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China BAK Battery, Inc. (NASDAQ:CBAK)

F1Q09 (Qtr End 12/31/08) Earnings Call

January 23, 2009 7:00 pm ET

Executives

Tony Shen - CFO and Secretary

Analysts

Rick Fearon - Accretive Capital Partners

Mark Tobin - Roth Capital Partners

Doug Ruth - Lenox Financial Services, Inc.

Operator

Good evening, everyone, and thank you for joining us on the China BAK Battery's Fiscal 2009 First Quarter Conference Call. During today's call, we will provide details on the company's FY '09 first quarter results, as well as provide a corporate update about recent activities. Today's call will be limited to one hour.

With me today on the call is China BAK's senior management team led by Mr. Xiangqian Li, China BAK's President and Chief Executive Officer. All of them will be available to answer questions during the Q&A section.

Our agenda for today is as follows. Mr. Tony Shen, China BAK's Chief Financial Officer, will make remarks on behalf of the management team on the company's financial performance and discuss current business strategies, and he then will make remarks about China BAK's business outlook. Finally, we will open the call to your questions.

Before we get started, I'd like to remind our listeners that comments today will contain forward-looking statement, and management may make additional forward-looking statements in response to your question. Such written and verbal disclosures are made in pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995.

Investors are cautioned that such forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from anticipated results. These types of statements and underlying factors as well as risk and uncertainties are listed in the company's filings with the Securities and Exchange Commission as well as in news release that was distributed earlier this afternoon.

China BAK's statements on this call are made as of January 23, 2009, and the company undertakes no obligations to update any of the forward-looking statements contained here within whether as a result of new information, future events, changes in expectations or otherwise.

With that said, it is my pleasure to turn the call over to China BAK's CFO, Mr. Shen.

Tony Shen

Thank you, Keith. I would like to extend a warm welcome to everyone joining us on the call today. Because of the Chinese New Year's holiday, Mr. Li and Dr. Mao are calling from outside, and they may not be calling in on time for the Q&A session. But I will be able to answer your questions throughout the whole session.

First, some highlights. In the first quarter of FY '09, our net revenue remained strong in the midst of the global financial crisis and recession. Gross margin remained at a similar level to previous quarter.

Cylindrical cells revenue continued to be robust accounting for 27% of total revenue. Prismatic cells revenue continued to grow and reflect further penetration after China OEM cell phone market. A number of cost cutting efforts were taken and at least $1.5 million of operating expense reduction per quarter is expected in the coming quarters.

Now, in more details. Net revenue for the first quarter of FY '09 were $68.1 million, down 6.4% from last quarter and up 29% from the same quarter of last year.

Revenues from cylindrical cells used in notebook computers were $18.4 million, down 6.5% from last quarter and up 615.7% from the same quarter of last year. Market demand from notebook computer manufacturers weakened slightly due to the global financial crisis and recession.

Revenues from prismatic cells, including aluminum-case cells, steel-case cells and battery packs, were $45.8 million, up 1.7% from last quarter and up 2.1% from the same quarter of last year. Revenues from aluminum-case cells were $37.3 million, up 3.6% from last quarter and up 24.0% from the same quarter of last year.

Revenues from battery packs were $5.4 million, up 0.2% from last quarter and up 8.1% from the same quarter of last year.

Revenues from steel-case cells were $3.1 million, down 15.1% from last quarter, and down 68.3% from the same quarter of last year. We have started to phase out the production of steel-case cells in this quarter, so revenue from steel-case cells is expected to be minimal in coming quarters.

Revenues from lithium polymer cells, used in personal electronic devices such as PDAs, MP3 players and Bluetooth devices, were $3.9 million in the first quarter of FY '09, down 51.2% from last quarter, and down 27.4% from the same quarter of last year. Market demand from our largely US based lithium polymer cell customers weakened due to the financial crisis and recession.

