China BAK Battery, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended March 31, 2015. Financial statements are unaudited and reported in U.S. dollars. The issuer was named China BAK Battery, Inc. in this filing.
Business context and reporting period
Following the June 2014 foreclosure and disposal of BAK International and its subsidiaries, the company’s continuing business was substantially reduced. It sold high-power lithium battery cells, largely produced by former subsidiary BAK Tianjin under outsourcing arrangements, while building a new manufacturing facility in Dalian. Management said construction was nearly complete, trial production began in April 2015, and commercial operations were expected in the second quarter of calendar 2015.
Financial performance and position
| Metric | Three months ended March 31, 2015 | Six months ended March 31, 2015 |
|---|---|---|
| Revenue | $3.07 million | $6.15 million |
| Gross profit (margin) | $0.35 million (11.4%) | $0.76 million (12.3%) |
| Operating loss | $0.26 million | $0.41 million |
| Continuing operations, net of tax | Loss of $0.45 million | Profit of $16.93 million |
| Net income | $1.07 million | $18.46 million |
| Operating cash flow | Not separately provided for the quarter | Use of $1.24 million |
- Quarterly net income included $1.52 million from discontinued operations, reflecting recovery of a receivable from former subsidiaries; continuing operations remained loss-making.
- Six-month profit was heavily affected by recognition of $23.22 million in government grant income and $5.80 million in income tax expense, primarily deferred tax associated with the subsidy. It should not be read as a measure of recurring operating profitability.
- Revenue fell 90.7% year over year in the quarter and 91.7% for the six months, primarily because the disposed subsidiaries had generated most prior-year sales. Six-month high-power-cell revenue declined 12.8%; management attributed this to a lower-priced product mix, partly offset by higher volume.
- Gross margin improved versus the prior year: 11.4% versus 7.7% for the quarter and 12.3% versus 7.0% for the six months. Management cited the absence of prior-year inventory write-downs and loss-making sales of reconditioned products. Prior-year six-month inventory write-downs were $5.65 million.
- At March 31, cash was $0.50 million, current assets were $10.15 million and current liabilities were $20.41 million, a working-capital deficit of approximately $10.26 million. Total assets were $47.32 million, total liabilities $33.20 million and shareholders’ equity $14.12 million.
- Short-term bank loans were $4.84 million; other short-term loans were $1.34 million. The bank loan bears 7.8% interest, matures August 18, 2015, and is guaranteed by the CEO and Shenzhen BAK, a former subsidiary.
- Six-month investing cash flow was positive $4.57 million, including government-subsidy proceeds and receipts from a former subsidiary, while financing cash flow used $3.82 million. Cash declined $0.50 million to $0.50 million.
- Construction in progress rose to $28.28 million. Six-month capital spending was $4.3 million; management estimated a further $8.1 million of capital expenditures for the remainder of fiscal 2015.
Material changes versus the prior comparable period
- The disposal of the former operating subsidiaries sharply reduced revenue, operating scale and operating expenses. Quarterly R&D, sales and marketing, and general and administrative expenses all fell substantially, largely due to the disposal and lower headcount.
- Quarterly operating loss improved to $0.26 million from $3.93 million, but the business still generated a loss from continuing operations. Quarterly finance costs were close to zero because interest on borrowings was capitalized into construction in progress; prior-year interest expense was substantial.
- Six-month results shifted from a $14.55 million net loss to $18.46 million net income, principally due to the $23.22 million grant-income recognition and the tax effect, as well as discontinued-operation adjustments—not a comparable increase in sales or operating profit.
- Receivables from former subsidiaries fell from $7.26 million at September 30, 2014 to $0.16 million net at March 31, 2015. The company recorded a $1.52 million recovery related to the disposal receivable during the period.
Outlook, risks, contingencies and unusual items
- Going concern and liquidity: Management stated that the working-capital deficit, historical recurring losses and short-term debt raise substantial doubt about the company’s ability to continue as a going concern. It planned to renew the $4.8 million bank loan at maturity and seek additional local-bank financing, but gave no assurance financing would be available. The financial statements contain no adjustments for the outcome of this uncertainty.
- Business execution: The Dalian facility’s expected start-up and production ramp are central to the outlook. Until it operates commercially, the company depends on outsourced production, principally from BAK Tianjin, identified as its major supplier.
- Commitments: Contracted capital commitments totaled $28.47 million, including $25.40 million of capital injections to subsidiaries, $2.74 million for construction and $0.33 million for equipment. MD&A listed total contractual obligations and commitments of $34.79 million, all shown as due within one year.
- Customer concentration: Three customers each represented at least 10% of quarterly revenue; the largest accounted for 26.72%. Three customers also represented at least 10% of receivables at March 31, 2015.
- Legal matter: The company disclosed default judgments in a contract lawsuit totaling $561,324, including additional attorneys’ fees. BAK International agreed to indemnify the company, but collectability and the practical value of that indemnity should be assessed.
- Reporting controls: Management concluded disclosure controls and procedures were ineffective at March 31, 2015. Disclosed material weaknesses included inadequate procedures for accounting for key agreements and insufficient technically qualified accounting staff. Remediation was in progress, with no assurance it would be completed successfully.
- No formal numerical revenue or earnings guidance was provided. Management’s outlook emphasized expected demand for high-power batteries and anticipated Dalian production, but these expectations are subject to financing, construction, ramp-up, customer and supplier risks.
Most important facts for investors to verify
- Whether the Dalian facility achieved commercial production as planned, and its capacity utilization, yields, customer orders and cash requirements.
- Whether the company renewed the August 2015 bank loan and obtained sufficient additional financing to meet liquidity needs and complete construction.
- How much of reported six-month profit came from nonrecurring government grants and disposal-related recoveries, and the continuing business’s underlying cash generation.
- Collection of trade receivables and amounts due from former subsidiaries, including the basis for the $1.52 million recovery and the remaining net receivable.
- Exposure to BAK Tianjin as supplier, customer concentration, and the terms and settlement of related-party balances.
- Progress in remediating the disclosed control weaknesses and any updates regarding the lawsuit and indemnity.
- The filing contains a period-label inconsistency in MD&A: one product-revenue table labels the six-month period as ending December 31, although the financial statements cover the six months ended March 31. Investors should confirm the intended period against the reported financial statements.