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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K/A
(Amendment No. 1)
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): January 20, 2005
CHINA BAK BATTERY, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Nevada 000-49712 88-0442833
------------------------------- ------------------------ -------------------
(State or other jurisdiction of (Commission File Number) (IRS Employer
incorporation or organization) Identification No.)
BAK Industrial Park, No. 1 BAK Street
Kuichong Town, Longgang District
Shenzhen, People's Republic of China 518119
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (86) 687-2200
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This Current Report on Form 8-K/A (Amendment No. 1) supplements the
information contained in the Current Report on Form 8-K previously filed with
the Securities and Exchange Commission ("SEC") on January 21, 2005, relating to
the stock exchange transaction by and between the registrant and the
shareholders of BAK International, Ltd., and the corresponding change-in-control
of the registrant that occurred on January 20, 2005.
ITEM 9.01. FINANCIAL STATEMENTS AND EXHIBITS
a. Financial Statements of business acquired. The following financial
statements are hereby included as part of this report.
Report of Independent Registered Public Accounting Firm...............1
Consolidated Balance Sheets as at September 30, 2004 and 2003.........2
Consolidated Statements of Operations for the Years Ended
September 30, 2004 and 2003.......................................3
Consolidated Statements of Changes in Stockholders'
Equity for the Years Ended September 30, 2004 and 2003............4
Consolidated Statements of Cash Flows for the Years Ended
September 30, 2004 and 2003.......................................5
Notes to Consolidated Financial Statements............................6
Consolidated Balance Sheets at December 31, 2004 and
September 30, 2004................................................1
Consolidated Statements of Operations for the Three Months Ended
December 31, 2004 and 2003........................................2
Consolidated Statements of Changes in Stockholders' Equity for the
Three Months Ended December 31, 2004 and 2003.....................3
Consolidated Statements of Cash Flows for the Three Months Ended
December 31, 2004 and 2003........................................4
Notes to Consolidated Financial Statements............................5
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto authorized.
BAK INTERNATIONAL, LTD.
DATED: April 7, 2005 By: /s/ Xiangqian Li
-------------------------------------
Xiangqian Li
President and Chief Executive Officer
BAK INTERNATIONAL LIMITED AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004 AND 2003
Together With Report of Independent
Registered Public Accounting Firm
(Amounts expressed in US Dollars)
BAK INTERNATIONAL LIMITED AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004 AND 2003
Together With Report of Independent
Registered Public Accounting Firm
(Amounts expressed in US Dollars)
TABLE OF CONTENTS
Report of Independent Registered Public Accounting Firm 1
Consolidated Balance Sheets as at September 30, 2004 and 2003 2
Consolidated Statements of Operations for
the Years Ended September 30, 2004and 2003 3
Consolidated Statements of Changes in Stockholders' Equity for the Years
Ended September 30, 2004 and 2003 4
Consolidated Statements of Cash Flows for the Years Ended September 30,
2004 and 2003 5
Notes to Consolidated Financial Statements 6 - 26
Schwartz Levitsky Feldman llp
CHARTERED ACCOUNTANTS
TORONTO, MONTREAL, OTTAWA
REPORT OF INDEPENDENT REGISTERED ACCOUNTING FIRM
To the Stockholders of
BAK International Limited and Subsidiary
We have audited the accompanying consolidated balance sheets of BAK
International Limited as of September 30, 2004 and 2003, and the related
consolidated statements of changes in stockholders' equity, operations and cash
flows for the years then ended (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
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management as well as evaluating the overall consolidated 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 BAK International
Limited as of September 30, 2004 and 2003 and the results of its operations and
its cash flows for the years then ended, in conformity with accounting
principles generally accepted in the United States of America.
As described in Notes 6 and 12 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.
/s/ Schwartz Levitsky Feldman llp
Toronto, Ontario, Canada
December 30, 2004 except for note 17
as to which the date is January 20, 2005 Chartered Accountants
1
BAK International Limited and Subsidiary
Consolidated Balance Sheets
As at September 30, 2004 and 2003
(Amounts expressed in US Dollars)
Assets
------
2004 2003
$ $
Current Assets
Cash 3,212,176 670,925
Cash - Restricted 7,120,069 820,692
Accounts Receivable, Net 20,999,561 6,758,283
Inventories 29,535,985 7,993,781
Prepaid Expenses 1,330,645 724,845
Notes Receivable 18,122 --
Accounts Receivable - Related Party 911,093 --
------------ ------------
Total Current 63,127,651 16,968,526
------------ ------------
Long-Term Assets
Property, Plant, & Equipment 19,875,583 4,968,737
Construction in Progress 23,656,190 555,395
Land Use Rights 4,029,038 --
Less Accumulated Depreciation (2,370,774) (643,616)
------------ ------------
Long-Term Assets, Net 45,190,037 4,880,516
------------ ------------
Other Assets
Other Receivables 225,972 925,833
Intangible Assets, Net 58,362 16,626
------------ ------------
Total other 284,334 942,459
------------ ------------
Total Assets 108,602,022 22,791,501
============ ============
Liabilities and Shareholders' Equity
------------------------------------
Current Liabilities
Accounts Payable 23,570,087 5,164,588
Bank Loans, Short Term 27,304,162 3,479,480
Short Term Loans 1,812,316 --
Notes Payable, Other 20,772,559 6,098,490
Land Use Rights Payable 3,750,756 --
Construction Costs Payable 6,347,846 --
Customer Deposits 369,390 655,391
Accrued Expenses 5,247,656 1,782,752
Other Liabilities 181,223 120,815
------------ ------------
Total Current 89,355,995 17,301,516
------------ ------------
CONTINGENCIES AND COMMITMENTS (NOTE 12)
Stockholders' Equity
Common Stock - $.001 Par Value; 50,000,000 Shares
Authorized; 31,225,642 Shares Issued and Outstanding 31,226 31,226
Additional Paid In Capital 12,052,845 1,176,927
Accumulated Comprehensive Loss (144) (49)
Reserves 1,724,246 651,583
Retained Earnings 5,437,854 3,630,298
------------ ------------
19,246,027 5,489,985
------------ ------------
Total Liabilities and Stockholders' Equity 108,602,022 22,791,501
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
2
BAK International Limited and Subsidiary
Consolidated Statements of Operations
For The Years Ended September 30, 2004 and 2003
(Amounts expressed in US Dollars)
2004 2003
$ $
Revenues, Net of Returns 63,746,202 20,045,496
Cost of Goods Sold 48,285,847 14,173,003
---------- ----------
Gross Profit 15,460,355 5,872,493
---------- ----------
Expenses:
Selling 1,869,275 442,112
General and Administrative 3,052,992 785,612
Research and Development 328,779 116,789
Bad Debts 326,990 448,285
Depreciation and Amortization 1,732,707 379,551
---------- ----------
Total Expenses 7,310,743 2,172,349
---------- ----------
Operating Income 8,149,612 3,700,144
Other Expense
Finance Costs 1,006,056 122,798
Other Expense 2,916 1,315
---------- ----------
Net Income Before Provision for Income Taxes 7,140,640 3,576,031
Provision for Income Taxes 394,333 --
---------- ----------
Net Income 6,746,307 3,576,031
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
3
BAK International Limited and Subsidiary
Consolidated Statements of Changes in Stockholders' Equity
For The Years Ended September 30, 2004 and 2003
(Amounts expressed in US Dollars)
Par Accumulated
Value Additional Other
Number of Common Paid-In Retained Comprehensive Stockholders'
Shares Stock Capital Earnings Reserves Income (Loss) Equity
----------- ----------- ----------- ----------- ----------- ------------- -------------
$ $ $ $ $ $
Balance - September 31,225,642 31,226 1,176,927 598,265 107,585 -- 1,914,003
30, 2002
Net Income -- -- -- 3,576,031 -- -- 3,576,031
Transfer to Reserves -- -- -- (543,998) 543,998 -- --
Foreign Currency -- -- -- -- -- (49) (49)
Translation
-----------------------------------------------------------------------------------------------------------------------------
Balance - September 31,225,642 31,226 1,176,927 3,630,298 651,583 (49) 5,489,985
30, 2003
Contribution of Cash by -- -- 10,875,918 -- -- -- 10,875,918
Stockholders
Net Income -- -- -- 6,746,307 -- -- 6,746,307
Transfer to Reserves -- -- -- (1,072,663) 1,072,663 -- --
Deemed Distribution to -- -- -- -- -- -- --
Shareholder -
Intangible Assets -- -- -- (3,866,088) -- -- (3,866,088)
Foreign Currency -- -- -- -- -- (95) (95)
Translation
-----------------------------------------------------------------------------------------------------------------------------
Balance - September 31,225,642 31,226 12,052,845 5,437,854 1,724,246 (144) 19,246,027
30,2004
=============================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
4
BAK International Limited and Subsidiary
Consolidated Statements of Cash Flows
For The Years Ended September 30, 2004 and 2003
(Amounts Expressed in US Dollars)
2004 2003
$ $
Cash Flows from Operating Activities
Net Income 6,746,307 3,576,031
Adjustments to reconcile net income to net cash
from operating activities:
Bad debt expense 326,990 448,285
Amortization 5,549 676
Depreciation 1,727,158 378,875
Changes in Assets and Liabilities:
Accounts Receivable (14,543,660) (5,786,874)
Inventory (21,542,204) (6,908,083)
Prepaid Expenses (605,800) (52,609)
Notes Receivable (18,122) --
