UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10−Q




(Mark
One)




x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For the
quarterly period ended: June 30, 2010




 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For the
transition period from ____________ to _____________




Commission
File Number: 001-32898





CHINA
BAK BATTERY, INC.


(Exact
name of registrant as specified in its charter)





Nevada
                
                88-0442833(State or other jurisdiction of incorporation
                  or organization)
                
                (I.R.S. Employer Identification No.)





BAK
Industrial Park


No.
1 BAK Street


Kuichong
Town, Longgang District


Shenzhen
518119


People’s
Republic of China


(Address
of principal executive offices, Zip Code)




(86-755)
8977-0093


(Registrant’s
telephone number, including area code)









(Former
name, former address and former fiscal year, if changed since last
report)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes  x  No   ̈





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files).  Yes   ̈   No   ̈





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.





Large accelerated filer   ̈
                
                Accelerated filer  xNon-accelerated filer   ̈(Do not check if a smaller reporting company)
                Smaller reporting company   ̈





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).  Yes   ̈  No x





The
number of shares outstanding of each of the issuer’s classes of common stock, as
of August 6, 2010 is as follows:




ClassofSecurities
                
                SharesOutstandingCommon
      Stock, $0.001 par value
                
                63,612,526
















CHINA
BAK BATTERY, INC.











TABLE
OF CONTENTS





PART
      IFINANCIAL
      INFORMATIONITEM
      1.
                                        FINANCIAL
      STATEMENTS.
                                        F-1ITEM
      2.
                                        MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS.
                                        1ITEM
      3.
                                        QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
                                        20ITEM
      4.
                                        CONTROLS
      AND PROCEDURES.
                                        21PART
      IIOTHER
      INFORMATIONITEM
      1.
                                        LEGAL
      PROCEEDINGS.
                                        22ITEM
      1A.
                                        RISK
      FACTORS.
                                        23ITEM
      2.
                                        UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
                                        23ITEM
      3.
                                        DEFAULTS
      UPON SENIOR SECURITIES.
                                        23ITEM
      4.
                                        (REMOVED
      AND RESERVED).
                                        23ITEM
      5.
                                        OTHER
      INFORMATION.
                                        23ITEM
      6.
                                        EXHIBITS.
                                        23










PART
I


FINANCIAL
INFORMATION




ITEM
1.             FINANCIAL
STATEMENTS.




CHINA
BAK BATTERY, INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED JUNE 30, 2010





Contents
                  
                  PageCondensed
      Consolidated Balance Sheets as of September 30, 2009 and June 30, 2010
      (unaudited)
                  
                  F-2Condensed
      Consolidated Statements of Operations and Comprehensive Loss for the three
      months ended June 30, 2009 and 2010 (unaudited)
                  
                  F-4Condensed
      Consolidated Statements of Operations and Comprehensive Loss for the nine
      months ended June 30, 2009 and 2010 (unaudited)
                  
                  F-5Condensed
      Consolidated Statements of Shareholders’ Equity for the nine months ended
      June 30, 2009 and 2010 (unaudited)
                  
                  F-6Condensed
      Consolidated Statements of Cash Flows for the three months ended June 30,
      2009 and 2010 (unaudited)
                  
                  F-7Condensed
      Consolidated Statements of Cash Flows for the nine months ended June 30,
      2009 and 2010 (unaudited)
                  
                  F-9Notes
      to the Condensed Consolidated Financial Statements
    (unaudited)
                  
                  F-11





F-1





PART
I


FINANCIAL
INFORMATION





Item
1. Financial Statements.





