issuer or used or referred to by the undersigned small business issuer; (iii) The portion of any other free writing prospectus relating to the offering containing material information about the undersigned small business issuer or its securities provided by or on behalf of the undersigned small business issuer; and (iv) Any other communication that is an offer in the offering made by the undersigned small business issuer to the purchaser. Insofar as indemnification for the liabilities arising under the Securities Act of 1933 (the "Act") may be permitted to directors, officers and controlling persons of the small business issuer pursuant to the foregoing provisions, or otherwise, the small business issuer has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. II-6 SIGNATURES In accordance with the requirements of the Securities Act of 1933, the Registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form SB-2 and authorizes this amendment to its registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Shenzhen, Peoples Republic of China. China BAK Battery, Inc. By: /s/ Xiangqian Li Date: March 13, 2006 -------------------------------------------------- Xiangqian Li, Chairman of the Board, President and Chief Executive Officer By: /s/ Yongbin Han Date: March 13, 2006 -------------------------------------------------- Yongbin Han, Chief Financial Officer, Secretary, Treasurer and Principal Accounting Officer In accordance with the requirements of the Securities Act of 1933, this amendment to the registration statement has been signed by the following persons in the capacities and on the date stated. By: /s/ Xiangqian Li Date: March 13, 2006 -------------------------------------------------- Xiangqian Li, Chairman of the Board, President and Chief Executive Officer EX-5.1 2 cb5112ex51.txt EXHIBIT 5.1 Exhibit 5.1 March 13, 2006 China BAK Battery, Inc. BAK Industrial Park, No. 1 BAK Street Kuichong Town, Longgang District Shenzhen, People's Republic of China Ladies and Gentlemen: We have acted as special Nevada counsel to China BAK Battery, Inc., a Nevada corporation (the "Company"), in connection with the filing of a Registration Statement on Form SB-2/A (the "Registration Statement") with the Securities and Exchange Commission (the "Commission") under the Securities Act of 1933, as amended (the "Act"), covering the registration for resale of 13,639,916 shares (the "Shares") of the Company's common stock, par value $.001 per share ("Common Stock") consisting all of the shares of Common Stock which were issued and sold to those persons signatory to that certain Securities Exchange Agreement, dated as of January 20, 2005 (the "Exchange Agreement"), by and among the Company, BAK International, Ltd. and the shareholders of BAK International, Ltd., as set forth in the Registration Statement. At your request this opinion is being furnished to you for filing as Exhibit 5.1 to the Registration Statement. In our capacity as such counsel, we have reviewed the proceedings taken by the Company in connection with the authorization and issuance of the Shares. For purposes of this opinion, we have assumed that such proceedings were timely completed in the manner set forth in the Exchange Agreement and described in the Registration Statement, that the Shares were issued in accordance with the terms of the Exchange Agreement, and that the terms of such issuance were in compliance with all applicable laws. In connection with the foregoing, we have made such legal and factual examinations and inquiries as we have deemed necessary or appropriate for the purpose of rendering this opinion. We have also examined originals or copies, certified or otherwise authenticated or identified to our satisfaction as being true copies or reproductions of originals of, the Registration Statement, certain corporate and other records of the Company, and such other documents, agreements, instruments and records, as we have deemed necessary or appropriate as a basis for the opinions expressed herein. We have also obtained from public officials and from officers and other representatives of the Company, and have relied upon, such certificates, representations and assurances as we have deemed necessary and appropriate for the purpose of this rendering this opinion. China BAK Battery, Inc. March 13, 2006 Page 2 Without limiting the generality of the foregoing, in our examination, we have assumed without independent verification, that (i) each document we reviewed has been duly and validly authorized, executed and delivered by each party thereto and is the valid and binding agreement of such party, enforceable in accordance with its terms, (ii) each natural person executing a document has sufficient legal capacity to do so, (iii) there are no oral or written modifications of or amendments to the documents we have examined, and there has been no waiver of the provisions thereof, by action or conduct of the parties, or otherwise, (iv) the statements of fact and representations and warranties set forth in the documents we have examined are true and correct, (v) all documents submitted to us as originals are authentic, the signatures on all documents that we examined are genuine, and all documents submitted to us as certified, conformed, photostatic, electronic or facsimile copies conform to the original document and (vi) all corporate records made available to us by the Company and all public records reviewed are accurate and complete. We are qualified to practice law in the State of Nevada. The opinions set forth herein are expressly limited to the general corporate laws of the State of Nevada, and we do not purport to be experts on, or to express any opinion herein concerning, or to assume any responsibility as to the applicability to or the effect on any of the matters covered herein of, any other laws or the laws of any other jurisdiction. We express no opinion concerning, and we assume no responsibility as to laws or judicial decisions related to, or any orders, consents or other authorizations or approvals as may be required by, any federal law, including any federal securities laws, or any state securities or "Blue Sky" laws or regulations. On the basis of the foregoing, and in reliance thereon, and having regard to legal considerations and other information that we deem relevant, we are of the opinion that the Shares have been duly authorized for issuance by the Company and are validly issued, fully paid and non-assessable. The opinions expressed herein are based upon the laws in effect and the facts in existence as of the date of this letter. No opinions are offered or implied as to any matter, and no inference may be drawn, beyond the strict scope of the specific issues expressly addressed by the opinions herein. We hereby consent to the filing of this opinion as Exhibit 5.1 to the Registration Statement and the reference to this firm therein under the caption "Legal Matters" in the prospectus included therein. In giving this consent, we do not admit that we are in the category of persons whose consent is required under Section 7 of the Act or the rules and regulations of the Commission promulgated thereunder. Very truly yours, /s/ SCHRECK BRIGNONE EX-10.4 3 cb5112ex104.txt EXHIBIT 10.4 EXHIBIT 10.4 SUBSCRIPTION AGREEMENT BAK International, Ltd. BAK Industrial Zone Atou Village Kui Chong Town Lunggang District Shenzhen, China 518119 Attention: Li Xiang Qian, President Ladies and Gentlemen: The undersigned subscriber ("Subscriber") hereby tenders this Subscription Agreement (this "Agreement") in accordance with and subject to the terms and conditions set forth herein: 1. Subscription. 1.1 Subscriber hereby subscribes for and agrees to purchase the number of shares (the "Shares") of common stock (the "Common Shares"), of BAK International, Ltd., a Hong Kong corporation (the "Company"), indicated on the signature page attached hereto at the purchase price set forth on such signature page (the "Purchase Price"). Subscriber has made payment by wire transfer of funds in accordance with instructions from the Company in the full amount of the Purchase Price of the Common Shares for which Subscriber is subscribing (the "Payment"). 1.2 This Agreement is part of an offering of Common Shares being conducted by the Company (the "Offering"). Under the terms of the Offering, the Company seeks to raise a minimum of $8 million (USD) (the "Minimum Offering") up to a maximum of $17 million (USD) (the "Maximum Offering") ( proceeds from the Minimum and Maximum Offerings being collectively referred to herein as the "Gross Proceeds Amount") based on an Offering price of $___ per share. The Company agrees that it shall not undertake any other financings (other than acquisitions utilizing capital stock of the Company or the Public company, as hereinafter defined) involving its Equity Common Shares (as defined below) on terms more favorable than those in the Offering until thirty (30) days after the effectiveness of the Registration Statement (as that term is defined below) covering all of the Common Shares, without the prior written approval of the holders of a majority of the Common Shares subscribed for in this Offering. The term "Equity Common Shares" as used herein shall mean all capital stock of the Company or the Public Company (as hereinafter defined), plus all rights, warrants, options, convertible Common Shares or Public Company common shares or indebtedness, exchangeable Common Shares or Public Company common shares or indebtedness, or other rights, exercisable for or convertible into, directly or indirectly, capital stock of the Company or the Public Company. Notwithstanding the above, "Equity Common Shares" shall not include any Common Shares of the Company or common shares of the Public Company issued pursuant to any incentive or stock option plan of the Company or the Public Company approved by the shareholders or the board of directors of the Company or the Public Company. 1.3 Subscriber understands that it will not earn interest on any funds held by the Company prior to the date of closing of the Offering. The funds will be held in escrow pending the closing of the Offering. Attached as Exhibit "A" hereto is the form of Escrow Agreement (the "Escrow Agreement") that will govern the maintenance of funds until the sooner of the closing of the Offering or the expiration thereof. The Closing Date of the Offering is referred to as the "Closing Date." The Closing shall occur on or before December 28, 2004. The Company shall have the right to a one time 45 day extension of the Closing Date. If the Offering is not closed by said date all Gross Offering Proceeds then in escrow shall be returned to the Subscriber. The closing shall occur upon the satisfaction of the following conditions and in the following sequence: (a) confirmation from the Escrow Agent, as identified in the Escrow Agreement, that the proceeds from the Minimum Offering are on deposit; (b) participation by the each of the subscribers to the Offering in that certain exchange transaction (the "Exchange"), whereby each subscriber and all other shareholders of the Company will exchange their Common Shares for the identical number of shares (the "Public Company Shares") of a corporation domiciled in the United States of America which has common equity securities eligible for quotation on the 1 Over-the-Counter Bulletin Board (the "Public Company"); and (c) the Public Company files a registration statement on a suitable form (the "Registration Statement") with the U.S. Securities and Exchange Commission to register the Public Company Shares held by the subscribers to the Offering. Gross Offering Proceeds will not be released to either the Company or the Public Company until such time as each of the forgoing has been completed. Certificates will be issued in the name of each such subscriber, and the name of such subscriber will be registered on the stock transfer books of the Public Company as the record owner of Public Company Shares. The Public Company will promptly thereafter issue to each subscriber a stock certificate for the Public Company Shares to which it is entitled. 1.4 Subscriber hereby agrees to be bound hereby upon (i) execution and delivery to the Company of the signature page to this Agreement and (ii) written acceptance on the Closing Date by the Company of Subscriber's subscription, which shall be confirmed by faxing to the Subscriber the signature page to this Agreement that has been executed by the Company (the "Subscription"). 2. Offering Material. Subscriber represents and warrants that it is in receipt of and that it has carefully read the following items: (a) The Company's business plan , the form of which is attached hereto (the "Business Plan"); (b) The audited financial statement of Shenzhen BAK Battery Co., Ltd., the Company's wholly-owned subsidiary ("BAK") for the fiscal years ended September 30, 2003 and 2004. (c) The Exchange Agreement; (d) The Escrow Agreement; and (e) A draft of the Registration Statement. The documents listed in this Section 2 shall be referred to herein as the "Disclosure Documents." 3. Conditions to Subscriber's Obligations. 3.1 The obligation of Subscriber to close the transaction contemplated by this Agreement (the "Transaction") is subject to the satisfaction on or prior to the Closing Date of the following conditions set forth in Sections 3.2 through 3.5 hereof. 3.2 The Company shall have executed this Agreement. 3.3 The Board of Directors of the Company shall have adopted resolutions consistent with Section 4.1(d) below. 3.4 Subscriber shall have received copies of all documents and information which it may have reasonably requested in connection with the Offering. 3.5 The Exchange shall have been simultaneously consummated. 3.6 The Registration Statement shall have been filed with the SEC. 3.7 The representations and warranties of the Company shall be true and correct on and as of the Closing Date as though made on and as of such date. 3.8 If so requested by Subscriber, the Company shall have delivered to the custodian for the Subscriber duly executed certificate(s), registered in the name of Subscriber's nominee, representing the Public Company Shares. 2 4. Representations and Warranties; Covenants; Survival. 4.1 The Company represents and warrants to Subscriber that, at the date of this Agreement and as of the Closing Date: (a) The Company and each of its subsidiaries are corporations duly organized, validly existing and in good standing under the laws of their jurisdiction of incorporation, with all requisite corporate power and authority to carry on the business in which they are engaged and to own the properties they own, and the Company has all requisite power and authority to execute and deliver this Agreement and to consummate the transactions contemplated hereby. The Company and each of its subsidiaries are duly qualified and licensed to do business and are in good standing in all jurisdictions where the nature of their business makes such qualification necessary, except where the failure to be qualified or licensed would not have a material adverse effect on the business of the Company and its subsidiaries, taken as a whole. (b) Except as otherwise described in the Disclosure Documents, there are no legal actions or administrative proceedings or investigations instituted, or to the best knowledge of the Company threatened, against the Company, that could reasonably be expected to have a material adverse effect on the Company or any subsidiary, any of the Common Shares, or the business of the Company and its subsidiaries, or which concerns the transactions contemplated by this Agreement. (c) The audited financial statements of BAK as of September 30, 2003 and 2004 including the notes contained therein, fairly present the financial position of BAK at the respective dates thereof and the results of its operations for the periods purported to be covered thereby. Such financial statements have been prepared in conformity with generally accepted accounting principles consistently applied with prior periods subject to any comments and notes contained therein. Since September 30, 2004, there has been no material adverse change in the financial condition of the Company or BAK from the financial condition stated in such financial statements. (d) The Company, by appropriate and required corporate action, has, or will have prior to the closing, duly authorized the execution of this Agreement and the issuance and delivery of the Common Shares. The Common Shares are not subject to preemptive or other rights of any stockholders of the Company and when issued in accordance with the terms of this Agreement, the Common Shares will be validly issued, fully paid and nonassessable and free and clear of all pledges, liens and encumbrances. (e) Performance of this Agreement and compliance with the provisions hereof will not violate any provision of any applicable law or of the charter documents of the Company, or of any of its subsidiaries, and, will not conflict with or result in any breach of any of the terms, conditions or provisions of, or constitute a default under, or result in the creation or imposition of any lien, charge or encumbrance upon, any of the properties or assets of the Company, or of any of its subsidiaries, pursuant to the terms of any indenture, mortgage, deed of trust or other agreement or instrument binding upon the Company, or any of its subsidiaries, other than such breaches, defaults or liens which would not have a material adverse effect on the Company and its subsidiaries taken as a whole. The Company is not in default under any provision of its organizational documents or under any provision of any agreement or other instrument to which it is a party or by which it is bound or of any law, governmental order, rule or regulation so as to affect adversely in any material manner its business or assets or its condition, financial or otherwise. (f) The Disclosure Documents, taken together, do not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein to make the statements contained therein not misleading. (g) This Agreement has been duly executed and delivered by the Company and constitutes a valid and binding obligation of the Company, enforceable against the Company in accordance with its terms. (h) No registration, authorization, approval, qualification or consent of any court or governmental authority or agency is necessary in connection with the execution and delivery of this Agreement or the offering, issuance or sale of the Common Shares under this Agreement. 3 (i) The Company is not now, and after the sale of the Common Shares under this Agreement and under all other agreements and the application of the net proceeds from the sale of the Common Shares will not be, an "investment company" within the meaning of the Investment Company Act of 1940, as amended. (j) Subject to the accuracy of the Subscriber's representations and warranties in Section 7 of this Agreement, the offer, sale, and issuance of the Common Shares in conformity with the terms of this Agreement constitute transactions made exempt from the registration requirements of Section 5 of the Securities Act of 1933, as amended (the "Securities Act") and from the registration or qualification requirements of the laws of any applicable state. (k) Neither the Company, nor any of its affiliates, nor any person acting on its or their behalf, has directly or indirectly made any offers or sales in any security or solicited any offers to buy any security under circumstances that would require registration under the Securities Act of the issuance of the Shares to the Subscriber. (l) Li Xiangqian, the Company's and BAK's Chief Executive Officer has agreed that he will not sell, transfer or otherwise dispose of his holdings in either the Company or the Public Company, upon consummation of the Going Public Transaction, except to persons or entities who agree to be bound by the same restrictions, for a period of twelve months following the date the Public Company's securities become eligible for quotation on the NASDAQ Stock Market. (m) Executive management of the Company will escrow 10% of their holdings (the "Make Good Shares") in the Public Company following consummation of the Going Public Transaction, so that in the event the consolidated financial statements of the Public Company do not reflect $12 million of Net Income ("NI") for the fiscal year ending September 30, 2005 and $27 million NI for the fiscal year ending September 30, 2006, respectively (the "Guaranteed NI") the Make Good Shares shall be distributed on a pro rata to the subscribers to the Offering as follows: (i) in the event that the Guaranteed NI for fiscal 2005 is not achieved, 50% of the Make Good Shares will be delivered to participants in the Offering within ten (10) business days of the date the audit report for the period is filed with the SEC; and (b) in the event that the Guaranteed NI for fiscal 2006 is not achieved, the balance of the Make Good Shares will be delivered to participants in the Offering within ten (10) business days of the date the audit report for the period is filed with the SEC. If the Guaranteed NI is achieved for a given fiscal year, holders of the Make Good Shares can immediately take possession of the number of said shares reserved for distribution during said period to participants in the Offering. In the event the Make Good Shares are delivered to participants in the Offering, the holders thereof shall be afforded demand registration rights to have the Make Good Shares registered under the Securities Act. 4.2 The Company shall indemnify and hold harmless the Subscribers from and against all fees, commissions or other payments owing by the Company to any other person or firm acting on behalf of the Company hereunder. 