Gross profit for the first quarter was $10.6 million, down 7.7% from last quarter and up 49.1% from the same quarter of last year. Gross margin was 15.6%, compared to 15.8% last quarter and 13.5% in the same quarter of last year. The slight decrease in gross margin from the previous quarter was the result of lower average selling prices offset mostly by lower average costs. The increase in gross margin from the previous year's first quarter was attributable to improvements in our product mix and increased average selling prices, which outweighed the impact of average cost increases.

Operating expenses totaled $9.8 million or 14.4% of revenues in the first quarter, as compared to 11.6% of revenue last quarter and 13.1% of revenue in the same quarter of last year. R&D expense was $1.4 million or 2.1% of revenue, as compared to 2.3% of revenues last quarter and 2.5% of revenue in the same quarter of last year. Sales and marketing expense was $1.6 million or 2.3% of revenue, as compared to 2.2% of revenue last quarter and 2.6% of revenue in the same quarter of last year.

G&A expense was $6.8 million or 9.9% of revenue, as compared to 7.1% of revenue last quarter and 8.0% of revenue in the same quarter of last year. The $6.8 million expense number includes nearly $3 million of bad debt expense, most of which was related to delayed collection of accounts receivable relating to the timing of the Chinese New Year holiday of this year.

Operating income for the first quarter was $0.8 million, as compared to $3.0 million last quarter and $0.2 million, same quarter of last year.

Net loss was $1.7 million, as compared to net income of $1.5 million last quarter, and net loss of $0.9 million in the same quarter of last year. Diluted earnings per share were negative $0.03, compared with $0.03 per diluted share last quarter and a negative $0.02 per diluted share in the same quarter of last year.

For the first quarter, Days Sales Outstanding, the DSO, decreased to 103 days as compared to 104 days last quarter. And inventory turns increased to 3.64 from 3.6 turns last quarter.

From December 31, 2008 we had $37.2 in cash and cash equivalent and a negative $18.3 million in working capital reflecting a current ratio of 0.92 to 1. Short-term bank loans and long-term bank loans totaled $172.2 million, as compared to $117.1 million on September 30th, 2008.

Shareholders equity totaled $166.3 million. China BAK had $24.1 million available for borrowing under its credit facility.

Our performance is remarkable in light of the difficult market situation. However, the crisis has affected many markets our customer's serve. Looking at weakened demand from our customers we feel it necessary to take a more cautious look at our revenue guidance for FY'09. We now expect FY'09 revenue to fall in the range of $270 million to $300 million which at mid point of the range, will 16% growth from FY '08 levels.

In Q1, FY '09 we have initiated a number of actions to cut down costs and expenses, this included reduction in total headcount, work hours for hourly workers, and compensation packages for salaried employees, including senior executive. Employees were also required to take unpaid leaves and they will be required to take longer holiday leaves during the Chinese New Year holiday.

In addition, we are suspending prismatic cells production for the month of January 2009 to reduce inventory and to lower energy costs. All these measures are expected to bring at least $1.5 million reduction in operating expenses per quarter for the rest of FY09.

Now, thanks for listening. And we'll turn to the Q&A session. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of [Rick Fearon, Accretive Capital Partners].

Tony Shen

How are you, Rick?

Operator

Please proceed.

Rick Fearon - Accretive Capital Partners

Yes, first for taking the call, I appreciate it. I had a question about the capitalization of the company and it does seem like at the moment the company is being funded by majority of short-term financing and yet most of the company's assets are fixed assets, the long-term assets.

And I was curious if there is any effort to restructure the balance sheet so that the financing more closely matches the assets of the company. It just doesn't seem like its makes lot of sense. There is plenty of equity value, but the financing is mostly short-term. Why is that?

Tony Shen

This has to do with specific situation in banking industry in China. Chinese banks like to have very short-term loans for companies, because at every renewal they can (inaudible) have the opportunity to adjust the terms based on -- depend government policies. This can be good or bad for the company, but in our past this has been mostly good, because especially now, China is following most of the industrialized countries in lowering its interest rates to stimulate the economy. So in every renewal, we get a lower interest rate.

Of course, to match along -- your idea is more idealistic. In a perfect world, we should match the assets and the liabilities. And in our specific situation now, we only have a very small portion of the borrowings in long-term, but just based on our experience with dealing with the banks we had never had a problem in renewal in most of the credit facilities.