Accounts Payable 18,405,499 4,311,720
Customer Deposits (286,001) 593,776
Accrued Expenses 3,464,904 723,825
Construction Costs Payable 6,347,846 --
Other Liabilities 60,408 120,864
----------- -----------
Net Cash Flows from Operating Activities 88,874 (2,593,514)
----------- -----------
Cash Flows from Investing Activities
Acquisition of Property, Plant and Equipment (14,906,846) (4,095,998)
Construction in Progress (23,379,077) (555,395)
Investment in Intangible Assets (47,285) (17,302)
----------- -----------
Net Cash Flows from Investing Activities (38,333,208) (4,668,695)
----------- -----------
Cash Flows from Financing Activities
Proceeds from Borrowings 57,740,719 9,722,901
Repayment of Borrowings (17,429,652) (507,424)
Cash Pledged To Bank (6,299,377) (820,692)
Loans to Related Parties (235,840) (554,614)
Deemed Distribution to Shareholder- Intangible Assets (See Note 10) (3,866,088) --
Proceeds from Issuance of Capital Stock 10,875,918 --
----------- -----------
Net Cash flows from Financing Activities 40,785,680 7,840,171
----------- -----------
Effects of Exchange Rates Changes on Cash and Cash Equivalents
Effects of Exchange Rates on Cash and Cash Equivalents (95) (49)
Net Increase in Cash 2,541,251 577,913
Cash - Beginning of Year 670,925 93,012
----------- -----------
Cash - End of Year 3,212,176 670,925
=========== ===========
Supplemental Cash Flow Disclosures:
Interest Paid 1,007,287 122,798
=========== ===========
Income Taxes Paid -- --
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
5
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES
BAK International Limited 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. BAK International Limited acquired 100% of the outstanding shares of
Shenzhen BAK Battery Co., Ltd ("BAK") for a total consideration of USD$11.5
million on November 6, 2004. Simultaneously the former shareholders of BAK
acquired 96.8% of the issued shares of BAK International Limited.
Consequently, the shareholders of BAK International Limited are
substantially the same as the former shareholders as BAK therefore the
transaction has 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 consolidated as though the transaction occurred as of the
beginning of the first accounting period presented in these consolidated
financial statements. See note 17 - Subsequent Events.
BAK was founded on August 3, 2001 as a China-based company specializing in
lithium ion (known as "Li-ion" or "Li-ion cell") battery cell production,
for use in the replacement battery market, primarily for cell phones in the
Peoples Republic of China (PRC).
The Company is subject to the consideration and risks of operating in the
PRC. These include risks associated with the political and economic
environment, foreign currency exchange and the legal system in the PRC.
The economy of PRC differs significantly from the economies of the
"western" industrialized nations in such respects as structure, level of
development, gross national product, growth rate, capital reinvestment,
resource allocation, self-sufficiency, rate of inflation and balance of
payments position, among others. Only recently has the PRC government
encouraged substantial private economic activities. The Chinese economy has
experienced significant growth in the past several years, but such growth
has been uneven among various sectors of the economy and geographic
regions. Actions by the PRC government to control inflation have
significantly restrained economic expansion in the recent past. Similar
actions by the PRC government in the future could have a significant
adverse effect on economic conditions in PRC.
Many laws and regulations dealing with economic matters in general and
foreign investment in particular have been enacted in the PRC. However, the
PRC still does not have a comprehensive system of laws, and enforcement of
existing laws may be uncertain and sporadic.
The Company's operating assets and primary sources of income and cash flows
are of interests in the PRC. The PRC economy has, for many years, been a
centrally-planned economy, operating on the basis of annual, five-year and
ten-year state plans adopted by central PRC governmental authorities, which
set out national production and development targets. The PRC government has
been pursuing economic reforms since it first adopted its "open-door"
policy in 1978. There is no assurance that the PRC government will continue
to pursue economic reforms or that there will not be any significant change
in its economic or other policies, particularly in the event of any change
in the political leadership of, or the political, economic or social
conditions in, the PRC. There is also no assurance that the Company will
not be adversely affected by any such change in governmental policies or
any unfavorable change in the political, economic or social conditions, the
laws or regulations, or the rate or method of taxation in the PRC.
6
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (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 analysis and
monitors the financial condition of its clients in order to minimize credit
risk.
Any devaluation of the Renminbi (RMB) against the United States dollar
would consequently have adverse effects on the Company's financial
performance and asset values when measured in terms of the United States
dollar. Should the RMB significantly devalue against the United States
dollar, such devaluation could have a material adverse effect on the
Company's earnings and the foreign currency equivalent of such earnings.
The Company does not hedge its RMB - United States dollar exchange rate
exposure.
On January 1, 1994, the PRC government introduced a single rate of exchange
as quoted daily by the People's Bank of China (the "Unified Exchange
Rate"). No representation is made that the RMB amounts have been, or could
be, converted into US$ at that or any rate. This quotation of exchange
rates does not imply 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. 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 BAK International Limited and Shenzhen
BAK Battery Co, Ltd. for all periods presented.
3. 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 8, a portion
of the Company's cash is restricted cash, which has been pledged to its
bank to secure short-term bank loans. This restricted cash is not as liquid
as other cash, and has been reflected in the attached consolidated
financial statements.
7
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
3. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
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 collectibility of
outstanding accounts receivable. The Company evaluates the credit risk of
its customers utilizing historical data and estimates of future
performance.
C. Inventory
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 of, 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 life 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 25 years from the date the
Company acquired the trademark. Management is of the opinion that no
impairment loss is considered necessary at year-end.
8
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
3. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
F. Fair Value Of Financial Instruments
The carrying value of financial instruments including cash, receivables,
accounts payable and accrued expenses and debt, approximates their fair
value at September 30, 2004 and 2003 due to the relatively short-term
nature of these instruments.
G. Construction In Progress
Construction in progress represents buildings, machinery and other
long-term assets under construction or installation, which is stated at
cost less any impairment losses, and is not depreciated. Cost comprises 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.
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
the Company are fully exempt from income tax for five 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 the Company will be
taxable at the full rate, currently 15%.
Had this tax holiday not been available, income tax expense would have
increased by approximately US$692,000 for the year ended September 30,
2004, and US$537,000 for the year ended September 30, 2003, respectively.
I. Government Subsidies
Subsidies from the government are recognized at their fair values when
received or there is reasonable assurance that they will be received, and
all attached conditions are complied with.
9
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
3. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
I. Government Subsidies (cont'd)
Revenue from government sponsored grants or subsidies are 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.
During the year ended September 30, 2004, the Company received a repayable
grant from the Long Gang Technology and Science Bureau in the amount of
approximately $181,000. The grant was awarded to further the research of
the LiNiCo2 which is an advanced mode material in the Li-on battery cell.
The term of the grant is for a two year period with repayment of principal
together with interest at the rate of 3% per annum due on December 26,
2005. The grant is recorded as a liability in the accompanying consolidated
financial statements.
During the year ended September 30, 2003, the Company received a
non-repayable grant from the Shenzhen Technology and Finance Bureau in the
amount of approximately $120,000. The grant was awarded to further the
Company's research and development activities. The grant was recorded as an
offset to research and development expenses 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 was determined to be less
than the carrying value of the assets. If impairment is deemed to exist,
the assets will be 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, 2004, management expects its
long-lived assets to be fully recoverable.