5. Transfer and Registration Rights. 5.1 Subscriber acknowledges that it is acquiring the Common Shares for its own account and for the purpose of investment and not with a view to any distribution or resale thereof within the meaning of the Securities Act and any applicable state or other securities laws ("State Acts"). Subscriber further agrees that, except in connection with the Exchange, it will not sell, assign, transfer or otherwise dispose of any of the Common Shares or the Public Company Shares in violation of the Securities Act or State Acts and acknowledges that, in taking unregistered Common Shares and ultimately Public Company Shares, it must continue to bear economic risk in regard to its investment for an indefinite period of time because of the fact that neither of such securities have been registered under the Securities Act or State Acts and further realizes that such securities cannot be sold unless subsequently registered under the Securities Act and State Acts or an exemption from such registration is available. 5.2 Neither the Common Shares or the Public Company Shares issued pursuant to this Agreement may be transferred except in a transaction which is in compliance with the Securities Act and State Acts. 6. Closing. 4 6.1 The closing of the Offering shall take place at such time and at such place as the Company shall determine, provided that the Closing shall occur no later than December 28, 2004, unless otherwise extended for up to an additional 45 days . If the closing of the sale of Common Shares to Subscriber has not occurred within the time frame provided in the previous sentence, then Subscriber may terminate this Agreement by giving written notice to the Company. 7. Subscriber Representations. Subscriber hereby represents, warrants and acknowledges and agrees with the Company as follows: 7.1 Subscriber has been furnished with and has carefully read the Disclosure Documents as set forth in Section 2 hereto and is familiar with the terms of the Offering. With respect to individual or partnership tax and other economic considerations involved in this investment, Subscriber is not relying on the Company (or any agent or representative of any of the Company). Subscriber has carefully considered and has, to the extent Subscriber believes such discussion necessary, discussed with Subscriber's legal, tax, accounting and financial advisers the suitability of an investment in the Common Shares for Subscriber's particular tax and financial situation. 7.2 Subscriber has had an opportunity to inspect relevant documents relating to the organization and operations of the Company. Subscriber acknowledges that all documents, records and books pertaining to this investment which Subscriber has requested have been made available for inspection by Subscriber and Subscriber's attorney, accountant or other adviser(s). 7.3 Subscriber and/or Subscriber's advisor(s) has/have had a reasonable opportunity to ask questions of and receive answers and to request additional relevant information from a person or persons acting on behalf of the Company concerning the Offering. 7.4 Subscriber is not subscribing for the Common Shares as a result of or subsequent to any advertisement, article, notice or other communication published in any newspaper, magazine or similar media or broadcast over television or radio or presented at any seminar. 7.5 Subscriber is an "accredited investor," within the meaning of Rule 501(a) of Regulation D under the Securities Act ("Regulation D"). Subscriber, by reason of Subscriber's business or financial experience or the business or financial experience of Subscriber's professional advisers who are unaffiliated with and who are not compensated by the Company or any affiliate, directly or indirectly, can be reasonably assumed to have the capacity to protect Subscriber's own interests in connection with the transaction. Subscriber further acknowledges that he has read the written materials provided by the Company. 7.6 Subscriber has adequate means of providing for Subscriber's current financial needs and contingencies, is able to bear the substantial economic risks of an investment in the Common Shares for an indefinite period of time, has no need for liquidity in such investment and, at the present time, could afford a complete loss of such investment. 7.7 Subscriber has such knowledge and experience in financial, tax and business matters so as to enable Subscriber to use the information made available to Subscriber in connection with the Offering to evaluate the merits and risks of an investment in the Common Shares and to make an informed investment decision with respect thereto. 7.8 Subscriber recognizes that investment in the Common Shares involves substantial risks. Subscriber further recognizes that no Federal or state agencies have passed upon this offering of the Common Shares or made any finding or determination as to the fairness of this investment. 7.9 Subscriber acknowledges that each certificate representing the Public Company Shares shall contain a legend substantially in the following form: THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 (THE "SECURITIES ACT") OR UNDER APPLICABLE STATE SECURITIES LAWS AND MAY NOT BE SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF UNLESS REGISTERED UNDER THE SECURITIES ACT AND ANY 5 APPLICABLE STATE SECURITIES LAWS OR PURSUANT TO AVAILABLE EXEMPTIONS FROM SUCH REGISTRATION, PROVIDED THAT THE SELLER DELIVERS TO THE COMPANY AN OPINION OF COUNSEL (WHICH OPINION AND COUNSEL ARE SATISFACTORY TO THE COMPANY) CONFIRMING THE AVAILABILITY OF SUCH EXEMPTION. INVESTORS SHOULD BE AWARE THAT THEY MAY BE REQUIRED TO BEAR THE FINANCIAL RISKS OF THIS INVESTMENT FOR AN INDEFINITE PERIOD OF TIME. 7.10 If this Agreement is executed and delivered on behalf of a partnership, corporation, trust or estate: (i) such partnership, corporation, trust or estate has the full legal right and power and all authority and approval required (a) to execute and deliver, or authorize execution and delivery of, this Agreement and all other instruments executed and delivered by or on behalf of such partnership, corporation, trust or estate in connection with the purchase of the Common Shares, (b) to delegate authority pursuant to a power of attorney and (c) to purchase and hold such Common Shares; (ii) the signature of the party signing on behalf of such partnership, corporation, trust or estate is binding upon such partnership, corporation, trust or estate; and (iii) such partnership, corporation or trust has not been formed for the specific purpose of acquiring the Common Shares, unless each beneficial owner of such entity is qualified as an "accredited investor" within the meaning of Regulation D and has submitted information substantiating such individual qualification. 7.11 If Subscriber is a retirement plan or is investing on behalf of a retirement plan, Subscriber acknowledges that investment in the Common Shares poses risks in addition to those associated with other investments, including the inability to use losses generated by an investment in the Common Shares to offset taxable income. 8. Understandings. Subscriber understands, acknowledges and agrees with the Company as follows: 8.1 Subscriber hereby acknowledges and agrees that upon notice of acceptance from the Company pursuant to Section 1.3, the Subscription hereunder is irrevocable by Subscriber, that, except as required by law or as permitted under Section 6.1 above, Subscriber is not entitled to cancel, terminate or revoke this Agreement or any agreements of Subscriber hereunder and that this Subscription Agreement and such other agreements shall survive the death or disability of Subscriber and shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, executors, administrators, successors, legal representatives and permitted assigns. If Subscriber is more than one person, the obligations of Subscriber hereunder shall be joint and several and the agreements, representations, warranties and acknowledgments herein contained shall be deemed to be made by and be binding upon each such person and his or her heirs, executors, administrators, successors, legal representatives and permitted assigns. 8.2 No federal or state agency has made any findings or determination as to the fairness of the terms of this Offering for investment nor any recommendations or endorsement of the Common Shares. 8.3 The Offering is intended to be exempt from registration under the Securities Act by virtue of Section 4(2) of the Securities Act and the provisions of Rule 506 of Regulation D thereunder, which is in part dependent upon the truth, completeness and accuracy of the statements made by Subscriber herein. 8.4 It is understood that in order not to jeopardize the Offering's exempt status under Section 4(2) of the Securities Act and Regulation D, any transferee may, at a minimum, be required to fulfill the investor suitability requirements thereunder. 8.5 No person or entity acting on behalf, or under the authority, of Subscriber is or will be entitled to any broker's, finder's or similar fee or commission in connection with this Subscription. 8.6 Subscriber acknowledges that the information furnished in this Agreement by the Company to Subscriber or its advisers in connection with the Offering, is confidential and nonpublic and agrees that all such written 6 information which is material and not yet publicly disseminated by the Company shall be kept in confidence by Subscriber and neither used by Subscriber for Subscriber's personal benefit (other than in connection with this Subscription), nor disclosed to any third party, except Subscriber's legal and other advisers who shall be advised of the confidential nature of such information, for any reason; provided, however, that this obligation shall not apply to any such information that (i) is part of the public knowledge or literature and readily accessible at the date hereof, (ii) becomes a part of the public knowledge or literature and readily accessible by publication (except as a result of a breach of this provision) or (iii) is received from third parties (except third parties who disclose such information in violation of any confidentiality agreements or obligations, including, without limitation, any subscription agreement entered into with the Company). The representations, warranties and agreements of Subscriber and the Company contained herein and in any other writing delivered in connection with the Offering shall be true and correct in all material respects on and as of the Closing Date of such Subscription as if made on and as of the date the Company executes this Agreement and shall survive the execution and delivery of this Agreement and the purchase of the Common Shares. 8.7 IN MAKING AN INVESTMENT DECISION, SUBSCRIBER MUST RELY ON ITS OWN EXAMINATION OF THE COMPANY AND THE TERMS OF THE OFFERING, INCLUDING THE MERITS AND RISKS INVOLVED. THE COMMON SHARES HAVE NOT BEEN RECOMMENDED BY ANY FEDERAL OR STATE SECURITIES COMMISSION OR REGULATORY AUTHORITY. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. 9. Miscellaneous. 9.1 Except as set forth elsewhere herein, any notice or demand to be given or served in connection herewith shall be deemed to be sufficiently given or served for all purposes by being sent as registered or certified mail, return receipt requested, postage prepaid, in the case of the Company, addressed to it at the address set forth below: BAK Industrial Zone Atou Village Kui Chong Town Lunggang District Shenzhen, China 518119 Attention: Li Xiang Qian, President and in the case of Subscriber to the address set forth below: ___________________________________ ___________________________________ ___________________________________ ___________________________________ 9.2 This Agreement shall be enforced, governed and construed in all respects in accordance with the laws of Hong Kong, and shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. If any provision of this Agreement is invalid or unenforceable under any applicable statute or rule of law, then such provision shall be deemed inoperative to the extent that it may conflict therewith and shall be deemed to be modified to conform with such statute or rule of law. Any provision hereof that may prove invalid or unenforceable under any law shall not affect the validity or enforceability of any other provision hereof. 9.3 In any action, proceeding or counterclaim brought to enforce any of the provisions of this Agreement or to recover damages, costs and expenses in connection with any breach of the Agreement, the prevailing party, as determined by the finder of fact, shall be entitled to be reimbursed by the opposing party for all of the prevailing party's reasonable outside attorneys' fees, costs and other out-of-pocket expenses incurred in connection with such action, proceeding or counterclaim. 9.4 This Agreement constitutes the entire agreement among the parties hereto with respect to the subject matter hereof. There are no restrictions, promises, warranties or undertakings, other than those set forth herein. The 7 Company acknowledges that all material facts upon which it has relied in forming its decision to enter into this Agreement are expressly set forth herein and further acknowledges that the Subscriber has not made any representations, express or implied, which are not set expressly set forth herein. This Agreement supercedes all prior agreements and understandings among the parties hereto with respect to the subject matter hereof. 9.5 The Company shall indemnify, defend and hold harmless Subscriber and each of its agents, partners, members, officers, directors, representatives, or affiliates (collectively, the "Subscriber Indemnities") against any and all losses, liabilities, claims and expenses, including reasonable attorneys' fees ("Losses"), sustained by Subscriber Indemnities resulting from, arising out of, or connected with any material inaccuracy in, breach of, or nonfulfillment of any representation, warranty, covenant or agreement made by or other obligation of the Company contained in this Agreement (including the Exhibits hereto) or in any document delivered in connection herewith. 9.6 Subscriber shall indemnify, defend and hold harmless the Company and each of its agents, partners, members, officers, directors, representatives, or affiliates (collectively, the "Company Indemnities") against any and all Losses sustained by the Company Indemnities resulting from, arising out of, or connected with any material inaccuracy in, breach of, or non-fulfillment of any representation, warranty, covenant or agreement made by or other obligation of Subscriber contained in this Agreement (including the Exhibits hereto) or in any document delivered in connection herewith. 9.7 The Company shall not issue any public statement or press release, or otherwise disclose in any manner the identity of the Subscriber or that Subscriber has purchased the Common Shares, without the prior written consent of the Subscriber, except as may be required by applicable law; provided, however, that the Company may disclose such information in the Registration Statement filed with the SEC. 10. Signature. The signature page of this Agreement is contained as part of the applicable Subscription Package, entitled "Signature Page." 8 SUBSCRIPTION AGREEMENT GENERAL INSTRUCTIONS ------------------------------------------- General Instructions These Subscription Documents contain all documents necessary to subscribe for Common Shares ("Common Shares"), of BAK International, Ltd., a Hong Kong corporation (the "Company"). You may subscribe for Common Shares by completing the Subscription Agreement in the following manner: 1. On line (a) of the signature page state the number of Common Shares you wish to purchase. 2. On line (b) of the signature page state the total cost of the Common Shares you wish to purchase. To obtain the cost, multiply the number of Common Shares you desire to purchase by the purchase price per Common Share set forth therein. 3. Sign and state your address, telephone number and social security or other taxpayer identification number on the lines provided on the signature page to the Subscription Agreement and deliver the completed Subscription Agreement with payment of the entire purchase price of the Common Shares subscribed for as set forth below. Payment should be made in United States Dollars by wire transfer to: ___________________________________ ___________________________________ ___________________________________ ___________________________________ The Subscription Agreement Signature Page must be completed and signed by each investor. Send all documents to: Securities Transfer Corporation Attention: Kevin Halter 2591 Dallas Parkway, Suite 102 Frisco, Texas 75034 THE COMPLETED SUBSCRIPTION AGREEMENT SHOULD BE RETURNED IN ITS ENTIRETY TO THE ESCROW AGENT DESIGNATED ABOVE. Acceptance of Delivery All questions as to the validity, form, eligibility (including time of receipt) and acceptance of the completed Subscription Agreement will be reasonably determined by the Company. The Company reserves the absolute right to reject any completed Subscription Agreement, in its sole and absolute discretion. The Company also reserves the right to waive any irregularities in, or conditions of, the submission of completed Subscription Agreements. The Company shall be under no duty to give any notification of irregularities in connection with any attempted subscription for Common Shares or incur any liability for failure to give such notification. Until such irregularities have been cured or waived, no subscription for Common Shares shall be deemed to have been made. Any Subscription Agreement that is not properly completed and as to which defects have not been cured or waived will be returned by the Company to the Subscriber as soon as practicable. 9 SUBSCRIPTION AGREEMENT SIGNATURE PAGE The undersigned investor hereby certifies that he or she (i) has received and relied solely upon information provided by the Company, (ii) agrees to all the terms and conditions of this Subscription Agreement, (iii) meets the suitability standards set forth in this Subscription Agreement and (iv) is a resident of the state indicated below. (a) The undersigned subscribes for __________ Common Shares. (b) The total cost of the Common Shares subscribed for, at $____ per Common Share, is $__________ (the "Purchase Price"). If other than Individual check one and indicate _____________________________ capacity of signatory under the signature: [_] Trust [_] Estate _____________________________ [_] Uniform Gifts to Minors Act of State of____ Name of Subscriber (Print) [_] Attorney-in-fact [_] Corporation [_] Other______________________________________ _____________________________ If Joint Ownership, check one: Name of Joint Subscriber (if any) (Print) [_] Joint Tenants with Right of Survivorship [_] Tenants in Common _____________________________ [_] Tenants by Entirety Signature of Subscriber [_] Community Property _____________________________ Signature of Joint Subscriber (if any) _____________________________ Capacity of Signatory (if applicable) _____________________________ Backup Withholding Statement: Social Security or Please check this box only if the investor Taxpayer Identification Number is subject to: [_] backup withholding. _____________________________ Address Foreign Person: Please check this box only if the investor is a: [_] nonresident alien, foreign corporation, _____________________________ foreign partnership, foreign trust or City State Zip Code foreign estate. Telephone ( )____________________ Telecopy No. ______________________ The investor agrees to the terms of this Subscription Agreement and, as required by the Regulations pursuant to the Internal Revenue Code, certifies under penalty of perjury that (1) the Social Security Number or Taxpayer Identification Number and address provided above is correct, (2) the investor is not subject to backup withholding (unless the Backup Withholding Statement box is checked) either because he has not been notified that he is subject to backup withholding as a result of a failure to report all interest or dividends or because the Internal Revenue Service has notified him that he is no longer subject to backup withholding and (3) the investor (unless the Foreign Person box above is checked) is not a nonresident alien, foreign partnership, foreign trust or foreign estate. 