China
BAK Battery, Inc. and subsidiaries


Condensed
consolidated balance sheets


As
of September 30, 2009 and June 30, 2010





(In
US$)


September 30,
                  
                  
                  June 30,Note
                  
                  
                  2009
                  
                  
                  2010(Unaudited)AssetsCurrent
      assetsCash
      and cash equivalents
                  
                  
                  
                  
                  $
                  30,678,352
                  
                  
                  $
                  24,875,023Pledged
      deposits
                  
                  2
                  
                  
                  
                  31,115,109
                  
                  
                  
                  9,294,353Trade
      accounts receivable, net
                  
                  3
                  
                  
                  
                  83,291,698
                  
                  
                  
                  79,628,616Inventories
                  
                  4
                  
                  
                  
                  65,535,384
                  
                  
                  
                  64,799,264Prepayments
      and other receivables
                  
                  5
                  
                  
                  
                  4,632,424
                  
                  
                  
                  5,599,889Assets
      held for sale
                  
                  
                  
                  
                  
                  803,648
                  
                  
                  
                  800,247Deferred
      tax assets
                  
                  
                  
                  
                  
                  3,894,703
                  
                  
                  
                  8,059,375Total
      current assets
                  
                  
                  
                  
                  
                  219,951,318
                  
                  
                  
                  193,056,767Property,
      plant and equipment, net
                  
                  6
                  
                  
                  
                  219,684,994
                  
                  
                  
                  224,012,279Lease
      prepayments, net
                  
                  
                  
                  
                  
                  32,165,629
                  
                  
                  
                  31,605,838Intangible
      assets, net
                  
                  
                  
                  
                  
                  239,487
                  
                  
                  
                  202,149Deferred
      tax assets
                  
                  
                  
                  
                  
                  42,911
                  
                  
                  
                  53,718Total
      assets
                  
                  
                  
                  
                  $
                  472,084,339
                  
                  
                  $
                  448,930,751





See
accompanying notes to the condensed interim consolidated financial
statements.





F-2




China
BAK Battery, Inc. and subsidiaries
 Condensed
consolidated balance sheets
 As
of September 30, 2009 and June 30, 2010 (continued)
 (In
US$)





September 30,
                      
                      
                      June 30,Note
                      
                      
                      2009
                      
                      
                      2010(Unaudited)LiabilitiesCurrent
      liabilitiesShort-term
      bank loans
                      
                      7
                      
                      
                      $
                      139,159,380
                      
                      
                      $
                      138,944,458Current
      maturities of long-term bank loans
                      
                      8
                      
                      
                      
                      16,114,146
                      
                      
                      
                      11,796,974Accounts
      and bills payable
                      
                      
                      
                      
                      
                      92,571,516
                      
                      
                      
                      80,257,642Accrued
      expenses and other payables
                      
                      
                      
                      
                      
                      18,425,271
                      
                      
                      
                      21,236,423Total
      current liabilities
                      
                      
                      
                      
                      
                      266,270,313
                      
                      
                      
                      252,235,497Long-term
      bank loans, less current maturities
                      
                      8
                      
                      
                      
                      39,552,906
                      
                      
                      
                      29,492,436Deferred
      revenue
                      
                      
                      
                      
                      
                      7,441,806
                      
                      
                      
                      7,314,124Other
      long-term payables
                      
                      
                      
                      
                      
                      1,940,217
                      
                      
                      
                      3,381,544Deferred
      tax liabilities
                      
                      
                      
                      
                      
                      278,227
                      
                      
                      
                      1,109,361Total
      liabilities
                      
                      
                      
                      
                      
                      315,483,469
                      
                      
                      
                      293,532,962Commitments
      and contingencies
                      
                      12Shareholders’
      equityShares
      of common stock US$ 0.001 par value;100,000,000
      authorized; 57,737,481 and 63,608,776 issued and outstanding as of
      September 30, 2009 and June 30, 2010 respectively
                      
                      
                      
                      
                      
                      57,738
                      
                      
                      
                      63,609Donated
      shares
                      
                      
                      
                      
                      
                      14,101,689
                      
                      
                      
                      14,101,689Additional
      paid-in capital
                      
                      
                      
                      
                      
                      101,161,455
                      
                      
                      
                      123,131,461Statutory
      reserves
                      
                      
                      
                      
                      
                      7,227,195
                      
                      
                      
                      7,314,565Retained
      earnings / (accumulated deficit)
                      
