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ADVANCED BATTERY TECHNOLOGIES, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements: No Assurances Intended In addition to historical information, this Quarterly Report contains forward-looking statements, which are generally identifiable by use of the words "believes," "expects," "intends," "anticipates," "plans to," "estimates," "projects," or similar expressions. These forward-looking statements represent Management's belief as to the future of Advanced Battery Technologies. Whether those beliefs become reality will depend on many factors that are not under Management's control. Many risks and uncertainties exist that could cause actual results to differ materially from those reflected in these forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in Section 1A of our Annual Report on Form 10-K for the year ended December 31, 2010, entitled "Risk Factors." Readers are cautioned not to place undue reliance on these forward-looking statements. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Recent Developments in our Business In January 2011 Harbin ZQPT, a wholly-owned subsidiary of the Company, acquired all of the assets of Shenzhen Zhongqiang New Energy Science & Technology Co., Ltd. ("Shenzhen ZQ"). Shenzhen ZQ was a manufacturer of lithium batteries for mobile phones and MP3, MP4 and video game consoles, whose manufacturing facility has a daily production capacity of 70,000 batteries per day. Shenzhen ZQ's annual revenues in 2010 were approximately $11 million. The purchase price paid by Harbin ZQPT for the Shenzhen ZQ liabilities was $20 million, of which $16.9 million was applied to satisfy liabilities of Shenzhen ZQ. On January 5, 2011 Cashtech Investment Limited, a wholly-owned subsidiary of the Company, purchased the land and buildings at 3 Middle, Qingxi Town, Dongguan City, Guangdong Province, China. The buildings consist of four industrial facilities with a total of 36,468 square meters of floor space, an office building with 5246 square meters, three dormitories with a total of 14,710 square meters, and a power supply facility, and the associated land use right. The purchase price was 176 million RMB (approximately $26 million). Those assets have been transferred to a wholly-owned subsidiary of the Company named "Dongguan QiangQiang New Energy Technology Co., Ltd." The Company is developing the property as the center of an industrial park in Dongguan City. The new property is now under infrastructure construction and according to Company estimates the commissioning date will be in October 2011. Results of Operations The following tables present certain consolidated statement of operations information. Financial information is presented for the three and six months ended June 30, 2011 and 2010 respectively. For the Three Months Ended June 30, Change 2011 2010 Amount % Revenues $ 31,350,652 $ 22,835,358 $ 8,515,294 37.3 % Cost of Goods Sold 17,931,598 11,796,140 6,135,458 52.0 % Gross Profit 13,419,054 11,039,218 2,379,836 21.6 % Operating Expenses 2,374,649 1,992,831 381,818 19.16 % Operating Income 11,044,407 9,046,387 1,998,020 22.09 % Other Income 2,235,884 4,271,411 (2,035,527 ) 47.7 % Net Income $ 10,272,205 $ 12,510,238 $ (2,238,033 ) -17.9 % Gross margin 42.80 % 48.34 % -5.54 % For the Six Months Ended June 30, Change 2011 2010 Amount % Revenues $ 59,992,387 42,384,375 $ 17,608,012 41.5 % Cost of Goods Sold 34,739,768 21,729,456 13,010,312 59.9 % Gross Profit 25,252,619 20,654,919 4,597,700 22.3 % Operating Expenses 4,405,087 4,608,780 (203,693 ) -4.4 % Operating Income 20,847,534 16,046,139 4,801,393 29.9 % Other Income 11,358,477 5,544,823 5,813,654 104.8 % Net Income $ 27,241,411 20,034,811 $ 7,206,600 36 % Gross margin 42.1 % 48.71 % -6.64 % 38-------------------------------------------------------------------------------- Revenues We had total revenues of $ 31,350,652 for the three months ended June 30, 2011, an increase of $8,515,294 or 37.3%, compared to $22,835,358 for the three months ended June 30, 2010. For the six months ended June 30, 2011, total revenues of $59,992,387 represented an increase of $17,608,012 or 41.5%, compared to $42,384,375 for the six months ended June 30 2010. The increase in revenues was primarily due to the contribution of revenues from: 1. Wuxi ZQ. Wuxi ZQ revenues of $13,209,066 for the three months and $25,943,022 for the six months ended June 30, 2011 represented increases of $565,895 and $4,239,398 compared to revenues during the three and six months ended June 30, 2010. 2. Shenzhen-based Operations. We acquired the assets of Shenzhen ZQ in January, 2011. The three and six month revenue for the periods ended June 30, 2011 attributable to our new Shenzhen operations was $5,253,910 and $9,602,091, respectively. 