China BAK Battery Inc. F2Q09 (Qtr End 03/31/09) Earnings Call Transcript

Executives

Tony Shen – CFO, Treasurer and Secretary

Analysts

Mark Tobin – Roth Capital Partners

Doug Ruth – Lenox Financial

China BAK Battery Inc. (CBAK) F2Q09 (Qtr End 03/31/09) Earnings Call Transcript April 28, 2009 8:00 PM ET

Operator

Good evening, and thank you for joining us on China Battery second quarter fiscal year 2009 ended March 31^st, 2009 Conference Call. During today’s call, we will provide details on the company’s second quarter fiscal year 2009 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 in China BAK’s senior management team including Mr. Li, China BAK’s Chairman and Chief Executive Officer; and Mr. Tony Shen, China BAK’s Chief Financial Officer. All of them will be available to answer questions during the Q&A section.

Our agenda for today is as follows. Mr. Shen 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 our comments today will contain forward-looking statements, and management may make additional forward-looking statements in response to your questions. Such written and verbal disclosures are made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995.

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

Our statements on this call are made as of April 28, 2009 and the company undertakes no obligations to update any of the forward-looking statements contained herein whether as a result of new information, future events, changes in exceptions or otherwise.

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

Tony Shen

Thanks, Carla. I would like to extend a warm welcome to everyone joining us on the call today. Unfortunately, Mr. Li is on sick leave and couldn’t join us. We just found that out. So, I will be the only one hosting the call.

First, some highlights. China BAK was accepted into the approved vendor list of an international first-tier OEM notebook computer manufacturer during the quarter. We continued to optimize this business of our operation and to implement measures to reduce our costs and operational expenses. We’ve maintained positive operating cash flow during this quarter which has historically been a seasonally slow quarter.

Our Tianjin facility received positive market feedback to samples of our lithium-phosphate cells, used in electric bicycles, power tools, uninterruptible power supplies, and other applications

Now I will review the quarter’s financial performances in more details. All of the dollar numbers will be in US dollars. Net revenues for this quarter were $40.8 million, down 40.1% from last quarter and down 20.5% from the same quarter of last year. The substantial decrease in net revenue over – as compared to last period was generally due to the global financial crisis and recession, which weakened demand for many of the products that our customers sell.

Revenue from cylindrical sales used in notebook computers and other applications were $9.2 million, down 49.8% from last quarter and up $37.5% from the same quarter of last year. Revenue from lithium polymer cells, used in personal electronics devices such as PDAs, MP3 players, and Bluetooth devices were $2.0 million in the second quarter of FY ‘09, down 49.8% from last quarter and up 3.8% from the second of last year.

Revenues from prismatic cells, including aluminum-case cells, steel-case cells and battery packs, were $29.6 million, down 35.4% from last quarter and down 30.7% from the same quarter of last year. Revenue from aluminum-case cells were $23.3 million, down 37.5% from last quarter and down 23.0% from the same quarter of last year.

Revenue from battery packs were $4.8 million, down 11.1% from the last quarter and down 26.8% from the same quarter of last year. Revenues from steel-case cells were $1.5 million, down 52.6% from last quarter, and down 35.0% from the same quarter of last year.

Gross profit for the second quarter of FY ‘09 was $3.0 million, down 71.5% from last quarter and down 22.8% from the same quarter of last year. Gross margin was 7.4%, compared to 15.6% last quarter and 7.6% in the same quarter of last year. The decrease in gross margin from the last quarter and from the same quarter of last year was the result of lower average selling prices and lower average manufacturing costs, offset by lower average material cost.

Operating expenses totaled $6.4 million or 15.7% of revenue this quarter, as compared to 14.4% of revenue last quarter and 14.8% of revenue in the same quarter of last year. R&D expenses were $1.1 million or 2.8% of revenue, as compared to 2.1% of revenue last quarter and 2.7% of revenue in the same quarter of last year. Sales and marketing expenses were $1.2 million or 2.8% of revenue, as compared to 2.3% of revenue last quarter and 2.7% of revenue in the same quarter of last year.

G&A expenses were $4.1 million or 10.1% of revenue, as compared to 9.9% of revenue last quarter and 9.4% of revenue in the same quarter of last year. Operating loss for the second quarter of FY ‘09 was $3.4 million as compared to operating income of $0.8 million last quarter and an operating loss of $3.7 million in the same quarter of last year.

Net loss was $5.7 million this quarter as compared to net loss of $1.7 million last quarter, and a net loss of $6.2 million in the same quarter of last year. Diluted earnings per share were negative $0.10, compared with $0.03 per diluted share last quarter and a negative $0.12 per diluted share in the same quarter of last year.

For the second quarter of FY ‘09, day sales outstanding increased to 171 days as compared to 103 days last quarter. Day sales of inventory increased to 148 days from 99 days last quarter.

On March 31st, 2009 China BAK had $25.4 million in cash and negative $38 million in working capital, reflecting a current ratio of 0.83 to 1. Short-term bank loans and long-term bank loans totaled $172.7 million, as compared to $172.2 million on December 31st, 2008. Shareholders’ equity totaled $161.1 million. China BAK had $75.0 million available for borrowing under its credit facilities.