Rick Fearon - Accretive Capital Partners

Okay.

Tony Shen

So maybe we should call them the short-term to long-term borrowing, but in short form.

Rick Fearon - Accretive Capital Partners

Okay.

Tony Shen

Yes.

Rick Fearon - Accretive Capital Partners

And the company -- is it in any jeopardy of shifting any financial covenants or are there financial covenants with the Chinese banks?

Tony Shen

Yes, there are. In fact most of the banks have very similar requirements, for example, your revenues cannot be declining more than a certain percentage from quarter-to-quarter et cetera. But we have never had any breaches of such covenants, and in our observation, in China banks rarely enforce their covenants. Except when the company is already clearly in trouble.

Rick Fearon - Accretive Capital Partners

And out of curiosity, what are those more significant covenants, if you know off hand, that the company is tested on, is it on a quarterly basis?

Tony Shen

I can remember, that there is revenue consistency requirements, most of them are actually related to the assets that pledged against the loans. So most recently we have a loan from a credit facility from the Agricultural Bank of China on which we pledged the land and the associated buildings.

So as long as the value determined by a third party evaluator, less than decline is much, we don't break anything. And for all these significant covenants, you can find in our SEC filings.

Rick Fearon - Accretive Capital Partners

Okay, I'll spend a little time looking at those covenants, I appreciate that and I don't want to monopolize the call, I have a couple other questions here. I noted that, over the past few years, you've gone out in terms of private placement equity financings and right now your stock is at an all time low and this would seem to me about the worst time to be raising equity capital, is this anything that company's is planning anytime soon?

Tony Shen

We usually don't comment on the timing of those, but most of us, all had the same judgment as you just elaborated that this is, in general, a very tight market situation. We, of course, do want to, at this price if a financing work to be done, the dilution effect will be great.

Rick Fearon - Accretive Capital Partners

It sounds like, that's not the objective of the company.

Tony Shen

No.

Rick Fearon - Accretive Capital Partners

Okay. I hope that with future equity financing, just seems that these are being done on a very closed basis with a, private placements done with some institutions, some of which seemed to be repeat investors.

Is there an opportunity to write offerings instead and open that up to investors who have invested in the common equity and so they don't face the prospect of being diluted by some unforeseen equity financing?

Tony Shen

We will take that into consideration if we have another round of equity financing. In our previous private placements, all the previous investors were invited and shown the deal together with new private investors.

Rick Fearon - Accretive Capital Partners

Okay. But it wasn't opened to the common shareholder, that was the problem that.

Tony Shen

Well, this is just, in general, speaking and this in no way implies any future actions by the company. But, in general, for company at our size for the common shareholders to participate, we have to do a secondary offering of other source.

It's more like a second IPO. And that requires a lot of marketing time and also extensive road show etcetera. And with the amount that we are raising in previous two financings, it doesn't seem economical.

Rick Fearon - Accretive Capital Partners

Okay. The company's cash flowing positively now, which is good news, isn't it? These are, I agree, impressive results, given the economic climate. So congratulations for that. And hopefully, with some of the cost reductions and continued cash flowing positively and there won't be a need for immediate equity financing, but that would be a very significant request, I think, probably shared by other shareholder as well. Will there be any significant equity raise that would be done?

Tony Shen

We don't have any plans for the near future.

Rick Fearon - Accretive Capital Partners

Okay. Well, that is good news and obviously with the cash flow positive results now, it doesn't seem like you would need to. Hopefully, with some of that cash flow, you can begin paying down some of the debt too.

Tony Shen

Yes.

Rick Fearon - Accretive Capital Partners

Okay.

Tony Shen

To your last comment, actually I want to make a comment to all the listeners, all the callers. Although our outstanding loan balance at the end of each quarter in the last two quarters are similar, our finance cost was much lower in the December quarter. That reflects the active management of the average balance throughout the quarter, so the interest expense is lower.