3. Harbin-based Operations. Revenues of $12,896,872 and $24,447,274 from our Harbin- based battery operations for the three and six months ended June 30, 2011 represented increases of 26.4% and 18.2% respectively compared to the comparable periods ended June 30, 2010. In the three and six month periods ended June 30, 2011 and 2010, the contribution of batteries in our four sales categories as well as the contribution of electric vehicles to our total revenues was: For the Three Months Ended June 30, % (of total 2010 % (of total 2011 revenue) revenue) Small Capacity Battery $ 6,776,254 21.61% $ 870,283 3.81% Medium Capacity Battery 5,974,933 19.06% 2,691,335 11.79% Large Capacity Battery 4,290,365 13.69% 4,111,822 18.01% Miner's Lamp 1,100,034 3.51% 2,527,944 11.07% Electric Vehicle 13,209,066 42.13% 12,633,974 55.33% Total $ 31,350,652 100.00% $ 22,835,358 100.00% 39-------------------------------------------------------------------------------- For the Six Months Ended June 30, % (of % (of total 2010 total 2011 revenue) revenue) Small Capacity Battery $ 12,317,264 20.53% $ 2,067,985 4.88% Medium Capacity Battery 8,626,406 14.38% 7,558,590 17.83% Large Capacity Battery 11,465,325 19.11% 6,589,801 15.55% Miner's Lamp 1,640,370 2.73% 4,464,374 10.53% Electric Vehicle 25,943,022 43.25% 21,703,624 51.21% Total $ 59,992,387 100.00% $ 42,384,375 100.00% The increase in the portion of our revenue attributable to small capacity batteries is primarily attributable to the $9,602,091 contributed by our new Shenzhen operations during the first six months of 2011. In recent years, we had reduced our focus on this market, as we found it difficult to achieve high margins on small capacity batteries, primarily due to the extensive amount of competition. Our current expectation, however, is that, in time, the advanced technology and facilities that we acquired from Shenzhen ZQ, along with the established customer list, will allow us to achieve worthwhile margins in the small capacity battery sector. For that reason we expect that the focus of operations at the Dongguan industrial park that we currently have under construction will be in large part on small capacity batteries. Even with the acquisition of the Shenzhen production facility, which is focused on small capacity batteries, we continue to expect large capacity batteries to lead the growth of our battery segment. In line with that expectation, sales of the large capacity batteries (used for electric sanitation vehicles, stationary applications, and other large scale battery applications) increased by 74% from the first six months of 2010 to the first six months of 2011. We expect continued growth in this sector in coming years, as China' strong recent emphasis on environmentally sound growth should result in expansion of the electric vehicle industry in China. The contribution of miner's lamps to our revenue has diminished significantly in recent quarters. Our expansion in this market had been driven by a three year contract that we made in 2006 with a Hong Kong-based mining company. Since that contract expired, we have been unable to replace the sales. At June 30, 2011 we had a backlog of $61,230,000 for delivery through the next 6 months, including a battery backlog of approximately $33,030,000. Gross Profit. Our cost of goods sold consists of the cost of raw materials, labor costs and production overhead. In the three months ended June 30, 2011, our revenue increased by 37.3% but our cost of goods sold increased by 52%, from $11,796,140 to $17,931,598, compared to the same period in 2010. Similarly, cost of goods sold for the six months ended June 30, 2011 increased by 60% compared to the first half of 2010, although revenue increased by only 42%. The disproportionate increase on our cost of goods sold primarily occurred because the $9,602,091 in sales of small capacity batteries generated from our new Shenzhen facility yielded a low margin relative to our other revenue. The overall result was a decrease in our gross margin from 48% in the three months ended June 30, 2010 to 43% in the same period of 2011, and from 49% in the first half of 2010 to 42% in the first half of 2011. Although we believe that we will be able to improve the profitability of the Shenzhen operation, our gross margins for the remainder of 2011 are likely to remain lower than in 2010 due to the inclusion of Shenzhen sales. 40-------------------------------------------------------------------------------- Operating Expenses; Operating Income The Company's operating expenses increased by 21%, from $1,992,831 in the three months ended June 30, 2010 to $2,374,648 in the three months ended June 30, 2011. The primary reason for the increase was the fact that operating expenses of the Shenzhen operation that we acquired in January 2011 were included in our 2011 results. In addition, research and development expenses increased by $259,277 from the second quarter of 2010 to the second quarter of 2011. These increases were partially offset by a bad debt expense of $160,000 incurred in the second quarter of 2010 that was not replicated in 2011. Despite the increase in second quarter operating expenses, our operating expenses for the six months ended June 30, 2011 were 4% lower than our operating expenses in the six months ended June 30, 2010. In addition to the aforementioned bad debt expense in 2010, the improvement in operating expenses reflected our ongoing efforts at cost containment. Included in our general and administrative expense during the three and six months ended June 30, 2011 were $443,331 and $890,512, respectively, attributable to amortization of the