                      
                      
                      
                      
                      13,328,115
                      
                      
                      
                      (10,964,358
                      )Accumulated
      other comprehensive income
                      
                      
                      
                      
                      
                      24,791,288
                      
                      
                      
                      25,817,433160,667,480
                      
                      
                      
                      159,464,399Less:
      Treasury shares
                      
                      
                      
                      
                      
                      (4,066,610
                      )
                      
                      
                      (4,066,610
                      )Total
      shareholders’ equity
                      
                      
                      
                      
                      
                      156,600,870
                      
                      
                      
                      155,397,789Total
      liabilities and shareholders’ equity
                      
                      
                      
                      
                      $
                      472,084,339
                      
                      
                      $
                      448,930,751





See
accompanying notes to the condensed interim consolidated financial
statements.





F-3




China
BAK Battery, Inc. and subsidiaries
 Condensed
consolidated statements of operations and comprehensive loss
 For
the three months ended June 30, 2009 and 2010
 (Unaudited)
 (In
US$)


Three months ended June 302009
                
                
                2010Net
      revenues
                
                $
                44,688,608
                
                
                $
                58,557,246Cost
      of revenues
                
                
                (39,640,812
                )
                
                
                (59,764,391
                )Gross
      profit / (loss)
                
                
                5,047,796
                
                
                
                (1,207,145
                )Operating
      expenses:Research
      and development expenses
                
                
                (1,472,015
                )
                
                
                (2,129,607
                )Sales
      and marketing expenses
                
                
                (1,580,776
                )
                
                
                (2,586,950
                )General
      and administrative expenses
                
                
                (5,551,289
                )
                
                
                (7,429,001
                )Impairment
      charge
                
                
                -
                
                
                
                (5,057,745
                )Total
      operating expenses
                
                
                (8,604,080
                )
                
                
                (17,203,303
                )Operating
      loss
                
                
                (3,556,284
                )
                
                
                (18,410,448
                )Finance
      costs, net
                
                
                (1,896,552
                )
                
                
                (2,022,042
                )Government
      grant income
                
                
                222,136
                
                
                
                58,673Other
      (expense) / income
                
                
                (353,354
                )
                
                
                107,243Loss
      before income taxes
                
                
                (5,584,054
                )
                
                
                (20,266,574
                )Income
      tax benefit
                
                
                413,027
                
                
                
                2,003,609Net
      loss
                
                $
                (5,171,027
                )
                
                $
                (18,262,965
                )Other
      comprehensive (loss) / income-
      Foreign currency translation adjustment
                
                
                (141,384
                )
                
                
                1,297,751Comprehensive
      loss
                
                $
                (5,312,411
                )
                
                $
                (16,965,214
                )Net
      loss per share:-
      Basic
                
                $
                (0.09
                )
                
                $
                (0.29
                )-
      Diluted
                
                $
                (0.09
                )
                
                $
                (0.29
                )Weighted
      average number of shares of common stock:-
      Basic
                
                
                56,966,619
                
                
                
                62,887,664-
      Diluted
                
                
                56,966,619
                
                
                
                62,887,664





See
accompanying notes to the condensed interim consolidated financial
statements.





F-4


China
BAK Battery, Inc. and subsidiaries
 Condensed
consolidated statements of operations and comprehensive loss
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)
 (In
US$)


Nine months ended June 30,2009
                
                
                2010Net
      revenues
                
                $
                153,593,006
                
                
                $
                159,208,513Cost
      of revenues
                
                
                (134,930,310
                )
                
                
                (141,853,023
                )Gross
      profit
                
                
                18,662,696
                
                
                
                17,355,490Operating
      expenses:Research
      and development expenses
                
                
                (4,014,221
                )
                
                
                (5,523,092
                )Sales
      and marketing expenses
                
                
                (4,334,495
                )
                
                
                (6,320,569
                )General
      and administrative expenses
                
                
                (16,426,649
                )
                
                
                (20,884,801
                )Impairment
      charge
                
                
                -
                
                
                