10
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
3. 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, being the functional currency. Translation of amounts
from RMB in United States dollars ("US$") has been made at the following
exchange rates for the respective years:
September 30, 2004:
Balance Sheet - RMB 8.27670 to US$ 1
Operating Statement - RMB 8.26688 to US$ 1
September 30, 2003 -
Balance Sheet - RMB 8.27710 to US$ 1
Operating Statement - RMB 8.27699 to US$ 1
Foreign currency transactions in RMB are reflected using the temporal
method. Under this method, all monetary items are translated into the
functional currency at the rate of exchange prevailing at the balance sheet
date. Non-monetary transactions are translated at historical rates. Income
and expenses are translated at the rate in effect on the transaction dates.
Transaction gains and losses, if any, are included in the determination of
net income for the period. Transaction losses included in net income
amounted to US$6,766 and US$1,989 at September 30, 2004 and 2003,
respectively.
In translating the consolidated financial statements of the Company from
its functional currency into its reporting currency in United States
dollars, balance sheet accounts are translated using the closing exchange
rate in effect at the balance sheet date and income and expense accounts
are translated using the average exchange rate prevailing during the
reporting period. Adjustments resulting from the translation, if any are
included in cumulative other comprehensive income (loss) in stockholder's
equity.
The RMB is not readily convertible into United States dollars or other
foreign currencies. The foreign exchange rate between the United States
dollar and the RMB has been stable at approximately 1RMB to US$.1205 for
the last few years. No representation is made that the 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 consolidated financial statements and reported amounts of
revenues and expenses during the reporting period. Actual results could
differ from those estimates.
11
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
3. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
N. Revenue Recognition, Returns And Warranties
BAK 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, delivery has occurred, the
sales price is fixed and determinable, sales and value-added tax laws have
been complied with, and collectibility is reasonably assured. BAK generally
recognizes product sales when the product is shipped. 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 BAK. Concurrent with the recognition of revenue, at the end
of the fiscal year, BAK records a warranty reserve for product returns,
based upon historical experience, that are a percentage of sales during the
final month of the respective year.
The Company estimates the amount of claims made based upon the historical
experience with product returns and warranty claims. While the Company's
policy is to allow customers to return products or make warranty claims for
a period up to six to eight months after the sale, the historical
experience indicates that the vast majority of claims are made with 30
days. Hence, the Company provides for a certain percentage of its monthly
sales that it estimates will result in product returns or warranty claims.
O. Employees' Benefits And Pension Obligations
Mandatory contributions are made to the Government's health, retirement
benefit and unemployment schemes at the statutory rates in force during the
period, based on gross salary payments. The cost of these payments is
charged to the statement of income in the same period as the related salary
cost. While the Company has purchased all required insurance for management
personnel, the Company is not in compliance with the similar requirements
for other of its employees. See Note 12, Contingencies and Commitments.
In accordance with certain regulations of the Shenzhen Municipal
Government, all enterprises established in Shenzhen are required to
contribute to a retirement insurance fund administered by the Shenzhen
Municipal Government at rates ranging from 8% to 9% of the basic salaries
or a minimum changes of RMB155 per person per month of the company's
existing PRC staff. See Note 12, Contingencies and Commitments.
P. Comprehensive Income/(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 (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.
12
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
3. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
Q. Concentration 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 collectibility of
outstanding accounts receivable.
R. Research And Development Costs
Research and development costs are charged to operations when incurred and
are included in operating expenses. The amounts charged in 2004 and 2003
were $328,779 and $116,789, respectively.
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 through attendance at industry trade
exhibitions. The Company does not pay slotting fees, engage in cooperative
advertising programs, participate in buydown programs or similar
arrangements.
Advertising costs, except for costs associated with direct-response
advertising, are charged to operations when incurred. The costs of
direct-response advertising are capitalized and amortized over the period
during which future benefits are expected to be received. The Company did
not incur any direct-response advertising costs in 2004 and 2003,
respectively. Advertising costs included in selling expenses in the
accompanying consolidated financial statements amounted to $201,200 and
$65,900 in 2004 and 2003 respectively.
T. Shipping And Handling Costs
Shipping and handling cost represents cost incurred by the company to
transport its products. The company incurs shipping and handling costs
primarily by transporting goods using its own delivery vehicles or by
contracting with professional carriers.
The majority of goods are sold to customers in the Zhujiang Delta. For
those sales the Company uses its own delivery vehicles. Transportation and
Freight charges incurred for Company owned vehicles amounted to $57,579 and
$22,569 for 2004 and 2003, respectively. The charges incurred for
transportation by professional carriers amounted to $26,402 and $7,800 for
2004 and 2003, respectively.
For Sales made abroad the company incurs transportation charges for
delivery to the Port of Hong Kong which amounted to $18,621 and $ 6,537 for
2004 and 2003 respectively. All other transportation charges are borne by
the customer directly.
The Company does not bill the customer for any transportation charges
incurred. All transportation charges incurred by the company are recorded
as Selling Expenses in the accompanying consolidated financial statements.
13
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
3. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
U. Classification Of Operating Costs And Expenses
The Company records its operating costs and expenses generally with the
following classifications:
Cost of Goods Sold
------------------
Cost of goods sold consists primarily of raw materials, direct labor and
manufacturing overhead. Manufacturing overhead consists of an allocation of
purchasing and receiving costs, inspection fees, warehousing, office
expenses, utilities, supplies, factory and equipment repairs and
maintenance, safety equipment and supplies, packing materials, and loading
fees.
Selling Expenses
----------------
Selling Expenses consist primarily of transportation and freight charges,
travel and entertainment, maintenance, payroll, payroll taxes and benefits,
advertising and promotion, office expenses, telephone and utilities,
insurance, sales commissions and exports fees.
General and Administrative Expenses
-----------------------------------
General and Administrative expenses consist primarily of general office
expenses, travel and entertainment, transportation, payroll, payroll taxes
and benefits, maintenance, telephone and utilities, printing, advertising
and promotion, professional fees, continuing education, licenses and fees.
V. Recent Pronouncements
In July 2002, the FASB issued SFAS No. 146 "Accounting for Restructuring
Costs." SFAS 146 applies to costs associated with an exit activity
(including restructuring) or with a disposal of long-lived assets. Those
activities can include eliminating or reducing product lines, terminating
employees and contracts and relocating plant facilities or personnel. Under
SFAS 146, the Company will record a liability for a cost associated with an
exit or disposal activity when that liability is incurred and can be
measured at fair value. SFAS 146 will require the Company to disclose
information about its exit and disposal activities, the related costs, and
changes in those costs in the notes to the interim and annual consolidated
financial statements that include the period in which an exit activity is
initiated and in any subsequent period until the activity is completed.
SFAS 146 is effective prospectively for exit or disposal activities
initiated after December 31, 2002, with earlier adoption encouraged. Under
SFAS 146, a company cannot restate its previously issued consolidated
financial statements and the new statement grandfathers the accounting for
liabilities that a company had previously recorded under Emerging Issues
Task Force Issue 94-3.
14
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
3. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
V. Recent Pronouncements (Cont'd)
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure - an amendment of SFAS Statement No.
123, "Accounting for Stock Based Compensation" which provides alternative
methods for accounting for a change by registrants to the fair value method
of accounting for stock-based compensation. Additionally, SFAS 148 amends
the disclosure requirements of SFAS 123 to require disclosure in the
significant accounting policy footnote of both annual and interim
consolidated financial statements of the method of accounting for stock
based-compensation and the related pro forma disclosures when the intrinsic
value method continues to be used. The statement is effective for fiscal
years beginning after December 15, 2002, and disclosures are effective for
the first fiscal quarter beginning after December 15, 2002.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities".
The changes in SFAS No. 149 improve financial reporting by requiring that
contracts with comparable characteristics are accounted for similarly. This
statement is effective for contracts entered into or modified after June
30, 2003 and all of its provisions should be applied prospectively.
In May 2003, the FASB issued SFAS No. 150, "Accounting For Certain
Financial Instruments with Characteristics of both Liabilities and Equity".