Rick Fearon - Accretive Capital Partners

Yes. And here it looked like, it was $2.8 million for the quarter-ended December 2008, down from $3.6 million in September and your cash flowing more than that, so at least your EBITDA is greater than that. And if you add back $3 billion of bad debt expense, you have plenty of coverage, it seems.

Tony Shen

We don't think so.

Rick Fearon - Accretive Capital Partners

The obvious next question, I'm sure other callers will have some questions about other customers. But I'm curious about what the status with the HP deal is, if that's dead at this point? And if you'd like to comment.

Tony Shen

We are even more confident on gaining a major OEM customer.

Rick Fearon - Accretive Capital Partners

I'm sorry, you have even more confidence?

Tony Shen

Yes, the achievement is near.

Rick Fearon - Accretive Capital Partners

Okay. And when you talk about that major OEM customer being closed at hand, I mean, obviously, we've been talking about this for more than a year now. I know that they go through a very extensive testing process with you.

Tony Shen

Yes.

Rick Fearon - Accretive Capital Partners

Is this something that can be expected within this fiscal year?

Tony Shen

We cannot elaborate on the timing. But it should be sooner than that.

Rick Fearon - Accretive Capital Partners

Okay.

Tony Shen

It should be sooner than the end.

Rick Fearon - Accretive Capital Partners

Well, that's obviously exciting. They made a recent announcement related to Boston Power. Is that a completely different product than what you've been?

Tony Shen

In my observation, that's a different kind of technology. It lasts for about 8 hours I think and the news is that. So, I would speculate that that would first go to the higher end models. And I think in the foreseeable future, the cylindrical products, which we are supplying now to ASUS and other customers, will be survived for a long time, before everyone gets an 8-hour battery.

Rick Fearon - Accretive Capital Partners

Okay. I had a hunch that this is something you're still working on and it sounds like it's very close, which obviously is a great news. Does it require any additional ramp or expense on the part of the company to meet those needs at this point? Is your capacity sufficient to fulfill the needs of a potential new OEM?

Tony Shen

Yes.

Rick Fearon - Accretive Capital Partners

Okay. Very good. I will let another caller step on if there is another. If not, I may jump back in the queue.

Tony Shen

Thank you.

Rick Fearon - Accretive Capital Partners

Thank you.

Operator

Your next question comes from the line of Mark Tobin with Roth Capital Partners. Please proceed.

Mark Tobin - Roth Capital Partners

Hi. Tony. Happy New Year.

Tony Shen

Happy New Year. Sorry, you lost the first spot this time.

Mark Tobin - Roth Capital Partners

That's okay. First question on the guidance. I was hoping you could get a little more granular by product line, one, to give me a sense of how it would break down as far as the new guidance goes, and then, also, as far as the reduction, what segments drove the decrease?

Tony Shen

Unfortunately, we did not put that in the earnings release. So for the fear of selective disclosure, we cannot talk about the break down in the call. For you and for everybody else on the call, we will be presenting at the Roth Capital Conference in February, and by that time, I'll give the world an update on specific revenue projections on the line.

Mark Tobin - Roth Capital Partners

I guess, without getting into specific numbers, obviously, a 30% or so decrease in your revenue guidance, what product lines primarily were responsible for that decrease? Is it mobile handset, is it --

Tony Shen

All lines are affected because this is a general market downturn, especially for our end customers, either faced or selling to the US market. It's almost equally affected.

Mark Tobin - Roth Capital Partners

So about a 30% --

Tony Shen

With the prismatic cells, the cell phone sales selling to customers in China being affected a little bit less.

Mark Tobin - Roth Capital Partners

Okay. Second question, on the OpEx reduction efforts, you referred to $1.5 million quarterly decrease going forward. What level is that coming off of? This quarter is $9.8 million.

Tony Shen

We all understand it in the same way. The $1.5 million reduction is from previous quarter levels. For example, the September quarter of '08 had $5.2 million of G&A, and reduction will be from that level. It's not that from $5.2 million to $3.7 million, and then from $3.7 million to $2.2 million. It's compared to the previous quarter before this call.