                (5,057,745
                )Total
      operating expenses
                
                
                (24,775,365
                )
                
                
                (37,786,207
                )Operating
      loss
                
                
                (6,112,669
                )
                
                
                (20,430,717
                )Finance
      costs, net
                
                
                (7,100,544
                )
                
                
                (6,365,775
                )Government
      grant income
                
                
                392,722
                
                
                
                492,947Other
      expenses
                
                
                (189,197
                )
                
                
                (31,065
                )Loss
      before income taxes
                
                
                (13,009,688
                )
                
                
                (26,334,610
                )Income
      tax benefit
                
                
                377,980
                
                
                
                2,129,507Net
      loss
                
                $
                (12,631,708
                )
                
                $
                (24,205,103
                )Other
      comprehensive (loss) / income-
      Foreign currency translation adjustment
                
                
                (242,542
                )
                
                
                1,026,145Comprehensive
      loss
                
                $
                (12,874,250
                )
                
                $
                (23,178,958
                )Net
      loss per share:-
      Basic
                
                $
                (0.22
                )
                
                $
                (0.39
                )-
      Diluted
                
                $
                (0.22
                )
                
                $
                (0.39
                )Weighted
      average number of shares of common stock:-
      Basic
                
                
                56,961,797
                
                
                
                62,285,862-
      Diluted
                
                
                56,961,797
                
                
                
                62,285,862





See
accompanying notes to the condensed interim consolidated financial
statements.





F-5




China
BAK Battery, Inc. and subsidiaries
 Condensed
consolidated statements of shareholders’ equity
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


Retained
                
                
                AccumulatedSharesofcommonstock
                
                
                
                
                
                Additional
                
                
                
                
                
                earnings /
                
                
                other
                
                
                Treasuryshares
                
                
                TotalNumber of
                
                
                
                
                
                Donated
                
                
                paid-in
                
                
                Statutory
                
                
                (Accumulated
                
                
                comprehensive
                
                
                Number of
                
                
                
                
                
                shareholders’shares
                
                
                Amount
                
                
                shares
                
                
                capital
                
                
                reserves
                
                
                deficit)
                
                
                income
                
                
                shares
                
                
                Amount
                
                
                equityBalance
      as of October 1, 2008
                
                
                57,676,481
                
                
                $
                57,677
                
                
                $
                14,101,689
                
                
                $
                97,286,286
                
                
                $
                6,917,943
                
                
                $
                27,628,860
                
                
                $
                25,146,155
                
                
                
                (721,030
                )
                
                $
                (4,066,610
                )
                
                $
                167,072,000Net
      loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (12,631,708
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (12,631,708
                )Share-based
      compensation for employee stock awards
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                2,102,323
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                2,102,323Issuance
      of common stock to non- employee directors
                
                
                11,250
                
                
                
                11
                
                
                
                -
                
                
                
                (11
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Appropriation
      to statutory reserves
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                309,252
                
                
                
                (309,252
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Foreign
      currency translation adjustment
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (242,542
                )
                
                
                -
                
                
                
                -
                
                
                
                (242,542
                )Balance
      as of June 30, 2009
                
                
                57,687,731
                
                
                $
                57,688
                
                
                $
                14,101,689
                
                
                $
                99,388,598
                
                
                $
                7,227,195
                
                
                $
                14,687,900
                
                
                $
                24,903,613
                
                
                
                (721,030
                )
                
                $
                (4,066,610
                )
                
                $
                156,300,073Balance
      as of October 1, 2009
                
                
                57,737,481
                
                
                $
                57,738
                
                
                $
                14,101,689
                
                
                $
                101,161,455
                
                
                $
                7,227,195
                
                
                $
                13,328,115
                
                
                $
                24,791,288
                
                
                
                (721,030
                )
                
                $
                (4,066,610
                )
                
                $
                156,600,870Net
      loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (24,205,103
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (24,205,103
                )Share-based
      compensation for employee stock awards
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                2,359,797
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                2,359,797Exercise
      of stock options awards
                