SFAS No. 150 changes the accounting for certain financial instruments with
characteristics of both liabilities and equity that, under previous
pronouncements, issuers could account for as equity. The new accounting
guidance contained in SFAS No. 150 requires that those instruments be
classified as liabilities in the balance sheet.
SFAS No. 150 affects the issuer's accounting for three types of
freestanding financial instruments. One type is mandatory redeemable
shares, which the issuing company is obligated to buy back in exchange for
cash or other assets. A second type includes put options and forward
purchase contracts, which involves instruments that do or may require the
issuer to buy back some of its shares in exchange for cash or other assets.
The third type of instruments that are liabilities under this SFAS is
obligations that can be settled with shares, the monetary value of which is
fixed, tied solely or predominantly to a variable such as a market index,
or varies inversely with the value of the issuers' shares. SFAS No. 150
does not apply to features embedded in a financial instrument that is not a
derivative in its entirety.
15
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
3. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
V. Recent Pronouncements (Cont'd)
Most of the provisions of Statement 150 are consistent with the existing
definition of liabilities in FASB Concepts Statement No. 6, "Elements of
Financial Statements". The remaining provisions of this SFAS are consistent
with the FASB's proposal to revise that definition to encompass certain
obligations that a reporting entity can or must settle by issuing its own
shares. This SFAS shall be effective for financial instruments entered into
or modified after May 31, 2003 and otherwise shall be effective at the
beginning of the first interim period beginning after June 15, 2003, except
for mandatory redeemable financial instruments of a non-public entity, as
to which the effective date is for fiscal periods beginning after December
15, 2004.
In December, 2004 the FASB issued SFAS No. 153 "Exchanges of Non-monetary
Assets, an amendment of APB Opinion No. 29. The guidance in APB No. 29,
"Accounting for Non-monetary Transactions", is based on the principle that
exchanges of non-monetary assets should be measured on the fair value of
the assets exchanged. The guidance included certain exceptions to that
principle. This statement amends APB No. 29 to eliminate the exception for
non-monetary exchanges for similar productive assets and replaces it with
the general exception for exchanges of non-monetary assets that do not have
commercial substance. A non-monetary exchange has commercial substance if
the future cash flows of the entity are expected to change significantly as
a result of the exchange. This statement shall be effective for
non-monetary exchanges occurring in fiscal periods beginning after June 15,
2005. The Company does not believe that the adoption of this statement will
have a material effect on its consolidated financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN45"). FIN 45 elaborates on the
existing disclosure requirements for most guarantees, including loan
guarantees such as standby letters of credit. It also clarifies that at the
time a company issues a guarantee, the company must recognize an initial
liability for the fair market value of the obligations it assumes under the
guarantees and must disclose that information in its interim and annual
consolidated financial statements. The initial recognition and measurement
provisions of FIN 45 apply on a prospective basis to guarantees issued or
modified after December 31, 2002.
In January 2003, and as revised in December 2003, the FASB issued
Interpretation No. 46, "Consolidation of Variable Interest Entities"
"Interpretation No. 46"), an interpretation of Accounting Research Bulletin
("ARB") No. 51", "Consolidated financial statements". Interpretation No. 46
addresses consolidation by business enterprises of variable interest
entities, which have one or both of the following characteristics: (i) the
equity investment at risk is not sufficient to permit the entity to finance
its activities without additional subordinated support from other parties,
which is provided through another interest that will absorb some or all of
the expected losses of the entity; (ii) the equity investors lack one or
more of the following essential characteristics of a controlling financial
interest: the direct or indirect ability to make decisions about the
entity's activities through voting rights or similar rights; or the
obligation to absorb the expected losses of the entity if they occur, which
makes it possible for the entity to finance its activities; the right to
receive the expected residual returns of the entity if they occur, which is
the compensation for the risk of absorbing the expected losses.
16
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
3. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (cont'd)
V. Recent Pronouncements (cont'd)
Interpretation No. 46, as revised, also requires expanded disclosures by
the primary beneficiary (as defined) of a variable interest entity and by
an enterprise that holds a significant variable interest in a variable
interest entity but is not the primary beneficiary.
Interpretation No. 46, as revised, applies to small business issuers no
later than the end of the first reporting period that ends after December
15, 2004. This effective date includes those entities to which
Interpretation No. 46 had previously been applied. However, prior to the
required application of Interpretation No. 46, a public entity that is a
small business issuer shall apply Interpretation No. 46 to those entities
that are considered to be special-purpose entities no later than as of the
end of the first reporting period that ends after December 15, 2003.
Interpretation No. 46 may be applied prospectively with a cumulative-effect
adjustment as of the date on which it is first applied or by restating
previously issued financial statements for one or more years with a
cumulative-effect adjustment as of the beginning of the first year
restated.
Management does not expect these recent pronouncements to have a material
impact on the Company's consolidated financial position or results of
operations.
4. ACCOUNTS RECEIVABLE
The Company's accounts receivable at September 30, 2004 and 2003 are
summarized as follows:
2004 2003
$ $
Accounts receivable 21,763,923 7,220,263
Less: Allowance for doubtful accounts 764,362 461,980
---------- ----------
Accounts receivable, net 20,999,561 6,758,283
========== ==========
5. INVENTORIES
The Company's inventories at September 30, 2004 and 2003 are summarized as
follows:
2004 2003
$ $
Raw materials 9,934,263 2,643,542
Work in progress 1,872,465 425,698
Finished goods 17,729,257 4,924,541
---------- ----------
Total 29,535,985 7,993,781
========== ==========
17
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
6. LONG-TERM ASSETS
2004 2003
$ $
Building 4,535,876 --
Machinery 14,242,696 536,088
Vehicles 486,480 342,630
Office Equipment 304,773 90,019
Leasehold improvements 305,758 --
---------- ----------
Cost 19,875,583 4,968,737
---------- ----------
Less: Accumulated Depreciation
Building 19,024 --
Machinery 2,006,717 595,103
Vehicles 79,097 26,477
Office Equipment 53,402 22,036
Leasehold improvements 212,534 --
---------- ----------
Accumulated Depreciation 2,370,774 643,616
---------- ----------
Net Book Value 17,504,809 4,325,121
Land Use Rights 4,029,038 --
Construction in Progress 23,656,190 555,395
---------- ----------
Long-Term Assets - Net 45,190,037 4,880,516
========== ==========
Total depreciation expense for the years ended September 30, 2004 and 2003
was $1,727,158 and $378,875, respectively.
Construction in Progress consists of the following at September 30:
2004 2003
$ $
Land -- 120,821
Architect and engineering -- 13,109
Construction costs 18,258,222 12,082
Construction materials 790,864 --
Capitalized research and design 143,403 --
Other indirect costs 4,463,701 409,383
---------- ----------
Total 23,656,190 555,395
========== ==========
18
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
6. LONG-TERM ASSETS (cont'd)
The Company has funded much of the construction costs with cash flow from
operations and as such no interest expense has been capitalized. The
Company anticipates that the construction of the industry park will be
completed and placed into service by the end of 2005.
Land Use Rights
BAK has not yet obtained the certificate of land use right. The bureau of
city planning and land resource of Shenzhen have not yet approved the
application of BAK since the original zoning for the use of the land
conflicted with the city planning for education and biology and which is
presently being resulted to business use. According to the agreement with
the local government of Kuichong Township of Longgang district of Shenzhen,
BAK had paid approximately US$279,000 for the down payment of the land use
right and US$3,750,000 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 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 April, 2005. See Note 12, Contingencies and Commitments.
7. INTANGIBLE ASSETS
2004 2003
$ $
Trademarks 63,904 17,302
Less: Accumulated amortization 5,542 676
---------- ----------
Net book value 58,362 16,626
========== ==========
Amortization expense for the years ended September 30, 2004 and 2003 was US
$5,549 and US $676, respectively.
8. BANK INDEBTEDNESS AND NOTES PAYABLE
As of September 30, 2004 and 2003, the Company had several outstanding
short-term bank notes, which were used primarily to fund the construction
in progress. The notes, which had a cumulative balance of US$ 27,304,162
and US$ 3,479,480 for each respective year, carried interest rates ranging
from 4.536% to 5.841% and have maturity dates ranging from 5 to 12 months.