So, going forward, you should expect that the G&A expense should be roughly at the $3.7 million, $3.8 million range.

Mark Tobin - Roth Capital Partners

$3.7 million.

Tony Shen

This past quarter, the December quarter was a little bit unusual because we had an unusually large bad debt expense, as I mentioned earlier. Taking that out, it's more like a $4.8 million or $4.7 million G&A expense. That is, of course, not as much as the $1.5 million reduction, but we kicked those off in the middle of the quarter. So, this December quarter had a partial reduction in G&A expense.

Mark Tobin - Roth Capital Partners

Okay. That makes sense. And moving on, you talked about shutting down the steel-case production line, are we looking at any write-off of productive assets here in the near future, are those fully depreciated?

Tony Shen

This line is the oldest in the company.

Mark Tobin - Roth Capital Partners

Right.

Tony Shen

And almost fully depreciated, and also we are actively looking at opportunities to sell the equipment to other manufacturers. As long as it's not lower than book value there won't be any additional expense coming from this production closure.

Mark Tobin - Roth Capital Partners

Okay. So, as far as the equipments that you have on the balance sheet, it's all being utilized. There is not a risk at least at this point of write-offs?

Tony Shen

The amount is already very small.

Mark Tobin - Roth Capital Partners

Okay. And I guess moving on, same question for inventory. Obviously, a buildup on the mobile handset or the prismatic side, is there concern about inventory write-offs within that basket?

Tony Shen

We have incurred write-downs, but in small numbers every quarter. It's strictly on ageing. Right now, we don't see any significant risk for that number to be much larger in later quarters.

Mark Tobin - Roth Capital Partners

Okay. And then circling back to guidance, again, I know you only address topline, can you give us some sense of the visibility that you have throughout the P&L, specifically, gross margins? Do you expect those to be stable with this quarter's level or will it go significantly up or down from here?

Tony Shen

It's hard to predict right now, because it depends on total production and also the amount of cells we can sell in a particular quarter. We were in relatively full mutualzation in the last two quarters. So, gross margin was stable at about between 15% to 16%, but in coming quarters we are not sure how these prices is playing out on the notebook computer manufactures.

Mark Tobin - Roth Capital Partners

I guess almost looking at it more as a product margin, can you comment on the pricing environment and the raw material environment, both seem to in a much better shape than they were a year ago. I am just curious if you could pause there.

Tony Shen

Average selling price had started to come down at the end of the December quarter, because of weakening demand, but also a positive trend is that the raw material cost is also coming down pretty fast. So I think both of this trends will continue into the later part of 2009.

Mark Tobin - Roth Capital Partners

Okay. Last question and I will jump back in the queue. The Tianjin facility can you comment on the activity there and if there was any contribution during the quarter from that plant.

Tony Shen

There was no revenue from Tianjin in the quarter. We had some trial production and we have sent samples to customers. So it's operating and if you look at the recent press release on us being accepted into the A63 program. We will continue to have operation in Tianjin.

Mark Tobin - Roth Capital Partners

Okay. And that the focus there is still vehicles, both for LEDs and auto, or is there something more in there in the near-term?

Tony Shen

It's more like power cells for any application that it can fit in. So the first product has already been cells for electric bicycles.

Mark Tobin - Roth Capital Partners

Okay. All right, thank you. I'll jump back in the queue.

Tony Shen

Thank you, Mark.

Operator

The next question comes from the line of Doug Ruth of Lenox Financial Services. Please proceed.

Tony Shen

Hi, Doug. Doug, how are you?

Doug Ruth - Lenox Financial Services, Inc.

We're still somewhat confused with what's going on with Hewlett-Packard. At the last conference call, Henry told us that the company was making good progress and that you are very close being qualified. I mean how much closer can you be without getting the contract?

Tony Shen

Right now, there are several things happening in the industry. And the most significant for us is the demand. So at a lot of the packers in Taiwan, inventory has build up. So, I suspect that that affects certain OEMs decision on introducing their new suppliers or past suppliers to their lineup. But there is no negative development on our certification front.