                
                70,045
                
                
                
                70
                
                
                
                -
                
                
                
                226,526
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                226,596Issuance
      of common stock to non- employee directors
                
                
                11,250
                
                
                
                11
                
                
                
                -
                
                
                
                (11
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Issuance
      of new common stock
                
                
                5,790,000
                
                
                
                5,790
                
                
                
                -
                
                
                
                19,383,694
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                19,389,484Appropriation
      to statutory reserves
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                87,370
                
                
                
                (87,370
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Foreign
      currency translation adjustment
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                1,026,145
                
                
                
                -
                
                
                
                -
                
                
                
                1,026,145Balance
      as of June 30, 2010
                
                
                63,608,776
                
                
                $
                63,609
                
                
                $
                14,101,689
                
                
                $
                123,131,461
                
                
                $
                7,314,565
                
                
                $
                (10,964,358
                )
                
                $
                25,817,433
                
                
                
                (721,030
                )
                
                $
                (4,066,610
                )
                
                $
                155,397,789





See
accompanying notes to the condensed interim consolidated financial
statements.





F-6




China
BAK Battery, Inc. and subsidiaries
 Condensed
consolidated statements of cash flows
 For
the three months ended June 30, 2009 and 2010
 (Unaudited)
 (In
US$)


ThreemonthsendedJune30,2009
                
                
                2010Cash
      flow from operating activitiesNet
      loss
                
                $
                (5,171,027
                )
                
                $
                (18,262,965
                )Adjustments
      to reconcile net loss to net cash provided by operating
      activities:Depreciation
      and amortization
                
                
                3,982,887
                
                
                
                4,469,160Provision
      for doubtful debts
                
                
                2,538,670
                
                
                
                3,447,312Provision
      for obsolete inventories
                
                
                425,929
                
                
                
                5,573,979Impairment
      charge
                
                
                -
                
                
                
                5,057,745Share-based
      compensation
                
                
                553,848
                
                
                
                414,912Deferred
      income taxes
                
                
                (713,239
                )
                
                
                (2,004,232
                )Deferred
      revenue
                
                
                (58,567
                )
                
                
                (58,616
                )Exchange
      (gain) / loss
                
                
                (345,649
                )
                
                
                558,173Changes
      in operating assets and liabilities:Trade
      accounts receivable
                
                
                1,735,782
                
                
                
                1,545,615Inventories
                
                
                (4,545,283
                )
                
                
                5,842,860Prepayments
      and other receivables
                
                
                3,140,961
                
                
                
                1,954,428Accounts
      and bills payable
                
                
                4,015,291
                
                
                
                1,110,779Accrued
      expenses and other payables
                
                
                (399,438
                )
                
                
                (1,442,885
                )Net
      cash provided by operating activities
                
                
                5,160,165
                
                
                
                8,206,265Cash
      flow from investing activitiesPurchases
      of property, plant and equipment
                
                
                (1,765,783
                )
                
                
                (12,529,550
                )Purchases
      of intangible assets
                
                
                (49,291
                )
                
                
                (12,284
                )Net
      cash used in investing activities
                
                $
                (1,815,074
                )
                
                $
                (12,541,834
                )





See
accompanying notes to the condensed interim consolidated financial
statements.





F-7


China
BAK Battery, Inc. and subsidiaries
 Condensed
consolidated statements of cash flows
 For
the three months ended June 30, 2009 and 2010 (continued)
 (Unaudited)
 (In
US$)


ThreemonthsendedJune30,2009
                
                
                2010Cash
      flow from financing activitiesProceeds
      from borrowings
                
                $
                38,456,922
                
                
                $
                48,020,212Repayment
      of borrowings
                
                
                (19,801,349
                )
                
                
                (67,250,509
                )(Increase)
      / decrease in pledged deposits
                
                
                (17,656,329
                )
                
                
                8,793,960Net
      cash provided by / (used in) financing activities
                
                
                999,244
                
                
                