Each note, except for US$2,416,422, is guaranteed by Development and
Construction (Group) Company Limited By Shares ("Changchun Co.") of
Changchun Economic & Technology Development District, and/or Jilin Province
Huaruan Technology Company, Ltd. (a corporation owned by Xiangqian Li,
BAK's Chairman), related parties, and others who are not related. Neither
Huaran, nor Mr. Li, receive any compensation for acting as guarantor.
19
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
8. BANK INDEBTEDNESS AND NOTES PAYABLE (cont'd)
The Company is required to pledge cash in order to secure these short-term
bank loans and note payable. The amounts of those pledges, for the years
ending September 30, 2004 and 2003, are US$ 7,120,069 and US$ 820,692,
respectively. The cash pledged has been presented as "cash restricted" on
the balance sheet.
On September 30, 2004, contrary to relevant PRC laws and regulations, the
Company borrowed US$1,812,316 from Changzhou Lihai Investment Consulting
Co., Ltd. The Company subsequently repaid this loan on October 11, 2004.
Management believes that risk to the Company, due to this loan arrangement,
is very limited.
Notes payable, other represents promises to pay from customers received in
the ordinary course of business. The notes can generally be exchanged at a
discount for cash with financial institutions.
9. RESERVES
Pursuant to the accounting systems for business enterprises as promulgated
by the PRC, the profits of the 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 the 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
described in the preceding, 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, Company's are required to make annual appropriations
to two reserve funds, consisting of the statutory surplus and public
welfare funds. In accordance with the relevant PRC regulations and the
articles of association of the respective companies, the 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.
Net income as reported in the US GAAP consolidated financial statements
differs from that as reported in the PRC statutory consolidated financial
statements. In accordance with the relevant laws and regulations in the
PRC, the 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.
20
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
10. SIGNIFICANT CONCENTRATION
The Company grants credit to its customers, generally on an open account
basis.
BAK's five largest customers accounted for 38% of the sales in 2004, in
which only one customer was in excess of 10% of consolidated sales.
11. RELATED PARTY TRANSACTIONS
In October 2003, the Company acquired intangible assets from entities
controlled by its chairman and controlling shareholder. The amount due to
the chairman resulting from this transaction was effectively paid in cash,
in the amount of US$3,866,088, and was recorded at the fair market value of
the intangible, as determined by an independent appraisal firm. With
respect to consideration paid by the Company in excess of the chairman's
carrying cost of the intangible, such excess has been charged to retained
earnings, as a distribution to the chairman, resulting in the acquired
intangible being recorded by the Company at the chairman's original cost
basis.
The company has made short term advances to a former shareholder in the
amount of approximately $911,000. The advance bears no interest and has no
formal repayment terms. The advance is expected to be repaid during 2005.
On September 30, 2004, BAK Battery Company entered into an agreement with
HFG International LTD, in which HFG will provide financial consulting
services to the Company substantially in the form of the following, for a
period of one year in consideration of fee of $400,000.
As part of the agreement HFG would provide the Company, among other things,
advice on the development and implementation of 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 to assist the
Company with the solicitation of equity financing.
The fee is to be paid from the proceeds of the equity capital raised by HFG
on behalf of the Company. In January 2005 the Company was successful in
raising $17,000,000 from qualified investors in a private placement
offering. The fee to HFG will be recorded by the Company as a cost of
raising capital in 2005. The principal stockholder in HFG is also the
former Chief Executive Officer of Medina Coffee, Inc. The fee charged to
the Company for the services of HFG is on essentially the same terms as
those charged by HFG for financial consulting services performed for HFG's
other clients.
21
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
12. 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.
In the opinion of legal counsel, 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, the Company's legal counsel feels
that this possibility while present, and does exist is very small. At
a result, no provision has been made in the consolidated financial
statements for this potential occurrence.
2. 2004 - US$ 1,208,153 Guaranteed for Shenzhen Tongli, a non-related
party
2004 - US$ 1,208,153 Guaranteed for Shenzhen Zhengda, a non-related
party
2004 - US$ 18,122 Notes Receivable Discounted
The Company sells notes and accounts receivable from time to time to
banks at a discount. At the time of the sale all rights and privileges
of holding the note are transferred to the banks or suppliers. When
notes are sold, the Company removes the asset from its book with a
corresponding expense for the amount of the discount. The Company
remains contingently liable on a portion of the amount outstanding in
the event the note maker defaults. The company was contingently liable
at September 30, 2004 and 2003 in the amounts of $18,122 and $0,
respectively.
No provision has been made in the consolidated financial statements
for these contingencies.
BAK leases various factory and office space under short term operating
leases and is obligated under those leases in the amounts detailed
below as of September 30, 2004.
22
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
12. CONTINGENCIES AND COMMITMENTS (cont'd)
A Contingent liabilities (cont'd)
3. BAK and Development and Construction (Group) Company Limited By Shares
("Changchun Co.") of Changchun Economic & Technology Development
District, have entered into a Cross-Guaranty Agreement, dated February
20, 2004 (the "Agreement"), pursuant to which the parties were
obligated to guaranty a specified amount of each other's indebtedness
to specifically identified lending institutions. As of September 30,
2004, Chang Chu Jingkai had guaranteed indebtedness of the Company to
Longgang Division, Shenzhen Branch, Agricultural Bank of China
(Agricultural Bank) in the amount of USD$ 24,164,220 (The "BAK
Indebtedness"). As of September 30, 2004, BAK has not guaranteed any
indebtedness of Changchun Co. in accordance with the Agreement. On
December 22, 2004, the Company received from Changchun Co. a letter of
termination pursuant to which the Agreement was deemed terminated by
Changchun Co. and the Company was relieved of all obligations to
guaranty any indebtedness of Changchun Co. in the future. The
termination of the Agreement in no way effects Changchun Co.'s
continuing guaranty of the BAK Indebtedness.
4. Social Insurance of BAK's Employees:
As described in Note 3 (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. It is the opinion of legal counsel that BAK needs to
provide all employees with the required insurance.
In the event that any current employee, or former employee, files a
complaint with the government, not only will BAK be required to
purchase insurance for such employee, but BAK may be subject to
administrative fines. As the Company's legal counsel has advised that
these fines are nominal, no provision for any potential fines has been
made in the accompanying financial statement.
B. Commitments
1. Capital Commitments
BAK has commitments under construction contracts for the construction
of factory, office, and employee residence buildings, amounting to
$6,275,000. These contracts are contemplated to be completed at
various dates up to the end of the 2005 calendar year.
2. Lease commitment for factories: 2005 - US$ 717,127 2006 - US$ 159,273
23
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
13. CAPITAL CONTRIBUTION
During the year ended September 30, 2004 the existing stockholders
contributed cash to the Company in the amount of $10,875,918 which has been
recorded as an increase to additional paid-in capital in the accompanying
consolidated financial statements.
14. BUSINESS SEGMENT AND GEOGRAPHIC AREA DATA
The Company currently operates one business segment: the replacement
battery market. We manufacture of three types of batteries: steel cell,
aluminum cell and cylindrical cell. Our products are delivered to packing
plants operated by third parties primarily for use in mobile phones and
other electronic devices. Revenues by product were as follows for 2004 and
2003:
Product Sales
-------------
2004 2003
----------------- -----------------
$ % $ %
(000's) (000's)
Steel Cell 50.41 79.1 19.68 98.2
Aluminum Cell 13.08 20.5 .28 1.4
Cylindrical Cell .26 .4 .09 .4
------- ------- ------- -------
Total 63.75 100.0 20.05 100.0
------- ------- ------- -------
Geographic Area Information
---------------------------
Revenues
Domestic Sales - PRC 43.36 68.0 16.37 81.7
Foreign Sales 20.39 32.0 3.68 18.3
------- ------- ------- -------
Total 63.75 100.0 20.05 100.0
------- ------- ------- -------
Property, Plant & Equipment - Net
---------------------------------
Domestic - PRC 45.19 100.0 4.88 100.0
Foreign -- -- -- --
------- ------- ------- -------
Total 45.19 100.0 4.88 100.0
------- ------- ------- -------
The above geographic area data includes trade revenues based on product
shipment destination and property, plant and equipment based on physical
location.