Doug Ruth - Lenox Financial Services, Inc.

Is it possible that you are making a premature decision to adjust the guidance, if this fairly large contract is still pending?

Tony Shen

As I mentioned in previous calls, the winning of a major OEM will be a good certification on our ability to supply quality products. But it's not a large contract as you said. At the beginning there will be relatively smaller orders. And also these cells will be going through the same packers to whichever OEM [qualified].

And for example, if it's packer A, packer A used to order 5 million from us, $5 million of cells from us. It may be that at the beginning only $500,000 worth of cells are going to the OEM you mentioned and then they are escalating to other (inaudible) makers. So the certification or the beginning of the supply to a major OEM does not significantly increase our revenue. And the opposite side also true that, if we still don't get an OEM customer, the revenue picture doesn't change much.

Doug Ruth - Lenox Financial Services, Inc.

Okay, I understand that. Can you tell us what is the average price of the cobalt at this point?

Tony Shen

Okay. The most recent quarter was 337 yuan per kilo, so that's about less than $50 per kilo.

Doug Ruth - Lenox Financial Services, Inc.

Okay. Isn't that trending higher from where it was before?

Tony Shen

No, the September quarter was 402.

Doug Ruth - Lenox Financial Services, Inc.

Okay.

Tony Shen

It's nearly 20% decline.

Doug Ruth - Lenox Financial Services, Inc.

Okay. So that would be December 31st and then okay, so it's not that much time has passed, I guess. What was the CapEx for the December quarter?

Tony Shen

What was that, I didn't understand.

Doug Ruth - Lenox Financial Services, Inc.

The capital expenditure for the December quarter?

Tony Shen

That was $19 million.

Doug Ruth - Lenox Financial Services, Inc.

$19 million, okay.

Tony Shen

Most of which is related to setting up the lines, that is (inaudible).

Doug Ruth - Lenox Financial Services, Inc.

Okay. And where are the increase sales of cells coming for the telephones? Which customers are those going to?

Tony Shen

Equally for going to the lead customers such as (Shop), the Chinese Inc. that may not sound so familiar to you. Our top 10 customers in cell phone include called something and [NPONG] names in our filing, you can look it up.

Doug Ruth - Lenox Financial Services, Inc.

Okay. The goal ultimately is to stop the steel cell production completely, because we can make higher margins with aluminum cells. The aluminum cells will be as per the cell phones.

Tony Shen

The UK cells was only a few strongly of the aluminum in the several quarters. There was 3 million, 3.6 million in the September quarter. The June quarter was the only one that reached $10 million and this most quarter, a December quarter was 3.1, so it's also an older technologies, so it's a natural migration.

Doug Ruth - Lenox Financial Services, Inc.

Okay. You are giving a lower revenue guidance, but you also in the past had given us a gross margin guidance in the presentation. Can you give us any detail as far as what the gross margin might be for fiscal 2009?

Tony Shen

Yeah. As I said before in October, we are not ready to give our guidance for the rest of the year in gross margin, because it's quite difficult to predict how long this financial crisis and the recession will be playing out.

Right now, we are visiting our packer customer in Taiwan every month and they, in turn, get updates from their customers every month. So it will not be worry here until in a few months' time.

Doug Ruth - Lenox Financial Services, Inc.

How is the company's relationship with Foxconn coming along? Is the continuing to grow?

Tony Shen

Yes. Foxconn did not represent a large percentage of our revenue before. And right now, they are still not in the top 10 customers, but it's growing.

Doug Ruth - Lenox Financial Services, Inc.

Okay. And what about ASUS, how is that?

Tony Shen

ASUS is an end customer and they purchased the cells. While the cells we sold to them are packed by a Taiwanese packer CELXPERT, and CELXPERT was listed as our second largest customer in the most recent quarter.

Doug Ruth - Lenox Financial Services, Inc.

Okay.

Tony Shen

Not all the cells go to one customer, ASUS, though.

Doug Ruth - Lenox Financial Services, Inc.

I'm wondering about what's happening with Simplo.