                (10,436,337
                )Effect
      of exchange rate changes on cash and cash equivalents
                
                
                (79,908
                )
                
                
                2,521Net
      increase / (decrease) in cash and cash equivalents
                
                
                4,264,427
                
                
                
                (14,769,385
                )Cash
      and cash equivalents at the beginning of period
                
                
                25,374,498
                
                
                
                39,644,408Cash
      and cash equivalents at the end of period
                
                $
                29,638,925
                
                
                $
                24,875,023Supplemental
      disclosure of cash flow information:Cash
      received during the period for:Bills
      receivable discounted to banks
                
                $
                10,244,795
                
                
                $
                15,947,373Cash
      paid during the period for:Income
      taxes
                
                $
                530,793
                
                
                $
                621,442Interest,
      net of amounts capitalized
                
                $
                1,417,056
                
                
                $
                2,960,974





See
accompanying notes to the condensed interim consolidated financial
statements.





F-8




China
BAK Battery, Inc. and subsidiaries
 Condensed
consolidated statements of cash flows
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)
 (In
US$)


NinemonthsendedJune30,2009
                
                
                2010Cash
      flow from operating activitiesNet
      loss
                
                $
                (12,631,708
                )
                
                $
                (24,205,103
                )Adjustments
      to reconcile net loss to net cash provided by / (used in) operating
      activities:Depreciation
      and amortization
                
                
                11,503,691
                
                
                
                13,261,962Provision
      for doubtful debts
                
                
                5,861,135
                
                
                
                9,104,861(Recovery
      of) / provision for obsolete inventories
                
                
                (130,790
                )
                
                
                5,435,854Impairment
      charge
                
                
                -
                
                
                
                5,057,745Share-based
      compensation
                
                
                2,102,323
                
                
                
                2,359,797Deferred
      income taxes
                
                
                (1,003,707
                )
                
                
                (3,298,717
                )Deferred
      revenue
                
                
                (175,567
                )
                
                
                (175,790
                )Exchange
      loss
                
                
                409,774
                
                
                
                711,684Changes
      in operating assets and liabilities:Trade
      accounts receivable
                
                
                6,930,391
                
                
                
                (4,378,527
                )Inventories
                
                
                5,749,171
                
                
                
                (4,254,359
                )Prepayments
      and other receivables
                
                
                (5,114,724
                )
                
                
                (1,488,373
                )Accounts
      and bills payable
                
                
                16,871,050
                
                
                
                (11,278,196
                )Accrued
      expenses and other payables
                
                
                2,241,048
                
                
                
                2,462,334Net
      cash provided by / (used in) operating activities
                
                
                32,612,087
                
                
                
                (10,684,828
                )Cash
      flow from investing activitiesPurchases
      of property, plant and equipment
                
                
                (33,623,698
                )
                
                
                (20,238,084
                )Payment
      of lease prepayments
                
                
                (1,076,777
                )
                
                
                -Purchases
      of intangible assets
                
                
                (127,955
                )
                
                
                (13,922
                )Net
      cash used in investing activities
                
                $
                (34,828,430
                )
                
                $
                (20,252,006
                )





See
accompanying notes to the condensed interim consolidated financial
statements.





F-9




China
BAK Battery, Inc. and subsidiaries
 Condensed
consolidated statements of cash flows
 For
the nine months ended June 30, 2009 and 2010 (continued)
 (Unaudited)
 (In
US$)


NinemonthsendedJune30,2009
                
                
                2010Cash
      flow from financing activitiesProceeds
      from borrowings
                
                $
                173,007,057
                
                
                $
                189,852,315Repayment
      of borrowings
                
                
                (151,426,481
                )
                
                
                (205,519,128
                )(Increase)
      / decrease in pledged deposits
                
                
                (25,152,373
                )
                
                
                21,882,643Proceeds
      from issuance of capital stock, net
                
                
                -
                
                
                
                19,616,080Net
      cash (used in) / provided by financing activities
                
                
                (3,571,797
                )
                