market value of stock that we granted to employees or consultants. This non-cash expense resulted from our use of stock during our early years to incentivize key individuals. The market value of the stock at the time it was issued is being amortized over the term of the employee's or consultant's services, thus: ? In the case of employees, the period of amortization is based on a vesting schedule included in the employees' contracts. The average vesting period for the employees is 3.07 years. ? In the case of consultants, the period of amortization is based on the term of the consulting contracts, although amortization will be accelerated if the consulting relationship ceases. Again, to date, the consultants who received stock have remained involved in the Company's affairs, so there has been no acceleration of amortization. At June 30, 2011 there remained $4,792,569 in unamortized stock compensation on the Company's books. The amortization of this sum will contribute to our future operating expenses as described above. Operating income for the three months ended June 30, 2011 totaled $11,044,407, an increase of 22% from operating income in the three months ended June 30, 2010. Operating income for the six months ended June 30, 2011 totaled $20,847,534, an increase of 30% from operating income in the six months ended June 30, 2010. Other Income (Expenses) During the three months ended June 30, 2011we recorded $2,235,884 in other income (expenses), compared to other income (expenses) of $4,271,411 in the three months ended June 30, 2010. The primary components of this income in the three months ended June 30, 2011 were: ? $112,173 in net interest income, ? A foreign currency transaction loss of $90,677 resulting from changes in exchange rates between the date when Wuxi ZQ recorded revenue from foreign sales and the date on which it received payment, and ? An income of $2,189,565 related to the change in the fair value of our outstanding common stock purchase warrants. 41-------------------------------------------------------------------------------- During the six months ended June 30, 2011we recorded $11,358,477 in other income (expenses), compared to of $5,544,823 in the six months ended June 30, 2010. The primary components of this income in the six months ended June 30, 2011 were: ? $219,392 in net interest income, ? The foreign currency transaction loss of $90,677 described above, and ? An income of $11,209,384 related to the change in the fair value of our outstanding common stock purchase warrants. In the six months ended June 30, 2011, we recorded $219,392 in interest income, primarily attributable to our cash on hand, but also including $80,000 earned on our $1.6 million loan to Harbin Jinhuida Investment Consulting Limited. During the same period, we incurred no interest expense, as we have no outstanding debt. By comparison, in the six months ended June 30, 2010, we recorded approximately the same amount of interest income, but incurred $39,660 in interest expense, as we had not yet fully settled the bank loans that Wuxi ZQ had outstanding when we acquired it in 2009. In 2008 and 2009, the Company issued warrants in conjunction with the issuance of common shares or convertible preferred stock. The warrants permit the investors to buy additional common shares at the prices specified in the warrant agreements. Because the Company may be required to repurchase the warrants at their fair value in certain circumstances, the fair value of the warrants has been recorded as a liability on our balance sheet. At the end of each quarter, we re-calculate the fair value of the warrants using the Black-Scholes model, and record any increase or decrease in that fair value as other income or other expense. Because the market price of our common stock fell during the six months ended June 30, 2011 and the six months ended June 30, 2010, the fair value of the warrants fell by $11,209,384 and $5,397,280 in those periods respectively, which was recognized on our Statements of Income as other income. If in future quarters the warrants increase in value (e.g. by reason of an increase in the market price of our common stock), we will record an other expense equal to the amount of the increase. For the six months ended June 30, 2011, we recognized a $12,887 investment loss from our 49% equity investment in Beyond E-Tech, Inc., a Texas corporation organized to engage in distributing cellular telephones in the United States. The acquisition has been recorded as an "investment in unconsolidated entity" on our balance sheet, and our participation in that business will be accounted for through the equity method. Based upon its growing positions in the mobile phone distribution business in the United States, Beyond E-Tech anticipates that it will achieve profitability in three years. Until then, we will continue to record as investment losses our 49% shares of that company's losses. The loss is recorded as equity gain (loss) from unconsolidated entity on our Statements of Income. The table below presents the components of our pre-tax income during the three and six month periods ended June 30, 2011 and 2010. Pre-tax income was $41,745 greater in the second quarter of 2010 than in the second quarter of 2011, primarily due to the fact that income attributable to the change in fair value of warrants was $2,001,841 greater in the second quarter of 2010 than in the second quarter of 2011. On the other hand, pre-tax income was $10,600,286 greater in the first six months of 2011 than in the first six months of 2010, reflecting expansion and improvements in our operations, but also reflecting the fact that income attributable to the change in fair value of warrants was $5,812,104 greater in the first six months of 2011 than in the first six months of 2010. 