Business context and reporting period
China BAK Battery, Inc. (now CBAK Energy Technology, Inc.) filed this unaudited Form 10-Q for its fiscal third quarter and nine months ended June 30, 2015. The company had disposed of BAK International and its subsidiaries on June 30, 2014 following a loan default and foreclosure. It was rebuilding its business around high-power lithium batteries, outsourcing production mainly to former subsidiary BAK Tianjin while constructing a manufacturing site in Dalian. Dalian facilities began partial commercial operations in July 2015, after the reporting period.
Comparisons with 2014 are substantially affected by the disposal: the earlier periods include the former subsidiaries’ operations up to June 30, 2014, while 2015 revenue chiefly reflects high-power battery cells.
Financial results and position
Amounts are U.S. dollars. Figures below are rounded; income-statement comparisons are for the three and nine months ended June 30, respectively.
| Metric | Three months 2015 | Three months 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $2.45m | $47.99m | $8.60m | $122.04m |
| Gross profit (margin) | $0.23m (9.2%) | $4.32m (9.0%) | $0.98m (11.4%) | $9.48m (7.8%) |
| Operating loss | $1.21m | $3.61m | $1.62m | $10.28m |
| Continuing operations, net of tax | Loss of $1.27m | Loss of $9.83m | Income of $15.67m | Loss of $26.37m |
| Discontinued operations, net of tax | Income of $0.32m | Income of $46.94m | Income of $1.84m | Income of $48.93m |
| Net income (loss) | Loss of $0.95m | Income of $37.11m | Income of $17.50m | Income of $22.56m |
| Basic and diluted EPS | Loss of $0.08 | Income of $2.92 | Income of $1.37 | Income of $1.78 |
- Cash flow: Nine-month operating cash outflow was $6.61m, compared with $19.43m in 2014. Investing activities provided $1.90m, including a $7.45m government subsidy receipt, while financing activities provided $15.28m. Cash increased by $10.56m to $11.55m.
- Liquidity: At June 30, current assets were $24.85m and current liabilities $40.53m, a $15.68m working-capital deficit (current ratio approximately 0.61). Cash was $11.55m.
- Debt: Short-term bank loans were $12.91m; other short-term loans were $11.96m, including related-party and third-party advances generally unsecured, non-interest-bearing, and repayable on demand. The Bank of Dandong facility totaled $19.36m, with $12.91m drawn and $6.45m available at quarter-end; collateral included Dalian land-use rights, buildings, machinery, and construction in progress. The company reported 7.84% interest on the new facility borrowings.
- Balance sheet: Total assets were $66.64m, total liabilities $53.27m, and shareholders’ equity $13.38m at June 30, 2015, versus a $4.34m shareholders’ deficit at September 30, 2014. Construction in progress was $20.92m.
Material changes versus the prior comparable period
- Revenue fell 94.9% in the quarter and 93.0% for the nine-month period, principally because the disposed subsidiaries had generated most of the prior-year sales. 2015 continuing revenue consisted entirely of high-power lithium battery cells.
- For the quarter, high-power cell revenue increased 7.7%, but gross profit fell 74.4%; management cited a product shift toward lower-priced cells for uninterruptible power supplies. For nine months, high-power cell revenue declined 7.8% as volume growth was offset by lower average selling prices.
- Operating losses narrowed as operating expenses fell following the disposal. Gross margin improved year over year, which management attributed partly to no inventory write-downs or loss-making reconditioned-product sales in 2015; the 2014 periods included substantial inventory write-downs.
- Nine-month continuing-operations income included $23.20m of government grant income and was offset by $5.77m of income-tax expense, primarily deferred tax associated with government grants. Reported nine-month net income also included $1.84m from discontinued operations, mainly recovery of amounts due from former subsidiaries. These items mean reported profit was not solely from ongoing battery operations.
Outlook, risks, contingencies, and unusual items
- Management expected demand and potential orders in China’s new-energy market, particularly electric vehicles, and believed the smaller, higher-power business could return to profitability. It planned to expand the Dalian sales team and estimated approximately $5.3m of remaining fiscal-2015 capital expenditures. No quantified revenue or earnings guidance was provided.
- Going concern: The filing says the working-capital deficiency, prior recurring losses, and short-term debt obligations raise substantial doubt about the company’s ability to continue as a going concern. Management planned to renew loans and seek additional financing but cautioned that funding was not assured. The statements contain no adjustments for the possible effects of this uncertainty.
- Funding and commitments: Contractual obligations and commercial commitments totaled $47.09m, all presented as due within one year, including $18.91m of capital injections to subsidiaries, $2.74m for building construction, and $0.07m for equipment, in addition to short-term debt and advances. The company also said it required more cash to complete the Dalian site.
- Post-period loan activity: The company disclosed that it repaid a $4.8m Bank of Dandong loan in August 2015 and borrowed a new $4.8m loan under the facility. The filing contains an apparent date inconsistency in one loan note; verify the loan’s stated maturity against the executed documents.
- Legal matter: A Texas court entered default judgments against the company in a contract case, with the second judgment totaling $561,324 including additional attorneys’ fees. BAK International agreed to indemnify the company, but recovery and enforceability are not established in the filing.
- Concentrations and related parties: Two customers accounted for approximately 59.8% and 20.4% of quarterly revenue; two customers accounted for 40.1% and 25.5% of nine-month revenue. The company also bought inventory from BAK Tianjin and had material advances from related and unrelated parties.
- Controls: Management concluded disclosure controls and procedures were ineffective as of June 30, 2015. Identified material weaknesses involved accounting for key agreements and insufficient U.S. GAAP and SEC-reporting expertise among accounting personnel. Remediation was underway, with no assurance it would be completed.
- The filing also reports $21.72m in contracted capital commitments, a $1.21m accrued liquidated-damages amount, and the continuing risk of further inventory write-downs if market conditions deteriorate.
Most important facts for investors to verify
- Whether Dalian production reached full commercial operation, and whether its capacity, customer orders, and margins can replace the revenue lost in the disposal.
- The sources, maturity terms, interest, collateral, guarantees, and renewal status of short-term borrowings and repayable-on-demand advances; also confirm the loan-date inconsistency noted above.
- Whether the company can fund the $47.09m of stated near-term obligations and complete construction while operating with a $15.68m working-capital deficit.
- How much reported profit depends on the $23.20m grant, deferred-tax accounting, and recoveries related to former subsidiaries, rather than continuing operations.
- Whether customer concentration, related-party transactions, the court judgment and indemnity, and the ineffective disclosure controls have changed since filing.