24
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
15. INCOME TAXES
U.S. PRC Total
------- ------- -------
$ $ $
(000's)
Income Before Provision for Taxes
---------------------------------
2004 -- 7,141 7,141
2003 -- 3,576 3,576
Provision for Taxes
-------------------
2004
----
Current -- 394 394
Deferred -- -- --
------- ------- -------
Total -- 394 394
------- ------- -------
2003
Current -- -- --
Deferred -- -- --
------- ------- -------
Total -- -- --
------- ------- -------
Principle reconciling items from income tax computed at the statutory rates
are as follows:
2004 2003
$ $
Computed Tax at statutory rate - PRC - 15% 1,071 537
Non-Deductible Items 15 --
Tax Holiday - PRC (692) (537)
------- -------
Total Provision for Taxes 394 --
------- -------
As of September 30, 2004 and 2003, the Company has no deferred tax assets
or liabilities and is not liable for any taxes in the United States or any
other foreign jurisdictions outside the PRC.
25
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
(Amounts expressed in US Dollars)
16. WARRANTY RESERVES
Warranty Reserves consists of the following at September 30:
2004 2003
$ $
Balance, beginning of year 95,874 --
Add: Provision for warranty claims 3,507,151 1,486,525
Less: Claims paid (3,382,522) (1,390,651)
---------- ----------
Balance, end of year 220,503 95,874
========== ==========
Warranty expense amounted to $3,507,151 and 1,486,525 for the years ended
September 30, 2004 and 2003, respectively and is included in cost of goods
sold in the accompanying consolidated financial statements.
17. SUBSEQUENT EVENTS
On November 6, 2004, BAK International Limited, a company controlled by the
chairman of BAK, purchased 30,225,642 shares of BAK from existing
shareholders for cash consideration of $11,500,000. This resulted in BAK
becoming a wholly owned subsidiary of BAK International Limited. See Note
1.
On January 20, 2005, BAK International Limited closed a private placement
of its securities with unrelated investors whereby it issued an aggregate
of 8,600,433 shares of common stock for gross proceeds of $17,000,000. The
cash and shares of common stock will be held in escrow until the completion
of the reverse merger transaction described in Note 1 and the filing of a
registration statement with the Securities and Exchange Commission as
described in the following paragraph.
On January 20, 2005, BAK International Limited acquired a 97.2% controlling
interest in Medina Coffee, Inc. through a share exchange agreement, a
reverse merger transaction. Medina Coffee, Inc. (a Nevada public company)
issued 39,826,075 shares of its common stock for all of the outstanding
shares of BAK International Limited. The transaction has been accounted for
as a recapitalization of BAK International Limited whereby the historical
operations of BAK International Limited and its wholly owned subsidiary,
BAK, become the historical operations of Medina Coffee, Inc. with no
adjustments to the historical basis of the assets and liabilities.
26
BAK INTERNATIONAL LIMITED AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 and 2003
(Amounts Expressed in US Dollars)
(Unaudited)
BAK INTERNATIONAL LIMITED AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 and 2003
(Amounts Expressed in US Dollars)
(Unaudited)
TABLE OF CONTENTS
Consolidated Balance Sheets at December 31, 2004 and September 30, 2004 1
Consolidated Statements of Operations for
the Three Months Ended December 31, 2004 and 2003 2
Consolidated Statements of Changes in Stockholders' Equity for the Three
Months Ended December 31, 2004 and 2003 3
Consolidated Statements of Cash Flows for the Three Months Ended
December 31, 2004and 2003 4
Notes to Consolidated Financial Statements 5 - 12
BAK International Limited and Subsidiary
Consolidated Balance Sheets
As of December 31, 2004 and September 30, 2004
(Amounts Expressed in US Dollars)
(Unauidted)
Assets
------
December 31, September 30,
2004 2004
$ $
(Audited)
Current Assets
Cash 3,257,064 3,212,176
Cash -Restricted 7,927,020 7,120,069
Accounts Receivable, Net 26,876,898 20,999,561
Inventories 19,300,759 29,535,985
Prepaid Expenses 409,172 1,330,645
Notes Receivable 455,645 18,122
Accounts Receivable - Related Party 532,680 911,093
------------- -------------
Total Current 58,759,238 63,127,651
------------- -------------
Long-Term Assets
Property, Plant, & Equipment 21,176,567 19,875,583
Construction in Progress 27,026,623 23,656,190
Land Use Rights 4,029,038 4,029,038
Less Accumulated Depreciation (3,119,592) (2,370,774)
------------- -------------
Long-term Assets, Net 49,112,636 45,190,037
------------- -------------
Other Assets
Other Receivables 312,579 225,972
Intangible Assets, Net 52,453 58,362
------------- -------------
Total other 365,032 284,334
------------- -------------
Total Assets 108,236,906 108,602,022
============= =============
Liabilities and Stockholders' Equity
------------------------------------
Current Liabilities
Accounts Payable 20,783,113 23,570,087
Bank Loans, Short Term 29,118,589 27,304,162
Short Term Loans -- 1,812,316
Notes Payable, Other 23,446,018 20,772,559
Land Use Rights Payable 3,751,028 3,750,756
Construction Costs Payable 7,094,405 6,347,846
Customer Deposits 232,044 369,390
Accrued Expenses 2,583,594 5,247,656
Other Liabilities 181,494 181,223
------------- -------------
Total Current 87,190,284 89,355,995
------------- -------------
Stockholders' Equity
Capital Stock-$.001 Par Value; 100,000,000 Shares 31,226 31,226
Authorized; 31,225,642 Shares Issued and Outstanding
Additional Paid In Capital 12,052,845 12,052,845
Accumulated Comprehensive Income (Loss) (1,669) (144)
Reserves 1,917,087 1,724,246
Retained Earnings 7,047,133 5,437,854
------------- -------------
21,046,622 19,246,027
------------- -------------
Total Liabilities and Stockholders' Equity 108,236,906 108,602,022
============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
1
BAK International Limited and Subsidiary
Consolidated Statements of Operations
For The Three Months Ended December 31, 2004 and 2003
(Amounts Expressed in US Dollars)
(Unaudited)
2004 2003
$ $
Revenues, Net of Returns 25,126,265 15,584,387
Cost of Goods Sold 20,021,337 11,991,689
----------- -----------
Gross Profit 5,104,928 3,592,698
----------- -----------
Expenses:
Selling Expense 806,018 432,385
General and Administrative Expenses 1,120,971 491,026
Research and Development 20,020 91,807
Bad Debts Expense (Recovery) 51,235 (12,286)
Depreciation and Amortization 754,727 189,777
----------- -----------
Total Expenses 2,752,971 1,192,709
----------- -----------
Operating Income 2,351,957 2,399,989
Other Expense
Finance Costs 389,650 50,672
Other Expense 16,120 9,000
----------- -----------
Net Income Before Provision for Income Taxes 1,946,187 2,340,317
Provision for Income Taxes 144,067 --
----------- -----------
Net Income 1,802,120 2,340,317
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
2
BAK International Limited and Subsidiary
Consolidated Statements of Changes in Stockholders' Equity
For The Three Months Ended December 31, 2004 and 2003
(Amounts Expressed in US Dollars)
(Unaudited)
Par Value Additional
Number of Common Paid-In Retained
Shares Stock Capital Earnings
------------- ------------- ------------- -------------
$ $ $
Balance - September 30, 2003 31,225,642 31,226 1,176,927 3,630,298
Capital Contribution -- -- 10,873,899 --
Net Income (Loss) -- -- -- 2,340,317
Transfer to Reserve -- -- -- (334,274)
Deemed Distribution to Shareholders -
Intangible Assets -- -- -- (3,866,088)
Foreign Currency Translation -- -- -- --
------------- ------------- ------------- -------------
Balance - December 31, 2003 31,225,642 31,226 12,050,826 1,770,253
------------- ------------- ------------- -------------
Balance - September 30, 2004 31,225,642 31,226 12,052,845 5,437,854
Net Income -- -- -- 1,802,120
Transfer to Reserves -- -- -- (192,841)
Foreign Currency Translation -- -- -- --
------------- ------------- ------------- -------------
Balance - December 31, 2004 31,225,642 $ 31,226 $ 12,052,845 $ 7,047,133
============= ============= ============= =============
All Other
Comprehensive Stockholders'
Reserves Income (Loss) Equity
------------- ------------- -------------
$ $ $
Balance - September 30, 2003 651,583 (49) 5,489,985
Capital Contribution -- -- 10,873,899
Net Income (Loss) -- -- 2,340,317
Transfer to Reserve 334,274 -- --
Deemed Distribution to Shareholders -
Intangible Assets -- -- (3,866,088)
Foreign Currency Translation -- 107 107
------------- ------------- -------------
Balance - December 31, 2003 985,857 58 14,838,220
------------- ------------- -------------
Balance - September 30, 2004 1,724,246 (144) 19,246,027
Net Income -- -- 1,802,120
Transfer to Reserves 192,841 -- --
Foreign Currency Translation -- (1,525) (1,525)
------------- ------------- -------------
Balance - December 31, 2004 $ 1,917,087 $ (1,669) $ 21,046,622
============= ============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
3
BAK International Limited and Subsidiary
Consolidated Statements of Cash Flows