42-------------------------------------------------------------------------------- Three months ended June 30 Six months ended June 30 2011 2010 2011 2010 Pre-tax income - U.S. $ 1,261,751 $ 3,313,451 $ 9,378,717 $ 3,468,262 Pre-tax income - China $ 12,017,617 $ 10,007,662 $ 22,814,407 $ 18,124,576 Pre-tax income - total $ 13,279,368 $ 13,321,113 $ 32,193,124 $ 21,592,838 The income tax expense as a result of our 2011 operations was $3,007,163 for the three months ended June 30, 2011 and $4,951,713 for the six months ended June 30, 2011, based on the standard 25% tax rate on corporate income in China. During the three and six months ended June 30, 2010, as a result of Chinese tax laws that reward foreign investment in China, Heilongjiang ZQ was entitled to a 50% tax abatement, which results in an effective corporate tax rate of approximately 12.5%. Accordingly, we only accrued $810,875 in income taxes on our Chinese income during the three months ended June 30, 2010 and $1,558,027 during the six months ended June 30, 2010. The table below shows our after-tax net income. Three months ended Increase/ Six months ended Increase/ June 30 (Decrease) June 30 (Decrease) 2011 2010 2011 2010Net income $ 10,272,205 $ 12,510,238 (17.9 %) $ 27,241,411 $ 20,034,811 36.0 % Our business operates primarily in Chinese Renminbi, but we report our results in our SEC filings in U.S. Dollars. The conversion of our accounts from RMB to Dollars results in translation adjustments. While our net income is added to the retained earnings on our balance sheet; the translation adjustments are added to a line item on our balance sheet labeled "accumulated other comprehensive income," since they are more reflective of changes in the relative values of U.S. and Chinese currencies than of the success of our business. During the six months ended June 30, 2011, the effect of converting our financial results to Dollars was to add $4,621,987 to our accumulated other comprehensive income. During the six months ended June 30, 2010, when the exchange rate was less volatile, the translation adjustment increased our accumulated other comprehensive income by $1,230,789. Liquidity and Capital Resources The growth of our Company has been funded by capital contributions - initially those of our founders and in recent years capital raised by the sale of equity to private investors. In December 2010, we obtained gross proceeds of $30 million from the sale of 7.5 million shares of common stock (accompanied by 3.75 million one year warrants) for a price of $4.00 per share. As a result, at June 30, 2011 we had no debt, having satisfied the bank loans that Wuxi ZQ carried when we acquired it, and we had $74,044,694 in cash on hand. At June 30, 2011 the Company had a working capital balance of $103,498,110, a reduction of $27,653,654 from our working capital at December 31, 2010. The reduction was attributable to our payment of over $40 million to purchase equipment and construct facilities in Dongguan City where we are constructing a multi-building battery manufacturing facility. Our accounts receivable at June 30, 2011 totaled $19,509,545. We have recorded an allowance for doubtful accounts of $68,938. The allowance was determined by reviewing all accounts remaining open more than sixty days after shipment. Consideration was given to the prior payment history of the customer, information we gather regarding the financial capability of the customer, and ongoing information gathered by our accounting personnel regarding the customer's plans for payment. The allowance reflects the ongoing relationships we have with most of our customers and a high level of confidence in their ability and intent to make full payment. We had insignificant bad debt expense incurred during the six months ended June 30, 2011. 43 -------------------------------------------------------------------------------- At June 30, 2011 we had two long term liabilities: ? a deferred tax liability of $3,025,847 attributable to the gain we realized when we acquired Wuxi ZQ in May 2009 for a price less than the fair value of its net assets; and ? a "warrant liability" of $540,419 attributable to the warrants that we issued in our three equity financing transactions in 2008 and 2009. Pursuant to provisions of ASC 815 (previously: EITF 07-05) that became effective for 2009 and subsequent years, the present value of the outstanding warrants is considered a liability. The table below sets forth our debt service obligations as of June 30, 2011. Less than 1-3 4-5 More than 5 Contractual Obligations Total 1 Year Years Years Years Long-Term Debt Obligations- $ 0 $ 0 $ 0 $ 0 $ 0 Operating Lease Obligations $ 140,455 $ 140,455 $ 0 $ 0 $ 0 Capital Expenditure Obligations $ 18,003,601 $ 18,003,601 $ 0 $ 0 $ 0 Raw Material Purchase Obligations $ 17,129,579 $ 17,129,579 $ 0 $ 0 $ 0 TOTAL $ 35,273,635 $ 35,273,635 $ 0 $ 0 $ 0 Our subsidiaries have sufficient liquidity to fund their near-term operations and to fund the working capital demands of future expansion. During 2011 and 2012 we intend to invest approximately $57 million in our new Dongguan industrial park, where we plan to develop facilities with a production capacity of $151 million per year. Our plan is to fund the development from our current capital resources. If we determine that additional funds are needed for other attractive growth opportunities or for the full implementation of our long term expansion plans for ABAT, we have available $107,508,191 in property, plant and equipment that Harbin ZQPT, Heilongjiang ZQPT, Wuxi ZQ and Dongguan QiangQiang own free of liens, for potential collateral loans. On June 30, 2011 our backlog of firm orders was approximately $61,230,000. Based on that backlog of orders, we believe that secured financing will be available on favorable terms if needed. Given the financial resources available to the Company, management believes that it has sufficient capital and liquidity to sustain operations for the foreseeable future. Restrictions on Dividends and Other Cash Transfers All of our business operations are carried out by our two subsidiaries and one variable interest entity in China. In the future, in order for the U.S. parent corporation to pay dividends to our shareholders from the earnings obtained in China, we will have to transfer funds from our Chinese subsidiaries through Cashtech Investment Limited, our BVI subsidiary, and then to Advanced Battery Technologies, our U.S. parent corporation. Our ability to transfer funds in this manner will limited by two factors: · Statutory Reserves. The Company Law of the PRC applicable to Chinese companies with foreign ownership provides that net income can be distributed as dividends only after: 44-------------------------------------------------------------------------------- a. Cumulative prior years' losses have been recouped; b. 10% of after tax income has been allocated to a statutory surplus reserve until the reserve amounts to 50% of the company's registered capital; c. 10% of after tax income has been allocated to a statutory common welfare fund, which is established for the purpose of providing employee facilities and other collective benefits to the company's employees; and d. Allocations have been made to the discretionary surplus reserve, if such a reserve is approved at the meeting of the equity owners. · Currency Conversion. The Chinese Yuan (Renminbi) is not freely convertible into Dollars. The State Administration of Foreign Exchange ("SAFE") administers foreign exchange dealings and requires that they be conducted though designated financial institutions. Foreign Investment Enterprises, such as Harbin ZQPT and Wuxi ZQ, may purchase foreign currency from designated financial institutions in connection with current account transactions, including profit repatriation. These factors will limit the amount of funds that we can transfer from our Chinese subsidiaries to our U.S. parent company and may delay any such transfer. In addition, upon repatriation of earnings of our Chinese subsidiaries to the United States, those earnings may become subject to United States federal and state income taxes. We have not accrued any U.S. federal or state tax liability on the undistributed earnings of our foreign subsidiaries because those funds are intended to be indefinitely reinvested in our international operations. Accordingly, taxes imposed upon repatriation of those earnings to the U.S. may reduce the net worth of the Company. Effects of Consolidation of Variable Interest Entity The financial statements presented in this Report consolidate the financial statements of Advanced Battery Technologies, Inc. with the financial statements of two operating subsidiaries, Harbin ZQPT and Wuxi ZQ. Also consolidated are the financial statements of an entity, Heilongjiang ZQPT, the legal owners of which are our Chairman, Zhiguo Fu, and four associates. The financial statements of Heilongjiang ZQPT are consolidated with our financial statements because Heilongjiang ZQPT is a variable interest entity with respect to Harbin ZQPT, which is a wholly-owned subsidiary of Advanced Battery Technologies. Harbin ZQPT is party to five agreements dated September 8, 2004 with the owners of the registered equity of Heilongjiang ZQPT and with Heilongjiang ZQPT. The agreements transfer to Harbin ZQPT all of the benefits and all of the risk arising from the operations of Heilongjiang ZQPT, as well as complete managerial authority over the operations of Heilongjiang ZQPT. Harbin ZQPT is the guarantor of all of the obligations of Heilongjiang ZQPT. The following table summarizes the effects of consolidating Heilongjiang ZQPT with Advanced Battery Technologies and its subsidiaries as of and for the six months ended June 30, 2011: 45-------------------------------------------------------------------------------- |