                
                25,831,910Effect
      of exchange rate changes on cash and cash equivalents
                
                
                (279,769
                )
                
                
                (698,405
                )Net
      decrease in cash and cash equivalents
                
                
                (6,067,909
                )
                
                
                (5,803,329
                )Cash
      and cash equivalents at the beginning of period
                
                
                35,706,834
                
                
                
                30,678,352Cash
      and cash equivalents at the end of period
                
                $
                29,638,925
                
                
                $
                24,875,023Supplemental
      disclosure of cash flow information:Cash
      received during the period for:Bills
      receivable discounted to banks
                
                $
                18,971,302
                
                
                $
                16,533,342Cash
      paid during the period for:Income
      taxes
                
                $
                625,726
                
                
                $
                843,781Interest,
      net of amounts capitalized
                
                $
                6,557,660
                
                
                $
                6,603,127





See
accompanying notes to the condensed interim consolidated financial
statements.





F-10




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


1.
            Principal
      Activities, Basis of Presentation and
  Organization





Principal
Activities





China BAK
Battery, Inc. (“China BAK”) is a corporation formed in the State of Nevada on
October 4, 1999 as Medina Copy, Inc. The Company changed its name to Medina
Coffee, Inc. on October 6, 1999 and subsequently changed its name to China BAK
Battery, Inc. on February 14, 2005. China BAK and its subsidiaries (hereinafter,
collectively referred to as the “Company”) are principally engaged in the
manufacture, commercialization and distribution of a wide variety of standard
and customized lithium ion (known as "Li-ion" or "Li-ion cell") rechargeable
batteries for use in cellular telephones, as well as various other portable
electronic applications, including high-power handset telephones, laptop
computers, power tools, digital cameras, video camcorders, MP3 players,
uninterruptible power suppliers, Bluetooth devices, electric bicycles, electric
buses, hybrid/electric vehicles, and general industrial
applications.





The
shares of the Company traded in the over-the-counter market through the
Over-the-Counter Bulletin Board from 2005 until May 31, 2006, when the Company
obtained approval to list its common stock on The NASDAQ Global Market, and
trading commenced that same date under the symbol "CBAK".





Basis
of Presentation and Organization





As of
June 30, 2010, the Company’s subsidiaries consisted of: i) BAK International
Limited (“BAK International”), a wholly owned limited liability company
incorporated in Hong Kong on December 29, 2003 as BATCO International Limited,
which changed its name to BAK International Limited on November 3, 2004; ii)
Shenzhen BAK Battery Co., Ltd. (“Shenzhen BAK”), a wholly owned limited
liability company established on August 3, 2001 in the People’s Republic of
China (“PRC”); iii) BAK Electronics (Shenzhen) Co., Ltd. (“BAK Electronics”), a
wholly owned limited liability company established on August 15, 2005 in the
PRC; iv) BAK International (Tianjin) Ltd. (“BAK Tianjin”), a wholly owned
limited liability company established on December 12, 2006 in the PRC; v)
BAK Battery Canada Ltd. (“BAK Canada”), a wholly owned limited liability company
established on December 20, 2006 in Canada as BAK Canada Battery Ltd., which
changed its name to BAK Battery Canada Ltd. on December 22, 2006; vi) BAK Europe
GmbH (“BAK Europe”), a wholly owned limited liability company established in
Germany on November 28, 2007; and vii) BAK Telecom India Private Limited (“BAK
India”), a wholly owned limited liability company established in India on August
14, 2008. BAK International beneficially owns 100% of BAK India partly through a
nominee agreement with one of its employees.