For The Three Months Ended December 31, 2004 and 2003
(Amounts Expressed in US Dollars)
(Unaudited)
2004 2003
$ $
Cash Flows from Operating Activities
Net Income 1,802,120 2,340,317
Adjustments to reconcile net income to net cash
from operating activities:
Bad debt expense 51,235 (12,286)
Depreciation and Amortization 754,727 189,777
Changes in Assets and Liabilities:
Accounts Receivable (5,947,411) (2,434,155)
Inventory 10,235,226 989,236
Prepaid Expenses and Deposits 921,473 (1,462,544)
Account Receivable-Related Party 378,413 (506,728)
Other Receivables (67,767) (553,287)
Note Receivable (437,523) (257,411)
Accounts Payable (2,786,974) 2,851,989
Customer Deposits (137,346) (224,899)
Accrued Expenses (2,664,062) 93,083
Construction Costs Payable 746,559 --
Other Liabilities 271 60,417
Land Use Right Payable 272 --
Deferred Expenses -- (27,360)
----------- -----------
Net Cash Flows from Operating Activities 2,849,213 1,046,149
----------- -----------
Cash Flows from Investing Activities
Acquisition of Property and Equipment (1,300,986) (2,805,621)
Construction in Progress (3,370,433) (8,586,825)
Investment in Intangible Assets -- (5,685)
----------- -----------
Net Cash Flows from Investing Activities (4,671,419) (11,398,131)
----------- -----------
Cash Flows from Financing Activities
Proceeds from Borrowings 21,519,898 10,006,855
Repayment of Borrowing (18,844,328) (4,821,945)
Cash Pledged To Bank (806,951) --
Capital Contribution -- 10,873,899
Deemed Distribution to Shareholders - Intangible Assets -- (3,866,088)
----------- -----------
Net Cash flows from Financing Activities 1,868,619 12,192,721
----------- -----------
Effect of Exchange Rate Changes on Cash (1,525) 107
Net Increase (Decrease) in Cash 44,888 1,840,846
Cash - Beginning of Period 3,212,176 670,925
----------- -----------
Cash - End of Period 3,257,064 2,511,771
=========== ===========
Supplemental Cash Flow Disclosures:
Interest Paid 313,195 52,798
=========== ===========
Income Taxes Paid 94,858 --
=========== ===========
The accompanying notes are an integral part of these consoldiated financial
statements.
4
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(Amounts Expressed in US Dollars)
(Unaudited)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements of BAK International
Limited and subsidiary (the "Company") included herein have been prepared
by the Company, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission (the "SEC"). Certain information and
footnote disclosures normally included in financial statements prepared in
conjunction with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations, although the
Company believes that the disclosures are adequate to make the information
presented not misleading. These condensed consolidated financial statements
should be read in conjunction with the annual audited consolidated
financial statements and the notes thereto included in the Company's annual
report on Form 10-KSB, and other reports filed with the SEC.
The accompanying unaudited interim consolidated financial statements
reflect all adjustments of a normal and recurring nature which are, in the
opinion of management, necessary to present fairly the financial position,
results of operations and cash flows of the Company for the interim periods
presented. The results of operations for these periods are not necessarily
comparable to, or indicative of, results of any other interim period or for
the fiscal year taken as a whole. Factors that affect the comparability of
financial data from year to year and for comparable interim periods include
non-recurring expenses associated with the Company's registration with the
SEC, costs incurred to raise capital and stock awards.
The condensed consolidated financial statements are prepared in accordance
with generally accepted accounting principles used in the United States of
America and include the accounts of BAK International Limited and Shenzhen
BAK Battery Co, Ltd. for all periods presented. All significant
intercompany balances and transactions have been eliminated on
consolidation.
5
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(Amounts Expressed in US Dollars)
(Unaudited)
2. RECAPITALIZATION TRANSACTION
On January 20, 2005, Medina Coffee, Inc. completed a stock exchange
transaction with the stockholders of BAK International Limited., a Hong
Kong company, or BAK International. The exchange was consummated under
Nevada law pursuant to the terms of a Securities Exchange Agreement dated
effective as of January 3, 2005 by and among Medina, BAK International and
the stockholders of BAK International. Pursuant to the Securities Exchange
Agreement, the Company issued 39,826,075 shares of common stock, par value
$0.001 per share, to the stockholders of BAK International (31,225,642
Shares are original shareholders of BAK and 8,600,433 Shares to new
investors), representing approximately 97.2% of the Medina 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 Shenzhen BAK Battery Co., Ltd., a Chinese
corporation and BAK International's wholly-owned subsidiary, or BAK
Battery.
The reverse merger transaction has been accounted for as a recapitalization
of BAK International whereby the historical financial statements and
operations of BAK become the historical financial statements of the
Registrant with no adjustment to the carrying value of the assets and
liabilities. The accompanying financial statements reflect the
recapitalization of the stockholders equity as if the transaction occurred
as of the beginning of the first period presented.
3. ORGANIZATION AND PRINCIPAL ACTIVITIES
BAK International Limited 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. BAK International Limited acquired 100% of the outstanding shares of
Shenzhen BAK Battery Co., Ltd ("BAK") for a total consideration of USD$11.5
million on November 6, 2004. Simultaneously, the former shareholders of BAK
acquired 96.8% of the issued shares of BAK International Limited.
Consequently, the shareholders of BAK International Limited are
substantially the same as the former shareholders as BAK therefore the
transaction has 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 consolidated as though the transaction occurred as of the
beginning of the first accounting period presented in these financial
statements. See note 6 - Subsequent Events.
6
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(Amounts Expressed in US Dollars)
(Unaudited)
3. ORGANIZATION AND PRINCIPAL ACTIVITIES (cont'd)
Shenzhen BAK Battery Co., Ltd. ("BAK") was founded on August 3, 2001 as a
China-based company specializing in lithium ion (known as "Li-ion" or
"Li-ion cell") battery cell production, for use in the replacement battery
market, primarily for cell phones in the Peoples Republic of China (PRC).
The Company is subject to the consideration and risks of operating in the
PRC. These include risks associated with the political and economic
environment, foreign currency exchange and the legal system in the PRC.
The economy of PRC differs significantly from the economies of the
"western" industrialized nations in such respects as structure, level of
development, gross national product, growth rate, capital reinvestment,
resource allocation, self-sufficiency, rate of inflation and balance of
payments position, among others. Only recently has the PRC government
encouraged substantial private economic activities. The Chinese economy has
experienced significant growth in the past several years, but such growth
has been uneven among various sectors of the economy and geographic
regions. Actions by the PRC government to control inflation have
significantly restrained economic expansion in the recent past. Similar
actions by the PRC government in the future could have a significant
adverse effect on economic conditions in PRC.
Many laws and regulations dealing with economic matters in general and
foreign investment in particular have been enacted in the PRC. However, the
PRC still does not have a comprehensive system of laws, and enforcement of
existing laws may be uncertain and sporadic.
The Company's operating assets and primary sources of income and cash flows
are of interests in the PRC. The PRC economy has, for many years, been a
centrally-planned economy, operating on the basis of annual, five-year and
ten-year state plans adopted by central PRC governmental authorities, which
set out national production and development targets. The PRC government has
been pursuing economic reforms since it first adopted its "open-door"
policy in 1978. There is no assurance that the PRC government will continue
to pursue economic reforms or that there will not be any significant change
in its economic or other policies, particularly in the event of any change
in the political leadership of, or the political, economic or social
conditions in, the PRC. There is also no assurance that the Company will
not be adversely affected by any such change in governmental policies or
any unfavorable change in the political, economic or social conditions, the
laws or regulations, or the rate or method of taxation in the PRC.