Our cost and expense reduction plan is on track. This quarter, China BAK continued to implement its aggressive cost management program announced earlier this year. As a result, operating expenses decreased by $3.4 million from the first quarter of FY ‘09, exceeding our $1.5 million cost and expense reduction target.

Moreover, our operating expenses were at their lowest level since fiscal year 2007. Throughout FY ‘09, prioritization of our product portfolio and aggressive cost and expense reduction will be our focus. We are delighted that the first year OEM notebook manufacturer determined that our cylindrical cells met their performance and reliability requirements. Also, we believe we will continue to gain market share in all products.

We will continue to take appropriate actions to address the downturn in the global economy, as well as the challenges related to weak customer demand. We have implemented aggressive measures to reduce cost and expenses, which will definitely strengthen the company’s ability to ride out the recession.

I would like to thank everyone for listening today and I’m happy to answer any questions you may have. Carla?

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Mark Tobin with Roth Capital Partners. Please proceed, sir.

Mark Tobin – Roth Capital Partners

Hi Tony.

Tony Shen

Hi Mark.

Mark Tobin – Roth Capital Partners

First quickly, can you comment on guidance? You have that guidance out there as of the last conference call and there was no mention in the press release.

Tony Shen

We took a hard look at the rest of the year and we see that – we think that the stability is low. Apparently, based on calculation, it will be quite difficult for us to achieve the previously announced guidance. But we are also not sure how much the new guidance should be at this time. So, we chose not to mention anything.

Mark Tobin – Roth Capital Partners

Okay. And can you comment on that tier 1 notebook computer OEM? I know you had expected shipments no later – at least the previous announcement was no later than the third quarter timeframe. Have those shipments started yet?

Tony Shen

Not yet, the expectation is still the same. In the third quarter, shipment will start.

Mark Tobin – Roth Capital Partners

Okay. And then looking at the quarter, obviously much kind of a reversal from the improvement we’ve seen over the past few quarters. Can you give us a sense of – do you have a handle on what went wrong during the quarter and as a result, are you prepared to take steps to improve and specifically, I’m looking at cylindrical sales being down 50% Q1 to Q2 and then also, 7 – back single-digit gross margins? I’m just trying to understand what drove that.

Tony Shen

There are several forces in play this past quarter. The underlying macro situation is of course the global recession; especially the US is the – top of it, a hardest hit. So, that experienced the weakened demand in notebook computers and as a result, weaker demand for notebook batteries and battery sales, et cetera. We – fortunately, we still have the domestic market for cell phone, which of course is also down, but not down as severely.

Another reason is the seasonality factor. The March quarter is traditionally the weakest quarter of the year. Last year, we didn’t encounter that because cylindrical was on its strongest upswing. But this year, cylindrical was hit by the recession as mentioned. So, the seasonality factor is once again here. We saw some upticks in March. In fact, January and February combined, did about the same in terms of revenue generation as March. So, the trend is encouraging, to put it not as optimistic as we all hope, but we expect the June quarter should be more favorable.

Another reason was this year in – it’s a rare case when Chinese New Year and the Calendar New Year both fall in January and a lot of companies including our customers chose to take the whole month of January off. So, that slows down business a little bit too.

Mark Tobin – Roth Capital Partners

Okay. And how about gross margin?

Tony Shen

Well, gross margin was hard hit this quarter because the volume was low. We had revenue of about $41 million, which is the lowest in the last eight or nine quarters and that makes the manufacturing cost per unit much higher, more than offsetting the decline in material cost. Lithium cobalt dioxide price came down quite significantly this past quarter, but it is a positive effect was more than offset.

Mark Tobin – Roth Capital Partners

Okay. And then can you – I guess, again looking at the quarter, can you comment on – obviously, it is limited. What type of early warning systems you have in place give you a heads up on this? I mean it appears that given the inventory levels that this – the slowdown was somewhat of a surprise to you.

Tony Shen

Well, we – in the last earnings release results conference, we announced that we stopped production of prismatic cells for the whole month of January. So, we actually had anticipated some slowdown, but unfortunately not enough on the cylindrical side. If you look at our inventory levels, it’s also the lowest in about eight quarters, although day sales of inventory is higher because of the lower revenue. So, we took some measures to try our best to offset the downturn including expense reduction. You can see that although revenue is much lower than the same quarter of last year, our gross margin was only slightly lower. So, that shows that we still tried our efforts.

Mark Tobin – Roth Capital Partners

Okay. And were there some order cancellations on the notebook, on the cylindrical side or typically, I view that segment is having better visibility than your mobile handset segment, maybe I’m mistaken?

Tony Shen

Yes. In general, that’s true, but the visibility for notebook computer demand has also turned unclear for our customers, the packers in Taiwan and they in turn gave us shorter time of visibility. In some cases, only half of what they forecast – I mean, the time, the lead time is only half as long as before.

Mark Tobin – Roth Capital Partners

Is that still the case or have they gone back to more traditional lead times?

Tony Shen

They improved a little, but have not gone back to the visibility before the downturn.

Mark Tobin – Roth Capital Partners

Okay. Thank you. I’ll get back in the queue.

Tony Shen

Yes, thank you.

Operator

Our next question comes from the line of Doug Ruth from Lenox Financial. Please proceed, sir.