10 THE SUBSCRIPTION FOR _____________ COMMON SHARES BAK INTERNATIONAL, LTD. BY THE ABOVE NAMED SUBSCRIBER(S) IS ACCEPTED AS OF ________________, 2004. BAK INTERNATIONAL, LTD. By: __________________________________________ Title:________________________________________ 11 ESCROW AGREEMENT This Escrow Agreement (the "Agreement"), dated effective as of the last date set forth opposite the respective signatories hereto, is entered into by and among BAK International, Ltd., a Hong Kong corporation (the "Company"), each of the subscribers to the Company's private offering of securities identified below (collectively, the "Subscribers"), and Securities Transfer Corporation (hereinafter referred to as "Escrow Agent"). WHEREAS, the Company and each of the Subscribers have entered into a Subscription Agreement (the "Subscription Agreement") pursuant to which each Subscriber has agreed to purchase from the Company, and the Company has agreed to sell to each Subscriber, the number of shares of the common stock of the Company identified therein; WHEREAS, pursuant to the Subscription Agreement, the Company and the Subscribers have agreed to establish an escrow on the terms and conditions set forth in this Agreement; WHEREAS, the Escrow Agent has agreed to act as escrow agent pursuant to the terms and conditions of this Agreement; and WHEREAS, all capitalized terms used but not defined herein shall have the meanings assigned them in the Subscription Agreement; NOW, THEREFORE, in consideration of the mutual promises of the parties and the terms and conditions hereof, the parties hereby agree as follows: 1. Appointment of Escrow Agent. The Subscribers and the Company hereby appoint Securities Transfer Corporation as Escrow Agent to act in accordance with the terms and conditions set forth in this Agreement, and Escrow Agent hereby accepts such appointment and agrees to act in accordance with such terms and conditions. 2. Establishment of Escrow. All amounts invested by the Subscribers as identified in each accepted Subscription Agreement shall be deposited with the Escrow Agent in immediately available funds by federal wire transfer, such funds being referred to herein as the "Escrow Funds". 3. Segregation of Escrow Funds. The Escrow Funds shall be segregated from the assets of Escrow Agent and held in trust for the benefit of the Company and the Subscribers in accordance herewith. 4. Receipt and Investment of Funds. (a) Escrow Agent agrees to place the Escrow Funds in a non-interest bearing and Federally insured depository account. Subject to Section 7.3 hereof, Escrow Agent shall have no liability for any loss resulting from the deposit of the Escrow Funds. (b) The Escrow Agent shall cause to be prepared all income and other tax returns and reports the Escrow Agent, in its sole discretion, deems necessary or advisable in order to comply with all tax and other laws, rules and regulations applicable to the Escrow Funds. 5. Disbursement of the Escrow Funds. (a) Duration. This Agreement shall terminate on the first to occur of the following dates: (i) on the Closing Date of the Offering, at which time the Escrow Funds shall be delivered to the Company; or (ii) on the termination date of the Offering, in which event the Escrow Funds shall be returned to the Subscribers. Either of the forgoing dates may be extended by joint written instructions to Escrow Agent by the Company and the Subscribers (any such date, or any later date to which any prior Termination Date has been so extended being referred to herein as the "Termination Date"). On the Termination Date, Escrow Agent shall disburse the Escrow Funds it then holds in accordance with the provisions of this Agreement and this Agreement shall terminate, whereupon all of Escrow Agent's liabilities and obligations in connection with the Escrow Funds shall terminate 6. Interpleader. Should any controversy arise among the parties hereto with respect to this Agreement or with respect to the right to receive the Escrow Funds, Escrow Agent shall have the right to consult counsel and/or to institute an appropriate interpleader action to determine the rights of the parties. Escrow Agent is also hereby authorized to institute an appropriate interpleader action upon receipt of a written letter of direction executed by the parties so directing Escrow Agent. If Escrow Agent is directed to institute an appropriate interpleader action, it shall institute such action not prior to thirty (30) days after receipt of such letter of direction and not later than sixty (60) days after such date. Any interpleader action instituted in accordance with this Section 6 shall be filed in any court of competent jurisdiction in Dallas County, Texas, and the portion of the Escrow Funds in dispute shall be deposited with the court and in such event Escrow Agent shall be relieved of and discharged from any and all obligations and liabilities under and pursuant to this Agreement with respect to that portion of the Escrow Funds. 7. Exculpation and Indemnification of Escrow Agent. (a) Escrow Agent is not a party to, and is not bound by or charged with notice of any agreement out of which this escrow may arise. Escrow Agent acts under this Agreement as a depositary only and is not responsible or liable in any manner whatsoever for the sufficiency, correctness, genuineness or validity of the subject matter of the escrow, or any part thereof, or for the form or execution of any notice given by any other party hereunder, or for the identity or authority of any person executing any such notice or depositing the Escrow Funds. Escrow Agent will have no duties or responsibilities other than those expressly set forth herein. Escrow Agent will be under no liability to anyone by reason of any failure on the part of any party hereto (other than Escrow Agent) or any maker, endorser or other signatory of any document to perform such person's or entity's obligations hereunder or under any such document. Except for this Agreement and instructions to Escrow Agent pursuant to the terms of this Agreement, Escrow Agent will not be obligated to recognize any agreement between or among any or all of the persons or entities referred to herein, notwithstanding its knowledge thereof. (b) Escrow Agent will not be liable for any action taken or omitted by it, or any action suffered by it to be taken or omitted, in good faith and in the exercise of its own best judgment, and may rely conclusively on, and will be protected in acting upon, any order, notice, demand, certificate, or opinion or advice of counsel (including counsel chosen by Escrow Agent), statement, instrument, report or other paper or document (not only as to its due execution and the validity and effectiveness of its provisions, but also as to the truth and acceptability of any information therein contained) which is reasonably believed by Escrow Agent to be genuine and to be signed or presented by the proper person or persons. The duties and responsibilities of the Escrow Agent hereunder shall be determined solely by the express provisions of this Agreement and no other or further duties or responsibilities shall be implied, including, but not limited to, any obligation under or imposed by any laws of the State of Texas upon fiduciaries. (c) Escrow Agent will be indemnified and held harmless, jointly and severally, by the Company and the Subscribers from and against any expenses, including reasonable attorneys' fees and disbursements, damages or losses suffered by Escrow Agent in connection with any claim or demand, which, in any way, directly or indirectly, arises out of or relates to this Agreement or the services of Escrow Agent hereunder; except, that if Escrow Agent is guilty of willful misconduct, fraud or gross negligence under this Agreement, then Escrow Agent will bear all losses, damages and expenses arising as a result of such willful misconduct, fraud or gross negligence. Promptly after the receipt by Escrow Agent of notice of any such demand or claim or the commencement of any action, suit or proceeding relating to such demand or claim, Escrow Agent will notify the other parties hereto in writing. For the purposes hereof, the terms "expense" and "loss" will include all amounts paid or payable to satisfy any such claim or demand, or in settlement of any such claim, demand, action, suit or proceeding settled with the express written consent of the parties hereto, and all costs and expenses, including, but not limited to, reasonable attorneys' fees and disbursements, paid or incurred in investigating or defending against any such claim, demand, action, suit or proceeding. The provisions of this Section 7 shall survive the termination of this Agreement. 8. Compensation of Escrow Agent. The Company will pay Escrow Agent an amount equal to Escrow Agent's standard fee schedule rate for all services rendered by Escrow Agent hereunder. 9. Resignation of Escrow Agent. At any time, upon ten (10) days' written notice to the Company, Escrow Agent may resign and be discharged from its duties as Escrow Agent hereunder. As soon as practicable after its resignation, Escrow Agent will promptly turn over to a successor escrow agent appointed by the Company all monies and property held hereunder upon presentation of a document appointing the new escrow agent and evidencing its acceptance thereof. If, by the end of the 10-day period following the giving of notice of resignation by Escrow Agent, the Company shall have failed to appoint a successor escrow agent, Escrow Agent may interplead the Escrow Funds into the registry of any court having jurisdiction. 10. Method of Distribution by Escrow Agent. All disbursements by Escrow Agent to a party to this Agreement will be made by wire transfer of immediately available funds to an account designated in writing by the party to receive any such payment. 11. Records. Escrow Agent shall maintain accurate records of all transactions hereunder. Promptly after the termination of this Agreement or as may reasonably be requested by the parties hereto from time to time before such termination, Escrow Agent shall provide the parties hereto, as the case may be, with a complete copy of such records, certified by Escrow Agent to be a complete and accurate account of all such transactions. The authorized representatives of each of the parties hereto shall have access to such books and records at all reasonable times during normal business hours upon reasonable notice to Escrow Agent. 12. Notice. All notices, communications and instructions required or desired to be given under this Agreement must be in writing and shall be deemed to be duly given if sent by registered or certified mail, return receipt requested, or overnight courier to the following addresses: If to Escrow Agent: Securities Transfer Corporation 2591 Dallas Parkway, Suite 102 Frisco, Texas 75034 Attention: Kevin Halter If to the Company: BAK Industrial Zone Atou Village Kui Chong Town Lunggang District Shenzhen, China 518119 Attention: Li Xiang Qian, President If to the Subscribers: Addresses noted in their respective Subscription Agreements or to such other address and to the attention of such other person as any of the above may have furnished to the other parties in writing and delivered in accordance with the provisions set forth above. 13. Execution in Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 14. Assignment and Modification. This Agreement and the rights and obligations hereunder of any of the parties hereto may not be assigned without the prior written consent of the other parties hereto. Subject to the foregoing, this Agreement will be binding upon and inure to the benefit of each of the parties hereto and their respective successors and permitted assigns. No other person will acquire or have any rights under, or by virtue of, this Agreement. No portion of the Escrow Funds shall be subject to interference or control by any creditor of any party hereto, or be subject to being taken or reached by any legal or equitable process in satisfaction of any debt or other liability of any such party hereto prior to the disbursement thereof to such party hereto in accordance with the provisions of this Agreement. This Agreement may be changed or modified only in writing signed by all of the parties hereto. 15. APPLICABLE LAW. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS APPLICABLE TO CONTRACTS MADE AND TO BE PERFORMED THEREIN, EXCEPT THAT THE PORTIONS OF THE TEXAS TRUST CODE, SECTION 111.001, ET SEQ. OF THE TEXAS PROPERTY CODE, CONCERNING FIDUCIARY DUTIES AND LIABILITIES OF TRUSTEES SHALL NOT APPLY TO THIS AGREEMENT. THE PARTIES EXPRESSLY WAIVE SUCH DUTIES AND LIABILITIES, IT BEING THEIR INTENT TO CREATE SOLELY AN AGENCY RELATIONSHIP AND HOLD THE ESCROW AGENT LIABLE ONLY IN THE EVENT OF ITS WILLFUL MISCONDUCT, FRAUD, OR GROSS NEGLIGENCE. ANY LITIGATION CONCERNING THE SUBJECT MATTER OF THIS AGREEMENT SHALL BE EXCLUSIVELY PROSECUTED IN THE COURTS OF DALLAS COUNTY, TEXAS, AND ALL PARTIES CONSENT TO THE EXCLUSIVE JURISDICTION AND VENUE OF THOSE COURTS. 16. Headings. The headings contained in this Agreement are for convenience of reference only and shall not affect the construction of this Agreement. 17. Attorneys' Fees. If any action at law or in equity, including an action for declaratory relief, is brought to enforce or interpret the provisions of this Agreement, the prevailing party shall be entitled to recover reasonable attorneys' fees from the other party (unless such other party is the Escrow Agent), which fees may be set by the court in the trial of such action or may be enforced in a separate action brought for that purpose, and which fees shall be in addition to any other relief that may be awarded. IN WITNESS WHEREOF, the parties have duly executed this Agreement as of the date set forth opposite their respective names. BAK International, Ltd. By: ______________________________ Its: ______________________________ Dated: ______________________________ SECURITIES TRANSFER CORPORATION By: ______________________________ Its: ______________________________ Dated: ______________________________ SUBSCRIBERS: _____________________________________ - -------------------------------------------------------------------------------- BAK CONFIDENTIAL BUSINESS PLAN SHENZHEN BAK BATTERY CO, LTD. November 2004 Confidential Treatment Requested -------------------------------- Confidential Material in this document has been redacted and ------------------------------------------------------------ filed separately with the Commission. ------------------------------------- - ---------------- [*****]Confidential Material redacted and filed separately with the Commission. CONFIDENTIAL TREATMENT DISCLAIMER IMPORTANT NOTICE TO RECIPIENTS OF THIS CONFIDENTIAL BUSINESS PLAN This Confidential Business Plan (the "Business Plan 2004") and its contents are the property of Shenzhen BAK Battery Co., Ltd ("BAK"). By accepting delivery of this Business Plan 2004, the recipient agrees to return this Business Plan 2004 and all related documents, if any, to BAK, upon request. The recipient agrees that neither it nor its agents, representatives, directors, or employees will copy, reproduce, or distribute this Business Plan, in whole or in part. The recipient agrees not to disclose the contents of this Business Plan 2004 to any party other than the recipient's business or tax advisors, for investment consideration only. Information contained in this Business Plan 2004 has been obtained from BAK, and from other sources deemed reliable, as of the date of its publishing, but no representation or warranty is made as to its accuracy or completeness. No person has been authorized in connection with this Business Plan 2004 to give any information or to make any representations other than those contained herein and, if given or made, must not be relied upon as having been authorized. Only those representations and warranties, which may be made by BAK, in a definitive written agreement, when and if one is executed, will have any legal effect. This Business Plan 2004 contains forward-looking statements concerning plans, intentions, strategies, expectations, predictions, financial projections and beliefs of BAK, in regard to future activities and results of operations and other future events or conditions. Actual results, events, or conditions could differ materially from those projected by BAK, due to a variety of factors, some of which are beyond the control of BAK. BAK disclaims any obligations to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future results, events or developments. This Business Plan 2004 is not, and should not be construed as, an offer to sell or a solicitation of an offer to buy securities of BAK and is for information purposes only. - -------------------------------------------------------------------------------- Table of Contents 1. Executive Summary 2. Industry Information 2.1 Industry introduction 2.2 World Li-ion industry trends 2.3 Chinese Li-ion industry trends 2.4 Li-ion industry segmentation and trends 3. The Company 3.1 History 3.2 Company organization framework 3.3 Employees and management 3.4 Facilities 3.5 R&D Center 3.6 Corporate culture and management model 4. Products and Services 4.1 Product lines 4.2 Proprietary technology 4.3 Post-sale service 4.4 Suppliers 5. Sales and Marketing 5.1 Marketing strategies 5.2 BAK's current market 5.3 Customers 5.4 Potential market opportunities 6. Strategic Analysis 6.1 SWOT analysis 6.2 Competitive analysis 6.3 Strategic Plan 6.4 Risks related to doing business in China 7. Proposed Equity Plan 7.1 The transaction 7.2 Financing and restructuring plan 7.3 Use of funds 7.4 Timetable 8. Historical Financial Information 9. Projected Financial Information Exhibits Photos of Facilities - -------------------------------------------------------------------------------- PART 1: EXECUTIVE SUMMARY Founded in 2001, Shenzhen BAK Battery Co., Ltd. ("BAK" or the "Company") is a China-based company specializing in lithium ion(as "Li-ion" or "Li-ion cell") battery cell production, primarily for cell phones. It has achieved high levels of growth over the past four years and has become the seventh largest Lithium battery cell manufacturer in terms of production capacity worldwide. Lithium Ion ("Li-ion") battery unit production has increased 30 times over the past 10 years (1994-2004). At the beginning of 1990's, the Li-ion battery industry was pioneered in Japan as a new and more efficient type of energy storage than previous technologies. Li-ion batteries rapidly became the batteries of choice for the rapid developing of mobile phone industry. In addition, due to development of electronic products like high-power handset phones, laptop computers, digital cameras and video camcorders, the compound annual worldwide growth rate of Li-ion battery production is estimated at 23.2% during the years 2003-2006 (according to the Chinese Battery Association Annual Report 2004,4). Longer term estimates through 2010 project similar growth rates. The annual growth rate of Li-ion battery's production has been more than 140% in China since 2001, and China's share of the worldwide market is rapidly growing. In 2002, the production of Li-ion batteries in China was 270 million pieces, which was more than 20% of global market share. Unit production reached 500 million in 2003, which was almost 30% of global market share. The newest report from the Association of Chemical and Physical Industry of China indicates that the annual growth rate will exceed 30% per year over the next several years. China has become Japan's biggest competitor in Li-ion battery production. Japan had a 93.9% global market share through 2000. However, Japan's share decreased to 69.4% in 2002, and 58.2% in 2003. Industry estimates are that by 2005 Japan's market share will drop to less than 50%. Japan has lost market share primarily to Chinese companies. One of the key reasons is that China is the biggest market for mobile phones. Another reason is lower prices from Chinese companies; China's lower labor and infrastructure costs result in a reduced product cost. The pressure from Chinese companies is the most important factor in decreasing Li-ion battery prices in the world market. The third reason is that China has established strong vertical integration of production, which results in significant production advantages. China is by far the biggest competitor for Japan in this market. Massive capacity, low manufacturing cost, high quality and the right marketing strategy are the major elements of company's core competitive edge. BAK's monthly output capacity is 15 million pieces and actual current production is 11.8 million which makes BAK the seventh largest Li-ion manufacturer in the world. BAK's specialty is the