7
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(Amounts Expressed in US Dollars)
(Unaudited)
3. ORGANIZATION AND PRINCIPAL ACTIVITIES (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 analysis and
monitors the financial condition of its clients in order to minimize credit
risk.
Any devaluation of the Renminbi (RMB) against the United States dollar
would consequently have adverse effects on the Company's financial
performance and asset values when measured in terms of the United States
dollar. Should the RMB significantly devalue against the United States
dollar, such devaluation could have a material adverse effect on the
Company's earnings and the foreign currency equivalent of such earnings.
The Company does not hedge its RMB - United States dollar exchange rate
exposure.
On January 1, 1994, the PRC government introduced a single rate of exchange
as quoted daily by the People's Bank of China (the "Unified Exchange
Rate"). No representation is made that the RMB amounts have been, or could
be, converted into US$ at that or any rate. This quotation of exchange
rates does not imply 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.
8
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(Amounts Expressed in US Dollars)
(Unaudited)
4. RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 151 "Inventory
Costs - an amendment of ARB No. 43, Chapter 4" ("SFAS 151"). This statement
amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to
clarify the accounting for abnormal amounts of idle facility expense,
freight, handling costs, and wasted material (spoilage). SFAS 151 requires
that those items be recognized as current-period charges. In addition, this
Statement requires that allocation of fixed production overheads to costs
of conversion be based upon the normal capacity of the production
facilities. The provisions of SFAS 151 are effective for fiscal years
beginning after June 15, 2005. As such, the Company is required to adopt
these provisions at the beginning of the fiscal year ended December 31,
2006. The Company is currently evaluating the impact of SFAS 151 on its
consolidated financial statements.
In December 2004, the FASB issued SFAS No. 152 "Accounting for Real Estate
Time-Sharing Transactions - an amendment of FASB Statements No. 66 and 67"
("SFAS 152"). This statement amends FASB Statement No. 66 "Accounting for
Sales of Real Estate" to reference the financial accounting and reporting
guidance for real estate time-sharing transactions that is provided in
AICPA Statement of Position 04-2 "Accounting for Real Estate Time-Sharing
Transactions" ("SOP 04-2"). SFAS 152 also amends FASB Statement No. 67
"Accounting for Costs and Initial Rental operations of Real Estate
Projects" to state that the guidance for incidental operations and costs
incurred to sell real estate projects does not apply to real estate
time-sharing transactions, with the accounting for those operations and
costs being subject to the guidance in SOP 04-2. The provisions of SFAS 152
are effective in fiscal years beginning after June 15, 2005. As such, the
Company is required to adopt these provisions at the beginning of the
fiscal year ended December 31, 2006. The Company is currently evaluating
the impact of SFAS 152 on its consolidated financial statements.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets - an amendment of APB Opinion No. 29" ("SFAS 153"). SFAS 153
replaces the exception from fair value measurement in APB Opinion No. 29
for nonmonetary exchanges of similar productive assets with a general
exception from fair value measurement for exchanges of nonmonetary assets
that do not have commercial substance. A nonmonetary exchange has
commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. SFAS 153 is effective for
all interim periods beginning after June 15, 2005. As such, the Company is
required to adopt these provisions at the beginning of the fiscal quarter
ended September 30, 2005. The Company is currently evaluating the impact of
SFAS 153 on its consolidated financial statements.
9
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(Amounts Expressed in US Dollars)
(Unaudited)
4. RECENTLY ISSUED ACCOUNTING STANDARDS (cont'd)
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment"
("SFAS 123R"). SFAS 123R revises FASB Statement No. 123 "Accounting for
Stock-Based Compensation" and supersedes APB Opinion No. 25 "Accounting for
Stock Issued to Employees". SFAS 123R requires all public and non-public
companies to measure and recognize compensation expense for all stock-based
payments for services received at the grant-date fair value, with the cost
recognized over the vesting period (or the requisite service period). SFAS
123R is effective for non-small business issuers for all interim periods
beginning after June 15, 2005. SFAS 123R is effective for small business
issuers for all interim periods beginning after December 15, 2005. As such,
the Company is required to adopt these provisions at the beginning of the
fiscal quarter ended September 30, 2005. Retroactive application of the
provisions of SFAS 123R to the beginning of the fiscal year that includes
the effective date is permitted, but not required. The Company is currently
evaluating the impact of SFAS 123R on its consolidated financial
statements.
5. 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.
10
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(Amounts Expressed in US Dollars)
(Unaudited)
5. CONTINGENCIES AND COMMITMENTS (cont'd)
A. Contingent Liabilities (cont'd)
1. Land Use and Ownership Certificate: (cont'd)
In the opinion of legal counsel, 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, the Company's legal counsel feels
that this possibility while present, and does exist is very small. At
a result, no provision has been made in the financial statements for
this potential occurrence.
2. 2004 - US$ 1,208,153 Guaranteed for Shenzhen Tongli, a non-related
party
2004 - US$ 1,208,153 Guaranteed for Shenzhen Zhengda, a non-related
party
2004 - US$ 455,645 Notes Receivable Discounted
The Company sells notes and accounts receivable from time to time to
banks at a discount. At the time of the sale all rights and privileges
of holding the note are transferred to the banks or suppliers. When
notes are sold, the Company removes the asset from its book with a
corresponding expense for the amount of the discount. The Company
remains contingently liable on a portion of the amount outstanding in
the event the note maker defaults. The company was contingently liable
at December 31, 2004 and 2003 in the amounts of $455,645 and $257,411,
respectively.
No provision has been made in the financial statements for these
contingencies.
3. BAK and Development and Construction (Group) Company Limited By Shares
("Changchun Co.") of Changchun Economic & Technology Development
District, have entered into a Cross-Guaranty Agreement, dated February
20, 2004 (the "Agreement"), pursuant to which the parties were
obligated to guaranty a specified amount of each other's indebtedness
to specifically identified lending institutions. As of December 22,
2004, Chang Chu Jingkai had guaranteed indebtedness of the Company to
Longgang Division,Shenzhen Branch, Agricultural Bank of China
(Agricultural Bank) in the amount of USD$ 24,164,220 (The "BAK
Indebtedness"). BAK has not guaranteed any indebtedness of Changchun
Co. in accordance with the Agreement. On December 22, 2004, the
Company received from Changchun Co. a letter of termination pursuant
to which the Agreement was deemed terminated by Changchun Co. and the
Company was relieved of all obligations to guaranty any indebtedness
of Changchun Co. in the future. The termination of the Agreement in no
way effects Changchun Co.'s continuing guaranty of the BAK
Indebtedness.
11
BAK International Limited and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(Amounts Expressed in US Dollars)
(Unaudited)
5. CONTINGENCIES AND COMMITMENTS (cont'd)
4. Social Insurance of BAK's Employees:
BAK is required to cover employees with various types of social
insurance. Although all insurances have been purchased for management
employees, BAK has not fully covered other employees. It is the
opinion of legal counsel that BAK needs to provide all employees with
the required insurance.
In the event that any current employee, or former employee, files a
complaint with the government, not only will BAK be required to
purchase insurance for such employee, but BAK may be subject to
administrative fines. As the Company's legal counsel has advised that
these fines are nominal, no provision for any potential fines has been
made in the accompanying financial statement.
B. Commitments
1. Capital Commitments
BAK has commitments under construction contracts for the construction
of factory, office, and employee residence buildings, amounting to
$3,337,602. These contracts are contemplated to be completed at
various dates up to the end of the 2005 calendar year.
2. Lease commitment for factories: 2005 - US$ 717,127 2006 - US$ 159,273
6. SUBSEQUENT EVENTS
On January 20, 2005, BAK International closed a private placement of its
securities with unrelated investors whereby it issued an aggregate of
8,600,433 shares of common stock for gross proceeds of $17,000,000. The
cash and shares of common stock will be held in escrow until the completion
of the reverse merger transaction described in Note 2 and the filing of a
registration statement with the Securities and Exchange Commission. In
conjunction with this financing, the Chief Executive Officer and major
shareholder of the Company agreed to place 2,179,550 shares of the
Company's common stock owned by him into an escrow account, of which 50%
are to be released to the investors in the private placement if audited net
income for the fiscal year ending September 30, 2005 is not at least
$12,000,000 and of which 50% are to be released to investors in the private
placement if audited net income for the fiscal year ending September 30,
2006 is not at least $27,000,000.
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