Tony Shen

Simplo was our third largest customer in the quarter two. So they are also growing steadily.

Doug Ruth - Lenox Financial Services, Inc.

My last question would be, could you just tell us what's the comment on SanDisk and how that relationship is going?

Tony Shen

SanDisk is our only major customer in the polymer cells product. This quarter the business that we got from them was lower. So that's the reason that our polymer cells revenue was also lower than the quarter before.

Doug Ruth - Lenox Financial Services, Inc.

Okay. Tony, we'd like you to put out a press release on Hewlett Packard contract if finalized.

Tony Shen

Of course. We always see those as significant developments.

Doug Ruth - Lenox Financial Services, Inc.

Yeah, and any large orders, if you could put out a press release, that would also be helpful.

Tony Shen

Of course.

Doug Ruth - Lenox Financial Services, Inc.

Okay. Well, thank you and good luck, and we're hoping for good news.

Tony Shen

Thank you.

Operator

Your next question comes from the line of Rick Fearon of Accretive Capital Partners. Please proceed.

Rick Fearon - Accretive Capital Partners

Thanks for taking another call, I appreciate it. What do you anticipate CapEx for this fiscal year being? It seems like the $19 million number for the cylindrical lines was unusually high. I know September, you'd kind of started ramping up and what you anticipate for the next three quarters?

Tony Shen

It will be at lower levels. We basically have planned this well before the crisis hit and now looking at this market situation, we will be very careful in coming quarters, in terms of expanding capacity or putting in the more cash.

Rick Fearon - Accretive Capital Partners

Okay and over the longer term, where would you expect sort of a normalized gross margin to be, as I guess that's really going to be a function of running at full capacity? And.

Tony Shen

I think, it will be in the high teens and lower 20s.

Rick Fearon - Accretive Capital Partners

Okay.

Tony Shen

When raw material price has stabilized and also production can be run on relatively full scale?

Rick Fearon - Accretive Capital Partners

Okay. And your operating expenses, where would those as a percentage of revenue on a normalized basis be? I know that you will be cutting some expenses that will be reflected in this coming quarter, which is good news and I am just trying to drill down to an operating margin level.

Tony Shen

Well, right now, our operating expenses all added up is about 12% to 13% right in the last several quarter, actually the September quarter was below 12%. And I think when revenue has stabilized at higher than $70 million per quarter level, the percentage eventually dropped down to below 10%.

Rick Fearon - Accretive Capital Partners

Okay. Meaning that your operating income or your operating margin could be as much as 10% of revenues if your operating expenses are less than 10%, and your gross margin is around 20s?

Tony Shen

Around 20s, yeah.

Rick Fearon - Accretive Capital Partners

Those days the sooner they can come, the better. and in the mean time hopefully you can manage your financings, that you don't find yourself calling a pickle and having to raise equity capital in these markets, because that would not be a good thing, obviously. And I hope you can reduce your debt. It sounds like the growth is there and congrats on maintaining the level you did in this tough market. I know that doesn't come easily.

Tony Shen

Thank you.

Rick Fearon - Accretive Capital Partners

Okay. Thanks. Look forward to the news on HP and others as they come out.

Tony Shen

Okay.

Operator

Your next question comes from the line of Mark Tobin with Roth Capital Partners. Please proceed.

Mark Tobin - Roth Capital Partners

Hi, Tony. Just a quick follow-up on the guidance. What FX assumption are you using, are you assuming flat exchange rate, currency exchange rate?

Tony Shen

Yes, we are assuming rough FX side.

Mark Tobin - Roth Capital Partners

Okay. So if there is further appreciation it would be upside from there? Okay. Thank you.

Tony Shen

Well, only upside on the R&D revenue from cell phone cells, because the cylindrical cells are priced in dollars.

Operator

There are no more questions at this time.

Tony Shen

Okay. If there are no more questions, I think we will conclude the call today. I will thank everybody for calling in and we look forward to meeting you in the next quarterly conference call.

Operator

Thank you for your participation in today's conference. This concludes the presentation you may now disconnect and have a great day.

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