production of Li-ion battery cells, offering three major types divided into 90 different models, including steel case, aluminum case and cylindrical Li-ion rechargeable batteries. The battery cells are the core components of Li-ion rechargeable battery packs. Chinese battery manufacturers have historically imported battery cells from foreign countries to produce Li-ion rechargeable battery. With BAK's large Li-ion cell manufacturing capacity, discounted prices, and sophisticated market positioning, Chinese Li-ion battery packing companies (which combine the cells into battery packs) now have a lower cost domestic supplier and are able to gain market share. BAK has gained a dominant, over 60%, market share of the replacement Li-ion battery market in China. BAK has enlarged its production capacity rapidly over the past year to become the second largest manufacturer in the Chinese market, with an output of 11.8 million pieces per month and a current capacity for 15 million pieces. In the Chinese replacement battery market, BAK has obtained over 60% of the market share, and has a dominant position in this market. Compared with B&K, HuanYu and Coslight, its smaller competitors in this segment, BAK provides both a more customized and higher quality product at a lower cost. Compared with BYD, BAK's largest competitor, the company has a [*****] cost for similar products. BAK is moving into the Original Equipment Manufacturing (OEM) Market. Having now succeeded in leading the replacement Li-ion battery market in China, BAK is now moving into the OEM market. Over the last year, BAK has begun the preliminary certification process with several cell phone manufactures to become an OEM supplier to these companies. In September 2004, BAK began the preliminary process with Motorola and expects to enter the formal stage of certification by March 2005. The Company expects to complete this certification process with Motorola by June 2005. BAK is also in the preliminary certification process with [*****] cell phone manufacturer, and expects to complete the OEM certification process with these companies in November 2005. BAK's management team and organizational structure meets the top standards of a US public company. BAK's management team is energetic, knowledgeable and professional. Mr. Xiangqian Li, CEO, has many years of experience in the capital markets in China. He founded the company in 2001, and successfully grew it to its current size through low cost manufacturing and Li-ion research in the battery industry. CFO Mr. Yongbin Han, CPA, has many years of experience in various financial fields. In BAK's technical team, the company has two world-class Li-ion battery experts. The first, Dr. Huanyu Mao, BAK's Chief Technology Officer is a PhD, with over 13 years of working experience in developing battery cells for laptop use and is widely recognized as one of the leading authorities in the world within this field. He assisted in starting Lishen (the third largest lithium-ion battery manufacture in China) and supervised Lishen's successful completion of Motorola's certification process. Dr. Mao is also well known in the Li-ion battery industry for his research with Polymer cells and HEV Batteries. In 1999, Dr. Mao won the "Friendship Award", which is the highest award for foreign workers in China, sponsored by China's Central Government to recognize his contribution to new technology development. In February 2002, he won the "State Science and Technology Cooperation Award", also given by China's Central Government, in appreciation for his contribution to the Chinese economy. BAK's second technical expert, Dr. Qingyi Yao, is also well known in the space. Dr. Yao has gain great success in the research of high capacity laptop PCs batteries. The specific battery created by his team has already obtained the European Union's ("EU's") safety certificate. BAK has a clear short and long-term plan. During the next two years, the Company plans to emphasize its push into the global original cellular phone battery market ("OEM"), the electric power tools battery market, and to significantly increase the production of laptop batteries. With the proceeds from this offering, the Company will build a production line for laptop batteries ("18650") to a monthly output of about 2.5 million pieces by June 2005. In two to three years, BAK plans to begin selling into the electric bicycle battery market. In conjunction with China FAW Group, China's largest automobile manufacturer, the Company has also recently begun research into the Hybrid Electric Vehicle ("HEV") battery market. BAK's objective is to reduce the cost of the Li-ion battery to the same level as that of Nickel Cadmium ("NiCd") and Nickel Metal Hydride ("NiMH") batteries, which will among other things make BAK's Li-ion battery a much more desirable alternative for the HEV market. BAK's R&D center is continuing to make significant progress on Li-ion battery manufacturing cost reductions and new technologies. [*****]. Summary of Historical and Projected Financial Data Over the next two years, BAK anticipates its net income will continue to grow at an average rate of [*****]. In the four years since its founding in 2001, BAK has increased its monthly production to 11.8 million units, resulting in revenues with a cumulative annual growth rate of more than 350% over the past two years. The Company is projecting revenues in excess of $110 million for the fiscal year ending September 30, 2005, compared to $64.1 million for the most recent fiscal year. Based upon its experience, management estimates net profits will grow 68% in 2005 and [*****] in 2006 or an average of [*****], resulting in net profits of $12.1 million dollars in fiscal year 2005 and [*****] million in fiscal year 2006. As part of a proposed $17 million equity financing, existing shareholders will escrow 10% of their BAK's stock, to be used as compensation for investors if the Company fails to deliver the projected profit. (For a more detailed description of the investment terms please reference section 7.1 of this business plan.) Table 1-1: Summary of historical and projected financial information
($ in 000,8.265RMB/$1.00) FYE September 30, --------------------------------------------------------------------------------- 2002 2003 2004 2005 2006 2007 ----------- ----------- ----------- ----------- ----------- ----------- Revenues $ 3,050.2 $ 20,266.6 $ 64,088.3 $ 110,103.3 **** **** Gross Income $ 536.5 $ 5,694.7 $ 14,458.0 $ 22,767.3 **** **** Gross Margin (%) 17.6% 28.1% 22.6% 20.7% **** **** Net Income $ 719.7 $ 3,765.3 $ 7,226.4 $ 12,111.3 **** **** Total Assets $ 3,778.7 $ 23,008.9 $ 103,168.3 $141,880,6 **** **** Total Equity $ 1,929.6 $ 5,682.1 $ 23,797.8 $ 52,499.7 **** **** Revenue Growth NA 564% 216% 72% **** **** Net Income NA 423% 92% 68% **** ****
For more detailed projections, see the projections and accompanying assumptions in Part 9 of this business plan. PART 2: INDUSTRY INFORMATION 2.1 Industry Introduction: The Li-ion battery industry is growing strongly. World production of Li-ion batteries has increased 30 times in the past 10 years. Since 1992, when Sony first commercialized Li-ion batteries, the Japanese controlled the Li-ion battery market. The market's growth has been driven primarily by the spread of the mobile phone. (Data source: Portable Power Conference & Expo, September 13, 2004, San Francisco.) Li-ion batteries are the most attractive rechargeable batteries available in the market to date. Lithium-based batteries can be categorized as non-rechargeable and rechargeable. Nowadays, non-rechargeable Lithium batteries are typically used in low-power consumer electronics applications such as film cameras, and rechargeable Lithium batteries (or "Li-ion") are used in heavy power consuming electric appliances such as cellular telephones, camcorders, digital cameras, laptops and so on. The rechargeable Li-ion market is growing much faster than the non-rechargeable lithium battery market. Compared to other kinds of rechargeable batteries such as Nickel Cadmium ("NiCd") and Nickel Metal Hydride ("NiMH"), Li-ion batteries have several very attractive features: - a high operational voltage (normally 3.6v in market, it is 3 times more than NiCd or NiMH batteries), - lower self-discharge (<8% per month, 30% less than NiCd and 40% less than NiMH), - long cycle life (can be used thousands of times), and - no memory effect (unlike NiCd). Table 2-1 below outlines these differences. Table 2-1: Comparison of NiCd, NiMH and Li-ion Batteries - ----------------------------- ---------------------------- --------- ----------- Feature NiCd NiMH Li-ion - ----------------------------- ---------------------------- --------- ----------- Operation voltage 1.2 1.2 3.6 - ----------------------------- ---------------------------- --------- ----------- Gravimetric Energy Density 50 65~105 140 Wh/kg - ----------------------------- ---------------------------- --------- ----------- Volumetric Energy Density 150 200 300 Wh/L - ----------------------------- ---------------------------- --------- ----------- Cycle life 500 500 1000 - ----------------------------- ---------------------------- --------- ----------- Self-discharge %/month 25~30 30~35 6~9 - ----------------------------- ---------------------------- --------- ----------- Rapid charge Not good Good Good - ----------------------------- ---------------------------- --------- ----------- Over charge Fair Good Not good - ----------------------------- ---------------------------- --------- ----------- Memory effect Yes No No - ----------------------------- ---------------------------- --------- ----------- Environmental Issues Release of cadmium, None None (poisonous) - ----------------------------- ---------------------------- --------- ----------- Information source: World Chemist 5th issue, 2002 Li-ion is taking market share from other technologies. According to Avicenne Development, an industry research group, the world NiCd market was $1 billion in 2003, and shrinking at an annual 10% rate. The world NiMH market was an estimated $640 million in 2003, shrinking at a 15% annual rate. By comparison, the Li-ion market has compound annual worldwide growth rate of 23.2% during the years 2003-2006, and estimates through 2010 project similar growth rates. The newest technology, Lithium polymer, has already reached $300mm in worldwide market size and is growing 20% per annum. Rechargeable lithium polymer batteries are a new technology to be commercialized. The lithium salt electrolyte used in lithium polymer has many advantages over lithium ion design. These batteries are less hazardous if mistreated. Furthermore, since no metal battery cell casing is needed, the battery can be lighter and it can be specifically shaped to fit the device it will power. Because of the denser packaging without the holes between cylindrical cells and the lack of metal casing, the energy density of Li-poly batteries is over 20% higher than that of a classical Li-ion battery. Lithium Polymer technology still has problems with internal resistance and life cycle. Other challenges include longer charge times and the slower maximum discharge rates compared to more mature technologies. Worldwide Li-ion battery production is shared by Japan, China and Korea. As the first county to research Li-ion battery techniques, Japanese Li-ion battery technology has historically been the most advanced in the world, and Japan's manufacturing equipment is mostly automatic. China and Korea imported techniques and equipment, put their own efforts into research and production practices, and have been making significant production improvements and research discoveries. China has become Japan's biggest competitor by offering quality products at lower prices. Korea is also growing quickly in this segment. Leading manufacturers by country are listed in table 2-2 below. Table 2-2: Leading World Li-ion Battery Manufacturers - --------------------- ---------------------------------------------------------- Country Company - --------------------- ---------------------------------------------------------- Japan Sanyo, Sony, Panasonic, GS, NEC, Hitachi - --------------------- ---------------------------------------------------------- Korea LG, Samsung, - --------------------- ---------------------------------------------------------- China BYD, BAK, Lishen, B&K, Huyo, Coslight - --------------------- --------------------------------------------------------- The Japanese manufacturers are also less dominant in the Li-ion market. According to Avicenne, in 2003 industry leader Sanyo controlled 40% of the NiCd market and 55% of the NiMH market, but only 31% of the Li-ion market. Matsushita, #2 in 2003 in both the NiCd and NiMH market share with 26% and 25% respectively, had only 11% of the Li-ion market. 2.2 World Li-ion Industry Trends Li-ion batteries are now replacing NiCd and NiMH battery. In recent years, wireless electronic product manufacturers and consumers have demanded the performance available only in Li-ion rechargeable batteries. Today in the global rechargeable battery market, Li-ion battery market share keeps increasing, from 20% in 2001 to 38% in 2003. According to projections sourced from the Chinese Battery Annual Report from April 2004, the Li-ion battery market is expected to experience a 23.2% compound annual growth rate over the next three years, which by 2006 is projected to result in a 56% share of the worldwide rechargeable battery market. Table 2-3: Sales of Li-ion batteries compared with total sales of all rechargeable batteries (in US$ Millions) Polymer Li-ionl NiMH NiCD Total ------- ------- ------ ------ ----- 1991 100 1,500 1,600 1992 150 1,550 1,700 1993 <50 250 1,900 2,200 1994 150 800 2,050 3,000 1995 500 1,050 2,150 3,700 1996 1,200 850 1,750 3,850 1997 1,750 850 1,650 4,250 1998 1,850 850 1,400 4,100 1999 <50 2,450 1,100 1,400 5,000 2000 200 2,800 1,300 1,200 5,500 2001 250 2,400 700 650 4,000 2002 250 2,400 650 950 4,250 2003 350 3,405 600 900 5300 2004 400 4,350 550 950 6,250 2005 300 4,200 560 940 6,000 AAGR 1991-2000 = 15% AAGR 2001-2005 = 11% (actual amounts cannot be determined) Data source: Portable Power Conference & Expo, September 13, 2004, San Francisco. The emergence of multiple applications has driven the growth of the Li-ion battery market. The demand for Li-ion batteries in laptops and camcorders keeps increasing, as is demand for power mobile phone batteries. More recently, the pocket PC and portable video games have become the new target market for Li-ion batteries. In addition to these uses, there is a huge untapped market: the development of power tools, electric scooters and pure electric cars and Hybrid Electric Vehicles ("HEV"), all provide new potential applications of Li-ion technology. All these changes have driven Li-ion battery growth. In 2003-2006, the world Li-ion battery manufacturing compound growth rate is projected at 23.2%. 2.3 China Li-ion Industry Trends: Taking market share. The average annual production growth rate in China has been at 140% since 2001, well ahead of the worldwide growth rate and the result of China's huge production capacity and low product costs. Spurred by the growth of BAK and similar companies, Li-ion battery production volume reached 270 million pieces in 2002, 20% of the global market share. China production volume exceeded to 500 million pieces in 2003, which was almost 30% of the global market. With the success of BYD, BAK, B&K, Lishen, Huanyu, and Coslight, the Chinese Li-ion battery industry is projected to grow 30% annually over the next 2-3 years. Compared to Japan and Korea, China's production advantages can be categorized into three main areas: (1) Low product cost. With abundant labor resources and low materials prices, Chinese companies can use semi-automated product lines to reduce costs and offer lower prices. The low price marketing strategy used by Chinese companies is the main reason that Li-ion batteries' prices have dropped worldwide. (2) China is the biggest consumer with the fastest growing and highest mobile phone sales volume in the world. (3) China has built an integrated industry chain from raw material to sales networks for Li-ion batteries, resulting in significant production efficiencies and lower costs. The emergence of Chinese companies such as BAK has created competition with market leader SANYO for market share. BAK's output grew dramatically over the last year to its current 11.8 million pieces per month. BAK's growth has separated itself from other second tier players in China such as B&K and Huyu. In addition, the quality of BAK's products, meet or even exceed that of the Japanese companies in several key areas. (1) High capacity: BAK uses technology resulting in higher storage capacity than Japanese products (2) High discharge voltage: BAK uses certain raw materials, which management believes are better than those used by Japanese or other Chinese companies. (3) Low internal resistance: most Chinese manufacturers use certain electrolyte ingredients, which more effectively reduce internal resistance. Lower battery resistance results higher power and better performance at lower temperatures. The net result of these three factors, is a BAK cell phone battery with longer talking time. These differences can be seen in the specifications described in table 2-4 below. Table 2-4: Li-ion Specifications for Chinese Companies (BAK,BYD) Compared to Japanese Companies (Sanyo, Sony) - ---------------------------------------- --------- --------- --------- --------- Feature BAK BYD SANYO SONY - ---------------------------------------- --------- --------- --------- --------- Operating voltage (V) 3.7 3.7 3.6 3.6 Capacity (mAh) 750 750 630 630 Internal resistance (mC) <50 <60 <60 <60 Self-discharge (%/month) 10 10 10 10 Time remaining above 3.6V at discharge 45-52 28-33 40-45 40-45 (minutes) Cycle life >500 >500 >500 >500 Safety Good Good Good Good - ---------------------------------------- --------- --------- --------- --------- BAK has gained a dominant position the replacement Li-ion battery market in China. From the time of the company's formation in 2001, BAK has focused on the replacement market as the segment where it wanted to establish a dominant position. The replacement market is a special section of the overall Li-ion battery market. Replacement batteries are not the original batteries that come with the cell phone purchase. This market provides customers with a second replacement battery or additional batteries for extended talking time and standby time. The replacement batteries are often sold with new cellular phones as a promotional technique, or sold to individuals who need more battery packs through retail channels. Also there is an extremely active pre-owned cellular phone market in China as most cellular phones in China are continuously used until the very end of the phone's life. This market is similar to the pre-owned car market in the US. The new types of phones are outdated in big cities in about one or two years. Then the phones are collected and sold to smaller cities or towns at lower prices. After another few years, these phones are collected and sold again to some rural areas at even lower prices. However in many cases, the phones are still functioning but the batteries are often not good enough to power the phones. There is a need to replace the original batteries with replacement batteries to keep the phones functional. Naturally, these batteries have to be at a fairly low price point. BAK's products fit this competitively priced requirement. With a constant focus on increasing market share, BAK currently possesses over 60% of the overall replacement battery market as shown in the following table: Table 2-5: Chinese Replacement Battery Market Shares Cell Suppliers Units/Month (in 000) Share - --------------- -------------------- -------- YinsiQi 1,320 7.4% Tianmao 1,020 5.7% AeroSpace 1,320 7.4% Funghua 440 2.5% B&K 880 5.0% HYB 660 3.7% HPS 1,100 6.2% BAK 11,000 62.0% -------------------- ------- Total 17,740 100.0% Source: BAK Market Investigation Group, September, 2004. In the future, BAK will continue to consolidate its dominant position in the replacement market, and will also focus on increasing its market share in the first tier OEM market through technological innovation, quality control systems and cooperation with Motorola and other world-class companies. 2.4 Li-ion market segmentation and trends The Li-ion market has several key applications which are experiencing strong growth. Mini Li-ion rechargeable batteries, used in small electronics, are the most established and largest market application. Table 2-6 below shows the usage of Li-ion batteries in Japan by application. Mobile phone applications remain the largest, at 57.4%. By comparison, in China, due to the relatively low commercialization rates of laptops and camcorders, the mobile phone market share is even higher. These new applications provide an excellent opportunity for growth in China.
Table 2-6: Li-ion battery usage by segment in Japan ------------------------------------------- ----------------- Equipment Percentage ------------------------------------------- ----------------- Mobile phones 57.4 ------------------------------------------- ----------------- Laptop computers 31.5 ------------------------------------------- ----------------- Camcorders 7.4 ------------------------------------------- ----------------- Other electric products 3.7 ------------------------------------------- ----------------- Information Source: Chinese Battery Association Annual Report, April 2004 2.4.1.1 Mobile phones The Chinese consumers are the most likely to update their cell phones than any other country in the world, according to an industry report from the Chinese Li-ion battery industry in 2003. This report also projects mobile user growth at 30% per year. Table 2-7 below outlines these growth rates: Table 2-7: 2003-2006 Projections of global mobile and battery market growth - ----------------------------------- ----------- ------------- ------------- ------------- 2003 2004 2005 2006 (Actual) (Projected) (Projected) (Projected) - ----------------------------------- ----------- ------------- ------------- ------------- Mobile sales volume 519/60 635/70 762/80 900/90 Global/China(units, in millions) - ----------------------------------- ----------- ------------- ------------- ------------- Battery set sales volume 934/108 1,143/126 1,372/144 1,620/162 Global/China(units, in millions) - ----------------------------------- ----------- ------------- ------------- ------------- Battery replacement 259/30 317/35 381/40 450/45 Global/China(units, in millions) - ----------------------------------- ----------- ------------- ------------- ------------- Total Battery need 1,194/138 1,460/161 1,753/184 2,070/207 Global/China(units, in millions) - ----------------------------------- ----------- ------------- ------------- -------------
Battery set sales volume = 1.8iA Mobile sales volume Battery replacement = 0.5iATotal mobile volume Total battery need = Battery set sales volume + Battery replacement Global Source: Gartner Group; China Source: Instat/MDR 2.4.1.2 Laptop computers. Along with cellular phone batteries, laptop batteries will be a critical source of growth for battery companies. Only six companies worldwide currently supply Li-ion battery laptop PCs cells (which are combined into battery packs): Sony, Sanyo and Matsushita in Japan; Samsung and LG in Korea; and E-ONE Moli Energy in Vancouver, Canada. Toshiba (Japan) recently exited the market. Laptop batteries are more difficult to manufacture than those for cell phones, for several reasons: 1. Uniformity. Cell phones only use one cell, while laptops use at least six cells, and sometimes twelve. For single cell applications, variations in individual batteries do not have much impact on the equipment. If even one cell is not uniform in a multiple cell application the performance of the entire battery pack will be degraded rapidly. To assure uniformity, companies typically utilize more automated equipment in production 2. There are high safety standards (these batteries have high energy density per cell, about 3 times higher than cell phones). 3. BAK is currently making a small quantity (10,000 daily) of laptop batteries manually, and will need to import automated equipment to meet laptop PC battery specifications. 4. BAK's current laptop cells are being sold instead for other applications, such as printers or portable DVD players. Customers are local Chinese companies. Table 2-8 PC Forecast Worldwide Portable PC Forecast (actual amounts cannot be determined) Shipments (000) --------------- 2002 31,000 2003 37,500 2004 44,000 2005 51,000 2006 56,000 2007 62,500 BAK believes there are significant opportunities to sell Li-ion laptop batteries in China. Currently, all laptops use either Japanese batteries, or, to a lesser extent, Korean batteries. According to presentations from the IIT Corp. Japan, (2004 Power Conference, September 2004, San Francisco), 445 million cells (estimated 10 cells/pack) will be sold worldwide in 2004 at an average $3-3.50 price per cell. Six to Twelve Li-ion cells are combined into battery packs, and cost about 70% of the total battery pack cost, resulting in an average price per (12) battery pack of $45. Battery packs are being assembled mostly in Taiwan. However, management estimates that at least 50% of Taiwan companies are moving their laptop manufacturing to the Chinese mainland, and manufacturers will be seeking China-based battery sources. Batteries manufactured in China should have significant competitive advantages. Despite the higher level of automation required, significant higher-level labor such as engineers are required, and China will benefit from lower labor costs. China also has a materials cost advantage. Overhead in China is much lower (land, housing, building, energy); environmental controls not as stringent in China as in Japan; and some government support is available, such as tax breaks. Finally by buying from China instead of Japan, laptop manufacturers will not have to pay 12% duties they pay if they import from Japan, and China-based suppliers will allow for easier logistics. Table 2-9(pound)(0)2003-2006 Global/China markets for Laptops and battery packs - ---------------------------- ---------- ------------- ------------- ------------ (units, in millions) 2003 2004 2005 2006 (Actual) (Projected) (Projected) (Projected) - ---------------------------- ---------- ------------- ------------- ------------ Laptop sales volume 38/1.3 44/1.8 51/2.5 56/3.4 Global/China - ---------------------------- ---------- ------------- ------------- ------------ Total battery cell demand 380/13 440/18 510/25 560/34 Global/China - ---------------------------- ---------- ------------- ------------- ------------ Total Battery Cell Demand = 10xLaptop Sales Volume Source: IDC; China: CCW Research 2.4.1.3 Camcorders and digital cameras. A report from IIT, a premier global market intelligence and advisory firm in the information technology of Battery industries, indicates that the Li-ion batteries shipment for Digital cameras was 16.3 million units in 2001 growing to a projected 88 million units by 2005. The global Li-ion battery shipment for camcorders was 47.5 million units in 2001 growing to a projected 87 million by 2005. Table 2-10 below outlines this opportunity. Table 2-10(pound)(0)2003-2005 global Li - Ion market demand for digital camera/camcorder - --------------------------------------- ----------- ------------- -------------- (units, in millions) 2003 2004 2005 Actual Projected Projected - --------------------------------------- ----------- ------------- -------------- Li -Ion Batteries for digital cameras 58.6 75.1 88 - --------------------------------------- ----------- ------------- -------------- Li -Ion Batteries for camcorders 73.7 70.9 87 - --------------------------------------- ----------- ------------- -------------- Total battery need 132.3 146 175 - --------------------------------------- ----------- ------------- -------------- Data source: Portable Power Conference & Expo, September 13, 2004, San Francisco. 2.4.2 High power and large size Li-ion batteries High power and large size rechargeable Li-ion batteries have 2 distinguishable differences compared to the batteries used in cellular phones and laptops: 1) single cell capacity can be from 10 Ah to 100 Ah or more, while the cellular phone is normally about 1 Ah or less; and 2) the discharge power is much higher, can be as high as 10C rate (effectively discharging all the battery's energy within 0.1 hour), compared to 0.5C rate (effectively discharging all the battery's energy within 2 hours) for laptops. These batteries are projected to be major contributors to the Company's future growth. There are a series of new applications that would be users of high power and large size Li-ion batteries. 2.4.2.1 Pure Electric cars. The usage of Li-ion battery for pure electric cars is increasing, and the market share of Li-ion batteries in electric cars is projected to be 20% by 2005, particularly, as the price of these batteries decreases. Electric car sales volume is projected to be 720 thousand sets, or 1.2% of the global car market share, in 2005, growing to 1.7 million cars by 2010, or 2.6% of the global market. However, because pure electric cars need long recharge time, this is a hurdle to prevent it from wide use on the roads. 2.4.2.2 Electric bicycle. The technology of using Li-ion batteries in electric bicycles has been developed and is expected to be commercialized soon. China has 400 million bicycles; if 2% of them are replaced by electric bicycles, then there will be a market for an additional 2.4 billion Wh of battery energy. If high power and large size Li-ion cells are made with 10 Ah (36Wh) each, there is a need for an additional 67 million of such large and high power cells. According to a survey conducted by the Association of Chemical and Physical Industry of China, in the five biggest cites in China, 50% of people would like to upgrade their bicycles to electric bicycles. 2.4.2.3 Hybrid Electric Vehicles ("HEV"). HEVs are the most practical gas efficient vehicles running on the roads worldwide, with gas mileages as high as 65 miles per gallon. HEVs are equipped with a small gasoline engine and an electric motor powered by rechargeable batteries. HEVs are gaining widespread support and are expected to be a mainstream passenger car in the worldwide automobile market. (See Figure 2-4). Current rechargeable batteries used in HEVs are all NiMH. Li-ion batteries would have many beneficial characteristics in a HEV application; however, at the present time they remain cost prohibitive. BAK has the most cost efficient Li-ion battery manufacturing capabilities with costs nearing that of NiMH. A technology breakthrough in the HEV industry is possible as BAK drives down its cost of producing Li-ion batteries. For additional information on BAK's strategy on the HEV market, see Section 6.3. Table 2-11 HEV Six Year Market Forecast HEV shipment (1,000units/CY) Calendar Year TOTALS* ------------- ---------------------------- 01CY 100 02CY 110 03CY 180 04CY 240 05CY 390 06CY 570 07CY 800 08CY 1100 09CY 1500 10CY 2050 *Represents aggregated amounts from the following vehicle manufacturers: Fiat, Renault, PSA, VW, Opel, DC (Daimler), BMW, Audi, GM, Ford, DC (Chrysler), Suzuki, Daihatsu, Subaru, Mazda, Mitsubishi, Honda, Nissan, Toyota. Actual amounts for each vehicle manufacturer cannot be estimated. Source: IIT Corp, Japan, The 20th International Seminar & Exhibit on Primary & Secondary Batteries, March 17, 2003, Fort Lauderdale, FL, USA 2.4.2.4 Electric scooters. High power Li-ion battery technology provides a new opportunity in electric motor bikes. While electric motor bikes exist in the market today, they face mileage and speed limitations. China motorcycle manufacturers are also starting to research and develop the use of high power Li-ion batteries. 2.4.3 Li-polymer battery. Li-polymer batteries are also called LIB Laminated cells. As previously mentioned, the main difference between conventional Li-ion and Li-polymer batteries is the casing material; most of the Li-polymer batteries use soft plastic sheet to wrap up the internal part of the battery while the conventional Li-ion batteries use solid cases made of either steel or aluminum to contain the internal part. Li-polymer battery retains the same chemistry, even the same internal structure as the conventional Li-ion a lithium ion battery. The most significant advantage of the Li-polymer is that the batteries can be made very thin. This allows equipment such as Personal Digital Assistant (PDA, e.g. Palm V, i-Pod) and some thin cellular phones or games to be made thinner, as well as small electronic equipment such as Blue Tooth headsets and smart cards. The following Table 2-12 shows the market trends of the Li-polymer batteries: Table 2-12 Li-polymer Battery Market Trends by Sales (actual amounts cannot be determined) Sum of Sales (US$ Millions) -------------- 1998 0 1999 40 2000 190 2001 <190 2002 300 2003 350 2004 550 2005 520 Data source: Portable Power Conference & Expo, September 13, 2004, San Francisco. BAK has this technology ready. With its advantage of low cost production, BAK will advance a significant market share in the Li-polymer batteries. Table 2-13: Li-polymer Market Prospects: Unit Growth Will Continue (actual amounts cannot be determined) Year (Pieces in Millions) ------- -------------------- 1998 0 1999 2 2000 18 2001 27 2002 50 2003 64 2004 84 2005 108 2006 122 Source: Avicenne Forecast; The Worldwide Rechargeable Battery Market Reporter of Taiwan-Dec.2003 PART 3: THE COMPANY 3.1 History BAK was founded on 3rd August 2001 by its current CEO, Xiangqian Li, initially to manufacture Li-ion batteries for cell phones. A timeline of key company events is listed below: August 2001 Shenzhen BAK Battery Co., Ltd established June 2002 BAK, with headquarters in Shiyan, Shenzhen, begins operation. Initial monthly output in 2001 is about 220,000 units October 2002 BAK authorized to set up a postdoctoral workstation by the National Ministry of Personnel November 2002 BAK passes the EU CE attestation January 2003 BAK becomes Shenzhen Hi-Tech Enterprise February 2003 BAK passes the SaiBao attestation (cell phone manufacturer) March 2003 BAK aluminum case battery plant starts operation, monthly output reaches 2.4 million pieces June 2003 BAK monthly output reaches 6.6 million pieces, quantity and quality continue to improve September 2003 BAK passes ISO14001: 1996 environmental management system certification and ISO9001: 2000 Quality management system certification October2003 BAK industrial park foundation breaks ground in Longgang District, Shenzhen September 2003 BAK cylindrical battery Yangguang sub-plant starts operations December 2003 BAK total monthly capacity increases to 11 million pieces and monthly output increases to 8.8 million pieces December 2003 BAK receives UL designation August 2004 BAK industrial park aluminum can battery plant starts up operations. October 2004 BAK total monthly capacity increases to 15 million pieces and monthly output increased to 11.8 million pieces to make BAK one of the largest Li-ion battery manufacturers in the world. The Company's address is: BAK Industrial Park No. 1 BAK Street, Kuichong Town, Longgang District, Shenzhen, China. The Company is registered with the Shenzhen Industrial and Commercial Administration Bureau. There are currently 16 shareholders of the company. Table 3-1 below shows the ownership of the Company. Table 3-1: Company Stockholders - ---------------------------------------- ----------------------- Stockholder Share (%) - ---------------------------------------- ----------------------- Xiangqian Li 68% - ---------------------------------------- ----------------------- Jinghui Wang 12% - ---------------------------------------- ----------------------- Fenghua Li 8% - ---------------------------------------- ----------------------- Yunfei Li 4.5% - ---------------------------------------- ----------------------- Other 12 stock holders 7.5% - ---------------------------------------- ----------------------- 3.2 Company organization framework Table 3-2: Company organization, key management Chief Executive Officer Xiangqian Li | | | - -------------------------------------------------------------------------------- | | | | | | | | - ---------------- ---------------- ---------------- ---------------- Chief Chief Chief Vice President Financial Technology Operations Of Production Officer Officer Officer Yongbin Han Huanyu Mao, PhD Baicheng Zhou, PhD Shumin Li - ---------------- ---------------- ---------------- ---------------- 3.3 Employees and Management BAK currently has over 7,000 employees led by a highly qualified management team. Table 3-3 below outlines the educational levels of the Company's senior and middle management. Table 3-3: Management's education qualifications - -------------------------------------------------------------------------------- Statistics - -------------------------------------------------------------------------------- PhD Master Bachelor College High/Tech School Total - -------------------------------------------------------------------------------- 4 36 263 108 114 525 - -------------------------------------------------------------------------------- 1% 7% 49% 21% 22% 100% - -------------------------------------------------------------------------------- Last updated: July 31, 2004 - -------------------------------------------------------------------------------- Senior Management. BAK's senior management team consists of five key people. Table 3-4: Senior management - ----------------------------- ----------------------------------- ------- Name Title Age - ----------------------------- ----------------------------------- ------- Xiangqian Li Chief Executive Officer 36 - ----------------------------- ----------------------------------- ------- Yongbin Han Chief Financial Officer 35 - ----------------------------- ----------------------------------- ------- Huanyu Mao, PhD Chief Technology Officer 52 - ----------------------------- ----------------------------------- ------- Baicheng Zhou, PhD Chief Operations Officer 30 - ----------------------------- ----------------------------------- ------- Shumin Li Vice-President of Production 50 - ----------------------------- ----------------------------------- ------- Mr. Xiangqian Li, Chief Executive Officer. Mr. Xiangqian Li invested 20 million RMB ($2.4 million USD) and founded BAK in 2001. In four years time, he has increased monthly battery output from 200,000 to 11.8 million pieces growing revenues from $3 million to a projected $110 million this year. He provides the inspiration and teambuilding expertise to the Company. Because of the strong culture he has created at BAK, no manager has left BAK since it was established in 2001. He has managed the Company's high growth rate while maintaining the Company's fiscal health. Mr. Li's prior work experience was in the securities industry. From March 1994 to May 1995 he was trading equities and debt for his own account; From May 1995 to June 1998, he worked at China International Trust and Investment Corporation, Jilin office, as Manager of the Credit Department. Mr. Li was born in 1968. He received a bachelor's degree in Lanzhou Railway Institute in1991. In 2000, he began part-time study of quantitative economics in Jilin University, to obtain a Doctor's degree. Yongbin Han, Chief Financial Officer Mr. Han, is a Chinese certified public accountant and Chinese certified tax agent. He is proficient in Chinese financial systems and has many years of audit work experience. Mr. Han was born in 1969; in July 1995 he graduated from Chang Chun Taxation College with a bachelor's degree in accounting in the Jilin province. Huanyu Mao PhD, Chief Technology Officer Dr. Mao, a technological leader in the field of Lithium ion battery development, has worked with the company as a consultant since the beginning of 2004 and has been with the company full time since the second half of 2004. Previously, he was with Tiajin Lishen Battery Joint Stock Corporation, the third largest lithium-ion battery manufacturer in China, based in Tiajin. Dr. Mao moved to China in early 1997 and helped found Lishen. (www.lishen.com.cn). He built the first pilot line at Tianjin Institute of Power Sources in 1997. As the principal engineer, he was responsible for all operational elements, including construction, equipment specification and acquisition (primarily via Japan), raw materials, and commercialization of the production process. From his years of experience, Dr. Mao has in-depth equipment, materials and production expertise in China, Korea and Japan. He has been involved in every aspect of operations, from production planning, worker training and quality control method settings in every process, to error prevention, trouble shooting, spare parts, material stock control and logistics. While at Lishen, Dr. Mao combined the technology and materials from different countries and successfully developed Lishen's winding type of polymer lithium ion cells, which have been mass-produced under his supervision. Methods of production were developed to maximize use of existing liquid lithium ion equipment and materials, making the manufacturing simpler and lower cost than its Japanese counterparts. Within 4 years of startup, Lishen became the largest automated production lithium ion manufacturer in China and the 3rd largest overall in China, supplying over 4 million cells to Motorola and other leading cell phone makers per month in the OEM market. Motorola Energy System Group (ESG) has qualified 7 types of cylindrical and prismatic Lithium ion batteries and 1 type of polymer cell for Lishen. Meeting Motorola's standards for so many types of cells was one of Dr. Mao's key accomplishments. Prior to Lishen, Dr. Mao worked at NEC Moli Energy in Canada from 1991 to 1996, initially as a Research Scientist in Lithium ion battery research. During the 5 years with Moli, he was listed as the inventor on 7 US Patents and published various articles on Li-ion batteries. In 1999, Dr. Mao won the highest award for foreign workers in China, the "Friendship Award", sponsored by China's Central Government to recognize his contribution to new technology development for China. In February 2002, he won the "State Science and Technology Cooperation Award", also given by China's Central Government, in appreciation for his contribution to the Chinese economy. He is a Canadian citizen, with a permanent residence in Vancouver, B.C., Canada. He earned a Ph.D. in Electrochemistry in Conducting Polymers in 1990 from Memorial University of Newfoundland, Canada and had one year Postdoctoral work at Simon Fraser University, British Columbia in Electrochemistry of Conducting Polymers. During this time he published 6 papers in major US chemistry journals, including Journal of the American Chemical Society. Baicheng Zhou, PhD, Chief Operations Officer Mr. Zhou was born at 1974, Changchun City, Jilin Province; In 1997, he graduated from Jilin University with a Bachelor's degree and majored in Applied Mathematics. In 2000 he gained his Master's degree from Jilin University where he majored in Operations Research & Cybernetics; In 2003, Mr. Zhou gained his Doctor's degree from Jilin University, majoring in Quantitative Economics. From June 2001 - April 2003 he was working at Jilin Huaruan Technology Co., Ltd as secretary of directorate. Since April 2003 Mr. Zhou has been working at Shenzhen BAK Company in the capacity of assistant to General Manager. Shumin Li, Vice-President of Production Mr., Li was born at 1954, Changchun City, Jilin Province. From 1976 to 1979, he studied at SUN YAT-SEN University obtaining his bachelor's degree by majoring in Economics & Political Science. Mr. Li began working at Finance Bureau of Yushu City, Jilin province in 1982 as a Comprehensive Management Director until 2002. In 2002 he began working at Shenzhen BAK company in the position of Vice-Manager, in Charge of Manufacture. 3.4 Facilities The Company is in the process of developing additional world-class production facilities and infrastructure in the BAK Industrial Park in Shenzhen. BAK owns acreage of 250,000m(2) and has an option on another 100,000m(2) (about 86 acres total) on which to complete its facilities. The total construction space is projected to be 320,000m(2). The construction project is divided into Phase 1 and Phase 2. Phase 1 of construction will result in 185,000m(2) of new facilities, among which there is 15,450 m(2) of new manufacturing facilities; 19,100m(2) for warehousing and packaging; 2,950m(2) for a dining room; and 15,800 m(2) for dormitory space. Some of these facilities have already been put into use. The rest of the buildings in Phase 1 are still under construction, having erected the core structures and in the process of completing the FF&E work. These remaining Phase 1 buildings will include: 82,250m2 of manufacturing facilities; a 16,780m2 R&D center and administrative building; a 2,950m2 dining room; a 28,460m2 dormitory space; and some other attached facilities. Phase 1 construction should be completed by March 2005. Phase 2 of construction will result in 135,000m2 of new facilities. This project is not yet under construction, and is anticipated to begin in January 2007, and to be completed by the end of 2007. It includes an additional 66,480m(2) of manufacturing facilities; a 6,560m2 dining room; a 23,700m2 dormitory; a 26,560m2 comprehensive usage building; an 8,400m2 conference center; a 3,000m2 training center; and many other attached facilities. Once both phases of construction are completed, the Company's total manufacturing facilities will exceed 183,630m(2), with capacity to build 550 million pieces per year and house 12,000 employees. 3.5 R&D center The company has a world-class R&D center performing proprietary research, which has resulted in more than thirty patents awarded or applied for. Based on the technology of ChangChun Applied Chemistry Research Institute of the China Scientific Institute, Tstinghua Unversity, JiLin University, Electrochemistry Department of XiaMen University and Shenzhen University, BAK has gathered a team of professionals for its R&D center. There are over 100 staff members in the center, led by three specialists available to the Company by a government grant to promote research and development, as well as three professors. Upon the approval of the National Ministry of Personnel in October 2002, a Postdoctoral Workstation was established, the only such research position in the entire battery industry in China, and one of only two such positions in Guadong. The R&D center focuses research on projects relating to liquid Li-ion, high power Li-ion batteries, solid polymer Li-ion batteries, and cylindrical and rectangular Li-ion batteries.
The R&D center's mission focuses on researching advanced technologies, advanced battery materials, new cell development and training first-class specialists. The Company's goal is to build an internationally known R&D facility. Table 3-5 below outlines the organizational structure of the R&D center. Table 3-5: R&D center organizational structure R&D Director | | Vice-Director -| | - ------------------------------------------------------------------------------------------------------------- |Physical & | Battery | Technology | Material | High | Polymer | Servicing | IPOffice | Administrative | | Chemical | Testing | R&D | Research | Power | Battery | Dept. | | Dept. | | Analysis | Dept. | Dept. | Dept. | Battery | Dept. | | | | | Dept. | | | | Dept. | | | | | - -------------------------------------------------------------------------------------------------------------
3.6 Company culture and management model BAK has developed an open, professional, and innovative culture. The company uses various tools to help build its culture, including a company LAN, BAK BATTERY magazine and BAK newspaper. The company believes its people are its most precious asset A formal performance assessment system is applied throughout the Company. Objective management techniques focus on meeting goals, emphasizing judgment and managing processes. The desired outcome is fairness and encouraging positive outcomes. PART 4: PRODUCTS 4.1 Product lines There are three main forms of battery cells, aluminum, steel and cylinder, which are sold in over 90 types. The Company's first key product in 2002 was a steel case Li-ion battery. Subsequently, BAK developed more production lines, and the Company's product mix is now 69% steel cases battery cells, 30% aluminum, and 1% cylinder form. Before 2003, all of BAK's products were made using a manual production line. In 2003, BAK developed the semi-automatic production lines that are utilized today. BAK's products' primary uses are mobile phones, digital cameras, digital camcorders, MP3's, laptops, electric bicycles, and general industrial applications. Going forward, BAK will also concentrate on development of Li-polymer batteries, high power batteries and HEV batteries. The growing number of product types is illustrated below: Table 4-1: Number of BAK products by type (actual amounts cannot be determined) Steel Case Aluminum Case Cylindrical ---------- ------------- ----------- 2002 20 2.5 NA 2003 35 15 NA 2004 52.5 30 5 4.2 Proprietary Technology BAK's products meet or exceed international standards. BAK's Li-ion batteries have high capacity, low internal resistance, and a safety guarantee that meet or exceed industry standards. Certificates or approvals the Company has received include: certificate of Shenzhen Hi-tech enterprise (which lowers the Company's income tax rate from 33% to 15%, allows for certain government grants, and access to land for a nominal price); EU's CE attestation; UL authentication; ISO9001: 2000 quality management system certification of the ZJQC; ISO4001: 1996 environmental management system certification of ZJQC; and certificates from the major cell phone manufacturers of China, including China Saibao; Xiaxin; Datang; Konka; Tianyu; and Tianshida. With these manufacturers' approvals, BAK controls 60% of the Chinese replacement market and 14% of the Chinese OEM market. BAK is in the process of receiving OEM certification from major international mobile phone manufacturers, such as Motorola, [*****]. BAK's battery has a higher discharge voltage so that it can provide a longer talking time on a mobile phone. BAK's products are charged or discharged at 1.0C (i.e., the discharge current is set to release all the battery energy in exactly 1 hour), and the discharge time is more than 48 minutes above 3.6V (the remaining energy is released below 3.6V), much higher than the normal standard (38-40 minutes); with the same capacity, BAK's battery can therefore provide a longer talking time on a mobile phone. Other key features of the Company's batteries include: High rate capability means that BAK's batteries are capable of discharging at high currents. 1.0c (means discharge all the energy for 1 hour) discharge capacity can reach more than 98% that of 0.2C (discharge all the energy for 5 hours), which far surpasses the 85% Chinese National standard. Thus, BAK's products can insure a much longer duration when making battery phone calls. This has particular significance for cellular phones with color screens, which have a high demand on the battery's continuous discharge voltage. Good performance at lower temperatures(pound)(0)BAK's Li-ion batteries perform well from -20 Celsius to +60 Celsius. At a temperature as low as -20 Celsius the batteries release 95% of the battery energy at 0.2C rate; and over 90% of the battery energy can be discharged at 1.0C. This feature allows improved cell phone battery duration, particularly in northern areas. 4.3 Post-sale service BAK has three strategic policies for sales and service. 1. BAK has built a sales and service network to cover all the coastal cities in China, and also has branches in Beijing, Shanghai, Ningbo, Huizhou, Fuzhou, and Guangzhou. 2. BAK's service capabilities include 24-hour customer response. 3. BAK has arranged for liability coverage with AIU, a China subsidiary of the international insurance company AIG. AIU provides coverage for BAK's products in the areas of personal injury, death and property loss, minimizing potential customer losses. 4.4 Suppliers The Company has built a complete supply chain, putting together a group of material and equipment suppliers, primarily Chinese, except for ENTEK (a separator supplier in the US). The main components of Li-ion batteries are the cathode, anode, separator, and electrolyte. Cathode material is primarily LiCoO2; LiMnO4 and LiCo1-xNixO2 are also used as cathode materials. Anode material mainly consists of carbon materials such as graphite, sourced primarily in China The separator material is imported from Japan and the US. There are sufficient supplies of electrolytes in China, and the quality is very good. The table below describes the key sources of the Company's key materials. There are a few sole suppliers for some materials. Table 4-2: Details of key material suppliers - ------ ------------------- ----------------------------------------------------- Item Materials Main suppliers - ------ ------------------- ----------------------------------------------------- 1 Case and caps Roofer Group Company, Yijinli technology company, Shenzhen Tongli Precision Stamping Products Co., Ltd. - ------ ------------------- ----------------------------------------------------- 2 Cathode materials CITIC Guoan - ------ ------------------- ----------------------------------------------------- 3 Anode materials Shanghai Shan Shan, Changsha graphite - ------ ------------------- ----------------------------------------------------- 4 Aluminum foil Aluminum Corporation of America, Shanghai - ------ ------------------- ----------------------------------------------------- 5 Copper foil Huizhou United Copper Foil - ------ ------------------- ----------------------------------------------------- 6 Electrolyte Zhangjiagang Guotai-Huarong New Chemical Materials Co.,Ltd - ------ ------------------- ----------------------------------------------------- 7 Separator Ube Industries, ENTEK, CELGARD - ------ ------------------- ----------------------------------------------------- Table 4-3: Details of key equipment suppliers - ------ ---------------------------------- -------------------------------------- Item Instruments Suppliers - ------ ---------------------------------- -------------------------------------- 1 Coating machine Beijing 706 Factory - ------ ---------------------------------- -------------------------------------- 2 Mixer Guangzhou Hongyun Machine - ------ ---------------------------------- -------------------------------------- 3 Press machine SevenStar Huachuang - ------ ---------------------------------- -------------------------------------- 4 Ultrasonic spot welding machine Zhenjiang Tianhua Machinery and Electrical Co.,Ltd. - ------ ---------------------------------- -------------------------------------- 5 Laser seam welder Wuhan Chutian Laser Group - ------ ---------------------------------- -------------------------------------- 6 Vacuum oven Jiangshu Wujiang Songling - ------ ---------------------------------- -------------------------------------- 7 Electrolyte filling machine BAK (internally developed) - ------ ---------------------------------- -------------------------------------- 8 Aging equipment Guangzhou Qiangtian Industrial Co. ,Ltd. - ------ ---------------------------------- -------------------------------------- 9 Testing and sorting equipment Guangzhou Qiangtian Industrial Co.,Ltd. - ------ ---------------------------------- -------------------------------------- PART 5: SALES AND MARKETING 5.1 Marketing strategies BAK has two key marketing strategies. 1. Dominate the replacement battery market. Excellent quality is the key factor for BAK to gain market share, and high volume production has significantly brought down BAK's costs. BAK currently controls over 60% of this market in China. 2. Advance the OEM (Original Equipment Manufacture) market, taking Japanese and Korean market share through a low price strategy. This will require gaining approvals from key international manufacturers, including Motorola, [*****], which are currently reviewing the Company's products. Approval by Motorola is the first step to entering the international OEM market which is expected by June 2005. 5.2 BAK's current market. As discussed above, the Company has built a sales network based on coastal cities in China. BAK products have also been exported to US, Canada, South Africa, Japan, Singapore, Taiwan, and Hong Kong. From 2001 to 2003, BAK's annual sales have grown from $3 million to $64 million, and by the end of fiscal 2005 sales volume is projected to reach $110 million, making BAK a dominant global supplier. 5.3 Customers. BAK's 30 major clients account for 85% of sales, predominantly in China. At present, the bulk of sales are into the replacement cell phone battery market. Table 5-1: Top 10 customers as a % of trailing 9 month revenues (1/04-9/04) Rank Customer % of Revenues - ---------- ------------------------------------------- ------------- 1 ShenzhenYa Litong Electronic Co., Ltd 13.62% 2 SCUD.iFujian.jElectronics Co., Ltd. 7.40% 3 Ming Ji Battery Co.,Ltd. 7.00% 4 Shenzhen Hai Ertai Electronic Co., Ltd. 4.95% 5 Guangdong Wei Liwang Electronic Co., Ltd. 4.57% 6 Shenzhen Bi Litong Electronic Co., Ltd. 3.25% 7 Bi Ke Technology Co., Ltd. 3.07% 8 Hai Lutong Electronic Co., Ltd. 2.66% 9 Chao Litong Electronic Co., Ltd. 2.79% 10 Zhong Yi Co., Ltd. 2.50% Total 51.82% Table 5-2: Domestic vs. International sales mix (%) (actual amounts cannot be determined) Domestic International -------- ------------- 2001 95% 5% 2002 85% 15% 2003 72% 28% 2004 70% 30% Over the past three years, the Company has developed a close strategic alliance with current key customers, including Yalitong, Konka, TCL and Desai. As noted previously, BAK has obtained the approval from Saibao, Konka, Tianyu, Tianshida, Datang, and is seeking approval from the top international mobile phone manufacturers such as Motorola, Siemens and Bird. 5.4 Potential market opportunities 1. Quick entry into the wholesale China telecommunications markets. The five major telecommunication markets in China are in Guangzhou, Shenzhen, Hangzhou, Chengdu, and Quanzhou. 2. Establish strategic partnerships with mobile phone manufacturers in China. There are nine manufacturers which obtained approvals from the National Plan Committee and Information Technology Department: Eastcom, ZTE, Xoceco, Hair, Soutec, TCL, Konka, Chinakejian and NingboBird. BAK has begun to supply limited numbers of battery cells to these companies. In the future, BAK will concentrate on establishing strategic partnerships with these mobile manufacturers, and provide comprehensive service. 3. Aggressively exploit the international market. Although BAK's products have been exported on a limited basis to the US, Canada, South Africa, Japan, Singapore, Taiwan and Hong Kong, most of BAK's products are sold into the Chinese market. BAK is seeking OEM certification approval from Motorola and Siemens, among other international companies. Exploiting international markets becomes one of the most important assignments for BAK. PART 6: STRATEGIC ANALYSIS 6.1 SWOT Analysis The following SWOT matrix chart provides some insight into the Company's competitive position. Table 6-1: SWOT matrix analysis Opportunity Strengths - --------------------------------------- ---------------------------------- 1.Rapid growth of the Li-ion battery 1.Technological advantage industry 2.Cost advantage 2.Huge market demand in China 3.Volume production advantage 3.Government industrial policy support 4.Strategic cooperative relationship between suppliers and customers Threats Weaknesses - --------------------------------------- ---------------------------------- 1.Foreign battery company investments 1. Limited product line directly or in joint ventures in China 2.Availability of capital 2.Product Substitution 3.No penetration yet of the mobile 3.China government economic control OEM market slows market growth 6.1a Strengths analysis Rapid industry growth. The annual compound rate of increase of worldwide Li-ion battery volume is projected 23.2% during the years 2003-2006, decreasing to a still healthy 9.85% compound annual growth rate in years 2007-10. Huge market demand in China. OEM sales of new mobile phones and replacement of existing mobile phone batteries are expected to reach to 576 million pieces in China in 2005. Along with mobile phones, China consumes the largest amount of high power bicycle batteries. In addition, the demand for laptop batteries in China is in the early phases of commercialization. BAK's technology leads the industry in these segments. Governmental industrial policy support. In its most recent Five Year Development Plan, the 9th National Economic and Social Development Plan (2002-2006) and National Development Plan 2004-2010, the Chinese government has committed to support products which are high value-added; containing high technology; and complying with governmental industry policy and following critical industry trends. Those products include NiMH batteries, Li-ion batteries, fuel batteries, high power batteries and solar batteries, as well as their relative materials and production research, R&D, manufacture and sale. The government primarily gives preferential support in the following areas: tax breaks, government grants, bank credit, inexpensive land and similar kinds of support. 6.1b Strengths Analysis Technological advantage: The rechargeable Li-ion cell phone battery made by BAK has excellent features, such as: good storage, high voltage platform, low internal impedance and better safety. Some of the features surpass similar products both at home and abroad (see the comparison in Table 2-4). The Company's products have already received approvals from 14 manufacturers and third party certification groups such as ISO & Underwriters Laboratories. In addition, the company's laptop batteries have been approved by Underwriters Laboratories for volume production.. BAK's industry leading research in the area of electric bicycles has resulted in a battery that can support 8 hours' riding time at a speed of 20 kilometers per hour. Cost advantage: Because of BAK's latest generation equipment and efficient use of labor, management believes the Company can produce at a [*****] cost savings relative to [*****]. The advantage of volume production: the current production capacity of BAK is 15 million pieces per month; and the monthly output is 11.8 million pieces. At present, only BAK and BYD have such production capacity in China and BAK ranked number seven in the world in Li-ion battery cell manufacturing capacity during the first quarter of 2004 and expects to reach number three upon completion of its new facility in fiscal 2005. The strategic cooperative partnership between BAK and its customers and suppliers: Unlike BYD, which is completely vertically integrated, BAK focuses exclusively on manufacturing Li-ion battery cells, which is believed to be the highest value-added segment of the supply chain. BAK leaves compound materials production to strategic partners and instead puts its energy into manufacturing the battery cell. Management believes this allows BAK to focus its capital on the manufacturing process and therefore allow it more flexibility in managing production volumes. 6.1c Weaknesses analysis Limited product line: The company primarily serves the mobile phone battery market. The laptop battery has only 220,000 pieces of output per month at present. If the Company can't successfully close a financing and enlarge the production volume, then it may lose the opportunity in this segment of the Li-ion market. Financial risk: The Company expanded aggressively, experiencing dramatic revenue growth in just three years, which caused it to incur significant debt to finance cash needs associated with this growth. According to the latest financial data, as of September 30, 2004, the Company's total liabilities to equity ratio was 3.1:1. The new facility is being financed with short-term debt, which will be replaced with permanent financing upon completion of the plant. The continued availability of financing will be critical to the Company's continued growth. No penetration (yet) into the international OEM mobile phone battery market: products of the Company are sold primarily into the replacement market. Although the Company awaiting approval from Motorola and others, and initial indications have been good, approval is not guaranteed and it is at least six months away. However, once approval is received, based on BAK's cost advantages and volume production advantages, BAK believes it will become a dominant OEM manufacturer in the mobile phone battery market. 6.1d Threats analysis Foreign battery company investments directly or in joint ventures in China: Japanese Li-ion battery companies can see the huge market in China and face a need to reduce costs. Many foreign battery companies are investing in joint ventures or investing directly in China. At present, Japanese companies like Sanyo, Sony and Panasonic are setting up Li-ion battery plants in Beijing, Wuxi and other locations. Table 6-2: Comparison of the Li-ion battery competitive strengths Item Japan Korea China -------------------- ----- ----- ----- Cost 5 8 10 R&D 10 8 7 Capital 8 8 5 Governmental support 10 9 8 Potential 8 10 10 Note: 10 is highest, 1 is lowest Product substitution: Worldwide, particularly Japan, companies are accelerating research in new energy storage. A particularly hot area of research is in fuel cells and it may impact the Li-ion battery market. At the Portable Power Conference and Expo in San Francisco in February 2004, Yoshio Nishi of Sony stated that if the cost of fuel cells can be reduced further, fuel cells are expected as a next potential portable power source in the coming 4-5 years. However, he also pointed out that the fuel cell could only be optimally deployed in connection with a Li-ion battery. The company believes the commercial viability of fuel cells as a replacement for Li-ion batteries is at least 10 years away. China government economic control slows market growth: The 3rd calendar quarter of the year has traditionally been the best sales quarter, but the main domestic cell phone manufacturers reduced output because of an economic slowdown caused by the Chinese government's tightening of monetary policy. As a result, BAK couldn't make full use of its capacity for the past six months and profits this year been reduced as a result. Although the company's revenue grew by 216% last year, the company believes its revenue would have been greater without the Government's tightening policy. Prior experience leads management to believe that the Chinese government will change its policies in the near term. 6.2 Competitive analysis Table 6-3: BAK and domestic competitors
Capacity Technical Company Main products (pieces/mo.) level Cost Market - -------------- --------------------- -------------- ----------- ----------- ------------------ BAK Steel Case & 11.8 million High Low Replacement market Aluminum Case cell BYD Aluminum Case cell; 15 million High Quite low OEM market Power tool; Battery Lishen Aluminum Case cell; 6 million High High OEM market Polymer battery TCL Polymer battery 4 million High Quite high OEM market
6.3 Strategic Plan Based on its increase in production capacity BAK will seek to increase the breadth of its product line, improve the quality of its products and increase profits. The Company will complete the move into its new industrial park during fiscal year 2005, which will enhance production capacity and allow for volume production advantages. In the next 1-2 years, the Company plans to aggressively pursue the international OEM mobile phone battery market and expand the sales of laptop batteries. The precondition of entering into the original equipment mobile phone battery market is obtaining the quality authentication from cell phone manufacturers, such as Motorola. High power batteries produced by BAK for use in portable computers have already received UL approval, which is the key permit Chinese companies receive to enter into the world market. By June 2005, the Company hopes to construct a production line for producing portable computer type-18650 battery through financing. Within 2-3 years, the Company's goal is to enter into the much larger electric bicycle and power tools battery markets. Key manufacturers of power tools are Black & Decker, TTI, Bosch and Makita. The Company has already made a breakthrough in the R&D for electric bicycle batteries, and can fully meet the requirements of commercialization. Ultimately, the Company seeks to make Li-ion batteries as inexpensive as NiCd or NiMH batteries. In this area the Company has already made several discoveries, which will be incorporated into production over time. With soaring oil prices and the pressure to go "Green", hybrid electric vehicles ("HEV") are in short supply in the USA. On September 23, 2004, in an effort to prompt more consumers to buy the fuel-efficient, low-emission cars, California Governor Arnold Schwarzenegger signed bill 1493 to allow single occupant HEVs to use carpool lanes. The Canadian Government charges zero sales tax on the purchase of any HEV. The reason for such government incentives is that HEVs are the most practical gas efficient vehicles running on the roads worldwide. The gas mileage can be as high as 65 miles per gallon, compared to conventional gasoline engine cars at 20 to 28 miles per gallon. HEVs are equipped with a small gasoline engine, usually only 3 cylinders and an electric motor powered by rechargeable batteries. The reason for such high gas mileage is the alternating use of the gasoline engine and the electric motor. At acceleration, both gasoline engine and electric motor power the car to provide enough power to be similar to conventional cars. The batteries are recharged during braking, downhill slopes and normal operation. There is no need to charge the batteries using household electricity at all. Therefore, drivers don't notice any performance difference from the conventional gasoline cars but great savings on gas bill. HEVs have gained great deal of publicity in the US, Japan, Canada and many other countries and will soon become a mainstream passenger car in the automobile market. However, current rechargeable batteries used in HEVs such as the Prius from Toyota, Insight from Honda and the 2005 Ford Escape HEV are all NiMH. As shown in Table 2-1, Li-ion batteries have much higher energy density than NiMH batteries. If HEVs use Li-ion batteries instead of NiMH, the battery weight can be easily reduced from 400 pounds to about 200 pounds or less. One of the major hurdles that prevent HEV makers from using Lithium ion battery is the cost. As mentioned earlier in this proposal, BAK has the most cost efficient lithium ion battery products, with costs close to NiMH. A technology breakthrough in the HEV industry is possible as BAK drives down its cost of producing Li-ion batteries. BAK has already noted the potential and is developing the rechargeable Li-ion batteries suitable for HEV. [*****]. As soon as it becomes a public company, BAK will intensify its efforts in this area and make major investments to develop HEV batteries. Table 6-4: BAK manufacturing capacity increases (unit: 1,000 pieces/month)
Steel case Aluminum Cylindrical Power Polymer Fiscal Year Item battery case battery battery battery battery Total - ------------ -------- ----------- ------------ ----------- -------- --------- -------- 2005 Capacity 7700 6600 660 440 0 15,400 Output 6600 4400 550 330 0 11,880 [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****] [*****]
6.4 Risks related to doing business in China A Downturn In The Chinese Economy May Slow Down Our Growth And Profitability. The growth of the Chinese economy has been uneven across geographic regions and economic sectors. There can be no assurance that growth of the Chinese economy will be steady or that any downturn will not have a negative effect on our business. Our profitability will decrease if expenditures for wireless value-added services decrease due to a downturn in the Chinese economy. More specifically, increased penetration of wireless value-added services in the less economically developed central and western provinces of China will depend on those provinces achieving certain income levels so that mobile phones and related services become affordable to a significant portion of the population. The Uncertain Legal Environment In China Could Limit The Legal Protections Available To Investors. The Chinese legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases have little precedential value. In the late 1970s, the Chinese government began to promulgate a comprehensive system of laws and regulations governing economic matters. The overall effect of legislation enacted over the past 20 years has significantly enhanced the protections afforded to foreign invested enterprises in China. However, these laws, regulations and legal requirements are relatively recent and are evolving rapidly, and their interpretation and enforcement involve uncertainties. These uncertainties could limit the legal protections available to foreign investors, such as the right of foreign invested enterprises to hold licenses and permits such as requisite business licenses. Any Recurrence Of Severe Acute Respiratory Syndrome, Or SARS, Or Another Widespread Public Health Problem, Could Adversely Affect Our Business And Results Of Operations. A renewed outbreak of SARS or another widespread public health problem in China, where all of our revenue is derived, and in Shenzhen, where our operations are headquartered, could have a negative effect on our operations. Our operations may be impacted by a number of health-related factors, including the following: o quarantines or closures of some of our offices or factories, which would severely disrupt our operations, o the sickness or death of our key officers and employees, and o a general slowdown in the Chinese economy. Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our business and results of operations. Changes In China's Political And Economic Policies Could Harm Our Business. The economy of China has historically been a planned economy subject to governmental plans and quotas and has, in certain aspects, been transitioning to a more market-oriented economy. Although we believe that the economic reform and the macroeconomic measures adopted by the Chinese government have had a positive effect on the economic development of China, we cannot predict the future direction of these economic reforms or the effects these measures may have on our business, financial position or results of operations. In addition, the Chinese economy differs from the economies of most countries belonging to the Organization for Economic Cooperation and Development ("OECD"). These differences include: o economic structure; o level of government involvement in the economy; o level of development; o level of capital reinvestment; o control of foreign exchange; o methods of allocating resources; and o balance of payments position. As a result of these differences, our business may not develop in the same way or at the same rate as might be expected if the Chinese economy were similar to those of the OECD member countries. Restrictions On Currency Exchange May Limit Our Ability To Receive And Use Our Revenues Effectively. Because almost all of our future revenues may be in the form of Renminbi, any future restrictions on currency exchanges may limit our ability to use revenue generated in Renminbi 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 Renminbi for current account transactions, significant restrictions still remain, including primarily the restriction that foreign invested enterprises may only buy, sell or remit foreign currencies, after providing valid commercial documents, at those banks authorized to conduct foreign exchange business. In addition, conversion of Renminbi for capital account items, including direct investment and loans, is subject to 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 Renminbi, especially with respect to foreign exchange transactions. The Value Of Our Securities Will Be Affected By The Foreign Exchange Rate Between U.S. Dollars And Renminbi. The value of our common stock will be affected by the foreign exchange rate between U.S. dollars and Renminbi. For example, to the extent that we need to convert U.S. dollars into Renminbi for our operational needs and should the Renminbi appreciate against the U.S. dollar at that time, our financial position and the price of our common stock may be adversely affected. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of declaring dividends on our common shares or for other business purposes and the U.S. dollar appreciates against the Renminbi, the U.S. dollar equivalent of our earnings from our subsidiaries in China would be reduced. PART 7: PROPOSED EQUITY PLAN 7.1 The transaction Before December 31, 2004, the Company plans to raise $17 million of common stock, simultaneously close a reverse merger, and begin trading on the Over the Counter Bulletin Board ("OTCBB"). As part of a proposed $17 million equity financing, BAK will escrow 10% of their post merger and financing stock, to be used as compensation for investors if the Company fails to deliver the projected profit. The Company has guaranteed $12 million of Net Income ("NI") for fiscal 2005 (year ending September 30, 2005) and $27 million NI for fiscal 2006 (year ending September 30, 2006) ("Guaranteed NI"). BAK agrees to put 10% of its entire post reverse merger and financing stock position in the public company ("Penalty Pool") into escrow at the Closing to satisfy any future shortfall between final audited numbers ("Audited NI") and the Guaranteed NI. Five business days after annual fiscal year audits are completed for the periods ending September 30, 2005 ("Make Good Period 1") and September 30, 2006 ("Make Good Period 2") the audited numbers will be compared to the Guaranteed NI. In the event that the Audited NI comes in less than the Guaranteed NI in Make Good Period 1, 50% of the Penalty Pool will be transferred to the Investors. In the event that the Audited NI comes in less than the Guaranteed NI in Make Good Period 2, the remainder of the Penalty Pool (50%) will be transferred to the Investors. If the Audited NI exceeds Guaranteed NI during each Make Good period, BAK can immediately take possession of the Penalty Pool portion for that respective Make Good period. The public company, within 30 days of the closing of the reverse merger transaction, will file a registration statement for the purpose of registering the shares acquired by the investors. Shortly thereafter, the Company will apply for listing to the NASDAQ and it is anticipated that the Company will list on the NASDAQ by May 2005. The Company plans to conduct a traditional secondary stock offering to raise at least $40 million in the second half of 2005. 7.2 Financing and post merger ownership Upon the closing of the going public transaction and the trading of the Company's stock on OTCBB, the current stockholders of the Company will have control of 76.2% of the issued and outstanding common stock of the public company, leaving 2.8% of the issued and outstanding common stock of the public company to be held by persons other than the current stockholders of the company, including the original shareholder of the shell company. The other 21.0% of issued and outstanding common stock of the Public Company will be held by the new investors. 7.3 Use of funds Net proceeds from the financing will be used as follows: 1. Invest $4.25 million to expand production capacity. The Company will spend $4.25 million to build a production line. This line will have capacity of 100 thousand pieces of laptop batteries per day. The funds will primarily used to construct workshops, buy equipment and build the new product line. Assuming a 12/31/04 closing date, the production line could be put into place by July or August 2005. The capital will used to buy equipment as follows: (in mm's) (in mm's) Item Units Cost/Unit Total ----- --------- ----- Mixer 2 $0.15 $0.30 Coating Machine 1 $1.00 $1.00 Press Machine 1 $1.00 $1.00 Cutting Machine 1 $0.30 $0.30 Rolling Machine 2 $0.32 $0.65 Assembling automated production line $1.00 $1.00 ----- Total $4.25 2. Invest $1.7 million for polymer Li-ion battery and high power battery research and development. The Company plans to spend part of the collected capital into the research of new products. 3. $10.05 million will used to support working capital. The increase in production will impact company's working capital requirements. 7.4 Timetable for capital operation plan and refinancing plan December 31, 2004: Complete a) $17 million financing b) reverse merger to trade on OTCBB and c) Company will file a registration statement, registering investors' shares; May 2005: List on NASDAQ; September 2005: Conduct a traditional secondary stock offering to raise $40+million. PART 8: HISTORICAL FINANCIAL INFORMATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS This discussion contains certain "forward-looking statements" which are inherently subject to risks and uncertainties that may cause actual events to differ materially from those discussed herein. Factors which may cause such differences in events include, among other things, our ability to maintain our relationships with our significant customers; increased global competition; increases in the prices of, or limitations on the availability of, our primary raw materials; or a downturn in the cellular industry, upon which we currently rely for the bulk of our sales revenue, and which is cyclical and dependent on, among other things, consumer spending, international economic conditions and regulations and policies regarding international trade. Many of these factors are beyond our ability to control or predict. Readers are cautioned not to place undue reliance on these forward-looking statements. We undertake no obligation to publish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. UNAUDITED STATEMENTS The financial statements included in this Part 8 are unaudited. The Company has engaged an auditor and is in the final stages of producing complete audited statements. These audited statements will be available upon completion, which will be prior to closing any financing. EXCHANGE RATE For the purposes of these discussions, an exchange rate for the Chinese Renminbi of 8.265 per U.S. dollar was used for all three years. RESULTS OF OPERATIONS The past year was resulted in continued strong growth of revenues and profits at the Company. Despite a decrease in price per unit for the third year in a row, Revenues more than tripled for our fiscal year ending September 2004. Our customers continued to demand price concessions, 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 cost reductions. As a result, our net profits still grew over 91%. 2002 2003 2004 -------- -------- -------- Revenues Steel case cell $ 3,050 $ 19,906 $ 50,750 Aluminum case cell -- 275 13,084 Cylindrical cell -- 86 254 $ 3,050 $ 20,267 $ 64,088 Revenues overall grew 216.2% to $64.09 million in fiscal year 2004, driven primarily by growth in the aluminum case segment, and to a lesser extent, our traditional steel case segment. Our traditional steel case business grew 154.9% to $50.75 million, while 2004 aluminum case revenue grew to $13.08 million, 47 times 2003 revenue. In its second year of sales, the cylindrical business tripled in size to $254 thousand. [*****] Following industry trends, unit prices declined across all segments, including 12.4% for steel case and 21.9% for aluminum case. The Company has been able to more efficiently source its raw materials and also is improving production efficiencies, especially as it now consolidates its plants into BAK industrial park. [*****] Gross income grew from $5.69 million to $14.46 million, a 153.9% increase. Gross income grew slower than revenues because unit prices continued to decrease (as discussed above) while unit costs fell for steel case cells, but rose in the aluminum case and cylindrical cell segments. Prior to 2004, the Company sold its products primarily into the replacement battery market (as opposed to the OEM market). The products in the replacement market face lower prices and consequently, lower gross profit margins. This should change as the company moves into the OEM segment (see the notes to projections). [*****] While steel case cell unit costs were down 5.5% in 2004, aluminum case cells were up 10.5% and cylindrical were up 39.2%. The primary reason why the unit cost of aluminum case cells increased in 2004 compared to 2003 was an increase in the price of cobalt, a critical ingredient. A second, less significant impact on prices was an increase in the price of aluminum. The Company added more process controls in 2004 and longer term expects to reduce costs by increasing yields and reducing materials usage. Unit costs of cylindrical cells were up in 2004 compared to 2003, but the tiny volume of cylindrical cells produced in 2003 does not make any changes in 2004 very meaningful. Selling expense grew to $1.87 million in 2004, or 2.9% of revenues, up from $.44 million or 2.2% of revenues in 2003 and 0.5% of revenues in 2002. Selling expense consists of advertising, marketing, exposition costs, sales personnel salaries, certain employee costs and certain transportation costs. The increase in these expenses as a percentage of revenues in the past two years is because the Company began a formal marketing program. Prior to 2003, the Company did no marketing or advertising. General and administrative expense grew to $3.96 million in 2004, or 6.2% of revenues, compared to $1.36 million or 6.7% of revenues in 2003, and down from 7.0% of revenues in 2002. General and administrative expense consists of research and development costs, salaries, benefits and office expenses. Certain redundant expenses are expected go away after the Company consolidates its six separate factories into the new BAK Industrial Park. Interest expense grew to $1.01 million in 2004, or 1.6% of revenues, up from $.12 million or 0.6% of revenues in 2003 and 0.0% of revenues in 2002. Interest expense consists primarily of interest expense, and, to a lesser extent, bank service charges, exchange gains or losses and credit enhancement fees on the Company's debt. As a result, operating profit grew from $3.76 million in 2003 to $7.62 million in 2004, despite the operating margin decreasing from 18.6% to 11.9%. Income taxes were $.39 million in 2004, for an effective tax rate of 5.1%, compared to $0 in 2003 and 2002. Because the Company is located in the Shenzhen Special Enterprise Zone, it receives favorable tax treatment. The Company paid no income tax during the first two years of operation, and then half the standard tax, or 7.5%, during the next three years. The reason for the difference between the 7.5% tax rate and the 5.1% reported in 2004 is that the income tax is applied on a calendar year basis, and the company's data reported here is on a September 30 fiscal year basis. 2004 net income was $7.23 million, up 92% from $3.76 million in 2003, which was up from $.72 million in 2002. DIVIDENDS In determining to pay dividends, the Board considers current profitability, the outlook for longer-term profitability, known and potential cash requirements and the overall financial condition of the Company. To date, the Company has not paid any dividends. PROPERTY, PLANT AND EQUIPMENT The Company's historical capital expenditures are listed in the table below: 2002 2003 2004 Total -------- -------- -------- -------- (in $000) Fixed Asset Expenditures Plant -- -- 4,586.7 4,586.7 Equipment 739.6 3,662.5 10,126.3 14,528.5 Office facility 66.5 23.5 214.1 304.1 Vehicles 67.9 274.1 143.4 485.3 Total Fixed Asset Expenditures 874.0 3,960.1 15,070.6 19,904.6 Construction Expenditures -- 556.2 17,056.1 17,612.4 Depreciation expense consisted of $.265 million in 2002, $.379 million in 2003 and $1.711 million in 2004 and is included in cost of goods sold on the income statement. LIQUIDITY AND CAPITAL RESOURCES The Company's holdings in cash and cash equivalents amounted to $11.52 million at September 30, 2004, an increase of $10.03 million compared to the end of 2003. Accounts receivable balances increased $13.33 million to $20.29 million, reflecting the strong increase in revenues. Inventory levels at the end of fiscal 2004 were $30.30 million, an increase of $22.24 million, which was somewhat higher than the revenue growth rate. There is some seasonality to the business, which the Company believes is the reason for the inventory growth in 2004. May through August is the slower period for Li-ion battery industry sales in China, while September through March are the peak selling months. During the slower May through August period in 2004 the Company built its inventory in anticipation of the peak selling period. Short Term Loans. The Company has incurred the debt primarily to support construction of its new infrastructure and manufacturing capacity at BAK Industrial Park. The table below outlines these borrowings. Management believes that the maturities of these notes can be extended, and will be rolled into longer term facilities upon completion of construction. - ----------------------------- ------------- ------------------- ---------------- Amount Institution ($mm) Interest Rate Maturity Date - ----------------------------- ------------- ------------------- ---------------- China Agriculture Bank $ 2.42 4.59% 4/10/2005 - ----------------------------- ------------- ------------------- ---------------- China Agriculture Bank $ 2.18 4.59% 4/8/2005 - ----------------------------- ------------- ------------------- ---------------- China Agriculture Bank $ 1.82 4.54% 12/7/2004 - ----------------------------- ------------- ------------------- ---------------- China Agriculture Bank $ 0.60 4.54% 11/28/2004 - ----------------------------- ------------- ------------------- ---------------- China Agriculture Bank $ 1.21 4.54% 12/2/2004 - ----------------------------- ------------- ------------------- ---------------- China Agriculture Bank $ 1.34 4.59% 3/29/2005 - ----------------------------- ------------- ------------------- ---------------- China Agriculture Bank $ 2.54 4.59% 3/30/2005 - ----------------------------- ------------- ------------------- ---------------- Shenzhen Development Bank $ 12.10 5.84% 4/1/2005 - ----------------------------- ------------- ------------------- ---------------- Xingye Bank $ 2.42 5.31% 3/11/2005 - ----------------------------- ------------- ------------------- ---------------- Mingsheng Bank $ 2.54 5.84% 1/14/2005 - ----------------------------- ------------- ------------------- ---------------- Total $ 29.16 - ----------------------------- ------------- ------------------- ---------------- Notes Payable. These are numerous smaller notes totaling $20.80 million at 9/30/04 and are from China Agriculture Bank and Shenzhen Development Bank. Income Statement ($) - ------------------------------------------- ------------ ------------ ---------- Item FY 2004 FY 2003 FY 2002 - ------------------------------------------- ------------ ------------ ---------- Revenues 64,088,286 20,266,590 3,050,158 - ------------------------------------------- ------------ ------------ ---------- less: cost of goods sold 49,630,238 14,571,849 2,513,633 - ------------------------------------------- ------------ ------------ ---------- Gross Income 14,458,048 5,694,741 536,525 - ------------------------------------------- ------------ ------------ ---------- plus: other income - - 411,570 - ------------------------------------------- ------------ ------------ ---------- less: selling expense 1,871,987 442,753 15,984 - ------------------------------------------- ------------ ------------ ---------- general and administrative expense 3,957,232 1,362,443 214,097 - ------------------------------------------- ------------ ------------ ---------- interest expense 1,007,516 122,976 -637 - ------------------------------------------- ------------ ------------ ---------- Operating profit 7,621,313 3,766,569 718,651 - ------------------------------------------- ------------ ------------ ---------- plus: investment income - - - - ------------------------------------------- ------------ ------------ ---------- other income - - 1,281 - ------------------------------------------- ------------ ------------ ---------- less: other expenses 2,919 1,318 220 - ------------------------------------------- ------------ ------------ ---------- Pretax Income 7,618,394 3,765,252 719,712 - ------------------------------------------- ------------ ------------ ---------- less: income tax 391,965 - - - ------------------------------------------- ------------ ------------ ---------- Net Income 7,226,429 3,765,252 719,712 - ------------------------------------------- ------------ ------------ ---------- Income Statement (%) - ------------------------------------------- ----------- ----------- ------------ Item FY 2004 FY 2003 FY 2002 - ------------------------------------------- ----------- ----------- ------------ Revenues 100.0% 100.0% 100.0% - ------------------------------------------- ----------- ----------- ------------ less: cost of goods sold 77.4% 71.9% 82.4% - ------------------------------------------- ----------- ----------- ------------ Gross Income 22.6% 28.1% 17.6% - ------------------------------------------- ----------- ----------- ------------ plus: other income 13.5% - ------------------------------------------- ----------- ----------- ------------ less: selling expense 2.9% 2.2% 0.5% - ------------------------------------------- ----------- ----------- ------------ general and administrative expense 6.2% 6.7% 7.0% - ------------------------------------------- ----------- ----------- ------------ interest expense 1.6% 0.6% 0.0% - ------------------------------------------- ----------- ----------- ------------ Operating profit 11.9% 18.6% 23.6% - ------------------------------------------- ----------- ----------- ------------ plus: investment income - ------------------------------------------- ----------- ----------- ------------ other income 0.0% - ------------------------------------------- ----------- ----------- ------------ less: other expenses 0.0% 0.0% 0.0% - ------------------------------------------- ----------- ----------- ------------ Pretax Income 11.9% 18.6% 23.6% - ------------------------------------------- ----------- ----------- ------------ less: income tax 0.6% - ------------------------------------------- ----------- ----------- ------------ Net Income 11.3% 18.6% 23.6% - ------------------------------------------- ----------- ----------- ------------ Balance Sheet - -------------------------------------- ---------- ----------- ------------ Assets 9/30/2002 9/30/2003 9/30/2004 - -------------------------------------- ---------- ----------- ------------ Current Assets: - -------------------------------------- ---------- ----------- ------------ Cash on hand & in bank 93,148 1,493,800 11,527,192 - -------------------------------------- ---------- ----------- ------------ Short term investment - -------------------------------------- ---------- ----------- ------------ Notes receivable 18,149 - -------------------------------------- ---------- ----------- ------------ Interest receivable - -------------------------------------- ---------- ----------- ------------ Accounts receivable 1,346,747 6,960,192 20,291,847 - -------------------------------------- ---------- ----------- ------------ Other receivable 405,166 - -------------------------------------- ---------- ----------- ------------ Prepaid Expenses 211,359 725,906 1,332,593 - -------------------------------------- ---------- ----------- ------------ Inventory 1,087,288 8,057,998 30,295,414 - -------------------------------------- ---------- ----------- ------------ Total current assets 3,143,708 17,237,896 63,465,194 - -------------------------------------- ---------- ----------- ------------ - -------------------------------------- ---------- ----------- ------------ Fixed assets: - -------------------------------------- ---------- ----------- ------------ Original cost of the fixed assets 874,017 4,834,088 19,904,680 - -------------------------------------- ---------- ----------- ------------ minus: Accumulated depreciation 265,129 644,558 2,374,245 - -------------------------------------- ---------- ----------- ------------ Net Fixed Assets 608,888 4,189,530 17,530,436 - -------------------------------------- ---------- ----------- ------------ - -------------------------------------- ---------- ----------- ------------ Construction in process - 556,207 17,612,372 - -------------------------------------- ---------- ----------- ------------ Disposal of fixed assets - -------------------------------------- ---------- ----------- ------------ Total fixed assets 608,888 4,745,737 35,142,808 - -------------------------------------- ---------- ----------- ------------ Intangible and other assets: - -------------------------------------- ---------- ----------- ------------ Intangible assets - 16,650 3,050,545 - -------------------------------------- ---------- ----------- ------------ Deposits - 141,923 - -------------------------------------- ---------- ----------- ------------ Other long term assets 26,104 - -------------------------------------- ---------- ----------- ------------ Accounts Receivable--Related Party 866,693 1,509,712 - -------------------------------------- ---------- ----------- ------------ Total intangible and other assets 26,104 1,025,266 4,560,257 - -------------------------------------- ---------- ----------- ------------ Total assets 3,778,700 23,008,899 103,168,259 - -------------------------------------- ---------- ----------- ------------ - -------------------------------------- ---------- ----------- ------------ Liabilities and shareholders' equity 9/30/2002 9/30/2003 9/30/2004 - -------------------------------------- ---------- ----------- ------------ Current Liabilities - -------------------------------------- ---------- ----------- ------------ Short term loan 362,976 3,484,574 29,159,105 - -------------------------------------- ---------- ----------- ------------ Notes payable 6,107,418 20,802,970 - -------------------------------------- ---------- ----------- ------------ Accounts payable 418,360 5,172,150 23,604,590 - -------------------------------------- ---------- ----------- ------------ Salary payable - -------------------------------------- ---------- ----------- ------------ Welfare payable - -------------------------------------- ---------- ----------- ------------ Accrued expenses 1,067,731 1,785,362 5,252,400 - -------------------------------------- ---------- ----------- ------------ Customer Deposits 656,350 369,931 - -------------------------------------- ---------- ----------- ------------ Other fee - -------------------------------------- ---------- ----------- ------------ Other current liabilities - -------------------------------------- ---------- ----------- ------------ Total current liabilities 1,849,067 17,205,854 79,188,997 - -------------------------------------- ---------- ----------- ------------ Long term liabilities: - -------------------------------------- ---------- ----------- ------------ Long term accounts payable - -------------------------------------- ---------- ----------- ------------ Notes payable, due after 1 year 120,992 181,488 - -------------------------------------- ---------- ----------- ------------ Other long term liability - -------------------------------------- ---------- ----------- ------------ Total long term liability 120,992 181,488 - -------------------------------------- ---------- ----------- ------------ Deferred tax: - -------------------------------------- ---------- ----------- ------------ Debit balance of deferred tax - -------------------------------------- ---------- ----------- ------------ Total liabilities 1,849,067 17,326,846 79,370,485 - -------------------------------------- ---------- ----------- ------------ - -------------------------------------- ---------- ----------- ------------ Shareholders' equity: - -------------------------------------- ---------- ----------- ------------ Capital stock 1,209,921 1,209,921 12,099,214 - -------------------------------------- ---------- ----------- ------------ Paid in capital - -------------------------------------- ---------- ----------- ------------ Retained earnings 719,712 4,472,132 11,698,560 - -------------------------------------- ---------- ----------- ------------ Total shareholders' equity 1,929,633 5,682,053 23,797,774 - -------------------------------------- ---------- ----------- ------------ Liabilities and 3,778,700 23,008,899 103,168,259 shareholders' equity - -------------------------------------- ---------- ----------- ------------ PART 9: PROJECTED FINANCIAL INFORMATION DISCLAIMER This document contains statements about future events and expectations which are characterized as forward-looking statements. Forward-looking statements are based upon management's beliefs, assumptions and expectations of the Business' future economic performance, taking into account the information currently available to them. These statements are not statements of historical fact. Forward-looking statements involve risks and uncertainties that may cause actual results, performance or financial condition to be materially different from the expectations of future results, performance or financial condition we express or imply in any forward-looking statements. Factors that could contribute to these differences include those discussed in other sections of this document (See "Forward Looking Statements" in Part 8). The words believe, may, will, should, anticipate, estimate, expect, intends, objective or similar words or the negatives of these words are intended to identify forward-looking statements. Any forward-looking statements are hereby qualified entirely by these cautionary factors. EXCHANGE RATE For the purposes of these discussions, an exchange rate for the Chinese Renminbi of 8.265 per U.S. dollar was used for all years. KEY ASSUMPTIONS The Company assumes that growth over the next several years will be from [*****], supplemented by [*****]. Revenues for the older steel case cells are projected [*****] than historical rates in 2005, 2006 and 2007; [*****], the other newer segments are projected to [*****] during the same period.
Revenue Growth 2002 2003 2004 2005 2006 2007 - ----------------------- --------------- -------------- -------------- --------------- -------------- --------------- Steel case cell NA 552.7% 154.9% 3.4% [*****] [*****] Aluminum case cell NA NA 4657.8% 215.8% [*****] [*****] Cylindrical cell NA NA 195.3% 4493.7% [*****] [*****] Power battery NA NA NA NA [*****] [*****] Polymer cell NA NA NA NA [*****] [*****] --------------- -------------- -------------- --------------- -------------- --------------- NA 564.5% 216.2% 71.8% [*****] [*****]
As a result, overall revenues are projected to reach $110 million in 2005, a 71.8% increase over 2004.
Revenues (in $000) 2002 2003 2004 2005 2006 2007 - ----------------------- --------------- -------------- -------------- --------------- -------------- --------------- Steel case cell $3,050 $19,906 $50,750 $52,480 [*****] [*****] Aluminum case cell - 275 13,084 41,321 [*****] [*****] Cylindrical cell - 86 254 11,668 [*****] [*****] Power battery - - - 4,634 [*****] [*****] Polymer cell - - - - [*****] [*****] --------------- -------------- -------------- --------------- -------------- --------------- $3,050 $20,267 $64,088 $110,103 [*****] [*****]
Unit prices on aluminum case and cylindrical cells are expected to rebound in 2005 after several years of decline, before decreasing again in 2006 and 2007. Prior to 2005, the Company sold its aluminum case product primarily into the replacement market, a lower price, lower gross margin business. However, because of the higher quality and associated costs of the OEM market, these unit prices are projected to increase in 2005. Doctor Mao, the new CTO, has had prior success in gaining certification from Motorola for OEM sales while at his previous employer, tianjin lishen. He is now in charge of the certification for BAK with Motorola, and it is estimated that the Company will begin to supply the OEM market during 2005. After 2005, the Company believes it will need to continue to reduce prices to remain competitive. [*****] [*****] Mirroring price increases related to the move into the OEM market, unit costs are projected to increase in 2005 before falling in 2006 and 2007. After 2005, the Company believes it will be able to reduce unit costs through efficiencies gained with higher volume manufacturing and replacement of higher cost ingredients (such as cobalt) in its batteries. [*****] [*****] Because the percentage increase in projected unit costs for aluminum case and steel case batteries [*****] projected unit price increases in 2005, gross margins in the Company are projected to [*****]. The introduction of the newer, [*****] results in a blended gross margin that [*****]. [*****] Selling and general and administrative expenses are projected to decline slowly as a percent of revenues, based on management's prior experience. The Company will benefit from the completion of BAK Industrial Park, consolidation of its factories and the associated efficiencies gained. Interest expense projections are based primarily on the Company's projected debt levels associated with the completion of the Company's new facilities. Upon completion, current short term debt is projected to be converted into longer term borrowings. The Company anticipates renewable 5 year loans from the China Agriculture Bank at rates which are priced at a spread over the China Central Bank interest rate. Tax rate. Because the company is located in the Shenzhen Special Enterprise Zone, the company receives favorable tax treatment. The Company paid no income tax during the first two years of operation, and then half the standard tax, or 7.5%, through 2006. The reason for the difference between the 7.5% or 15% tax rates projected and those reported in 2004 through 2007 is that the income tax is applied on a calendar year basis, and the Company's data reported here is on a September 30 fiscal year basis. Dividends. BAK has not paid any dividends in the past and for the purposes of these projections does not anticipate paying any dividends. Historical and Projected Income Statement ($)
Shenzhen BAK Battery Co., Ltd. US$ (000) Actual Actual Actual Projected Projected Projected FY FY FY FY FY FY Item 2002 2003 2004 2005 2006 2007 - ------------------------- --------- ------------ ----------- ------------- -------------- ----------- Revenues 3,050.2 20,266.6 64,088.3 110,103.3 [*****] [*****] less: cost of goods 2,513.6 14,571.8 49,630.2 87,336.0 [*****] [*****] sold Gross Income 536.5 5,694.7 14,458.0 22,767.3 [*****] [*****] plus: other income 411.6 - - - less: selling expense 16.0 442.8 1,872.0 2,747.0 [*****] [*****] general and administrative 214.1 1,362.4 3,957.2 5,303.0 [*****] [*****] expense interest expense -0.6 123.0 1,007.5 1,624.0 [*****] [*****] Operating Profit 718.7 3,766.6 7,621.3 13,093.3 [*****] [*****] plus: investment income other income 1.3 less: other expenses 0.2 1.3 2.9 Pretax Income 719.7 3,765.3 7,618.4 13,093.3 [*****] [*****] less: income tax 392.0 982.0 [*****] [*****] Net Income 719.7 3,765.3 7,226.4 12,111.3 [*****] [*****]
NOTE: Differences due to rounding Historical and Projected Income Statement (%) Shenzhen BAK Battery Co., Ltd.
Actual Actual Actual Projected Projected Projected FY FY FY FY FY FY Item 2002 2003 2004 2005 2006 2007 - ------------------------- --------- ------------ ----------- ------------- -------------- ----------- Revenues 100.0% 100.0% 100.0% 100.0% [*****] [*****] less: cost of goods 82.4% 71.9% 77.4% 79.3% [*****] [*****] sold Gross Income 17.6% 28.1% 22.6% 20.7% [*****] [*****] plus: other income 13.5% less: selling expense 0.5% 2.2% 2.9% 2.5% [*****] [*****] general and administrative 7.0% 6.7% 6.2% 4.8% [*****] [*****] expense interest expense 0.0% 0.6% 1.6% 1.5% [*****] [*****] Operating Profit 23.6% 18.6% 11.9% 11.9% [*****] [*****] plus: investment income other income 0.0% less: other expenses 0.0% 0.0% 0.0% Pretax Income 23.6% 18.6% 11.9% 11.9% [*****] [*****] less: income tax 0.6% 0.9% [*****] [*****] Net Income 23.6% 18.6% 11.3% 11.0% [*****] [*****]
EX-23.1 4 cb5112ex231.txt EXHIBIT 23.1 Exhibit 23.1 SCHWARTZ LEVITSKY FELDMAN LLP CHARTERED ACCOUNTANTS TORONTO, MONTREAL, OTTAWA CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The undersigned, Schwartz Levitsky Feldman llp, Chartered Accountants hereby consents to the use of our name and use of our report of Independent Registered Public Accounting Firm dated December 28, 2005 except for notes 20 a), b) and c) and 21 as to which the date is January 12, 2006, note 20 d) as to which the date is January 30, 2006, and notes 20 e) and f) as to which the date is March 14, 2006 for China BAK Battery, Inc. as filed with Amendment No. 7 to the Registration on Form SB-2 being filed by the Company. /s/SCHWARTZ LEVITSKY FELDMAN LLP Toronto, Ontario, Canada March 15, 2006 Chartered Accountants 1167 Caledonia Road Toronto, Ontario M6A 2X1 Tel: 416 785 5353 Fax: 416 785 5663 -----END PRIVACY-ENHANCED MESSAGE-----