BAK
Tianjin was established in Tianjin Technology Industrial District on December
12, 2006 as a wholly owned subsidiary of BAK International with registered
capital of US$99,990,000. Pursuant to BAK Tianjin’s articles of association and
relevant PRC regulations, BAK International was required to contribute
US$20,000,000 to BAK Tianjin as capital (representing 20% of BAK Tianjin’s
registered capital) before March 11, 2007. An extension from the Business
Administration Bureau of Beichen District, Tianjin, was obtained to make this
contribution no later than December 11, 2007. On November 16, 2007, BAK
International contributed approximately US$20,000,000 capital to BAK Tianjin.
The remaining US$79,990,000 was originally required to be fully contributed no
later than December 11, 2008 and an extension from the Business Administration
Bureau of Beichen District, Tianjin, was obtained to make this contribution no
later than December 11, 2009. On November 16, 2009, BAK International
contributed approximately US$9,000,000 capital to BAK Tianjin and as of November
16, 2009, the total contribution from BAK International was US$29,000,000. The
remaining US$70,990,000 was originally required to be fully contributed no later
than December 11, 2009 and an extension from the Business Administration Bureau
of Beichen District, Tianjin, was obtained to make this contribution no later
than December 2012. BAK Tianjin is principally engaged in the manufacture of
larger lithium ion batteries for use in cordless power tools and various types
of vehicles.





Pursuant
to Shenzhen BAK’s articles of association and relevant PRC regulations, BAK
International was required to contribute about US$5.72 million to Shenzhen BAK
as capital (representing 7% of Shenzhen BAK’s registered capital) no later than
October 2008. On May 5, 2009, an approval from Shenzhen Bureau of Trade and
Industry was obtained to reduce the required registered capital to
US$76,877,480, which had been fully paid up, and on June 22, 2009, an updated
business license of Shenzhen BAK from the Business Administration Bureau of
Shenzhen was obtained. On December 25, 2009, BAK International contributed
approximately US$10,122,520 capital to Shenzhen BAK and as of June 30, 2010, the
total contribution from BAK International and Shenzhen BAK’s registered capital
was US$87,000,000.





F-11




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


1.
            Principal
      Activities, Basis of Presentation and Organization
    (continued)





Basis
of Presentation and Organization (continued)





On
November 6, 2004, BAK International, a non-operating holding company that had
substantially the same shareholders as Shenzhen BAK, entered into a share swap
transaction with the shareholders of Shenzhen BAK for the purpose of the
subsequent reverse acquisition of the Company as described below. Pursuant to
the terms of the share swap transaction, BAK International acquired all of the
outstanding shares of Shenzhen BAK for US$11.5 million in cash, while the
shareholders of Shenzhen BAK acquired substantially all of the outstanding
shares of BAK International for US$11.5 million in cash. As a result, Shenzhen
BAK became a wholly-owned subsidiary of BAK International. After the share swap
transaction was completed, there were 31,225,642 shares of BAK International
stock outstanding, exactly the same as the number of shares of capital stock of
Shenzhen BAK that had been outstanding immediately prior to the share swap, and
the shareholders of BAK International were substantially the same as the
shareholders of Shenzhen BAK prior to the share swap. Consequently, the share
swap transaction between BAK International and the shareholders of Shenzhen
BAK was accounted for as a reverse acquisition of Shenzhen BAK with no
adjustment to the historical basis of the assets and liabilities of Shenzhen
BAK.





On
January 20, 2005, the Company completed a share swap transaction with the
shareholders of BAK International. The share swap transaction, also referred to
as the “reverse acquisition” of the Company, was consummated under Nevada law
pursuant to the terms of a Securities Exchange Agreement entered by and among
China BAK, BAK International and the shareholders of BAK International on
January 20, 2005. Pursuant to the Securities Exchange Agreement, the Company
issued 39,826,075 shares of common stock, par value US$0.001 per share, to the
shareholders of BAK International (including 31,225,642 shares to the original
shareholders and 8,600,433 shares to new investors who had purchased shares in
the private placement described below), representing approximately 97.2% of the
Company’s post-exchange issued and outstanding common stock, in exchange for
100% of the outstanding capital stock of BAK International.





The share
swap transaction has been accounted for as a capital-raising transaction of the
Company whereby the historical financial statements and operations of Shenzhen
BAK are consolidated using historical carrying amounts. The 1,152,458 shares of
China BAK outstanding prior to the stock exchange transaction were accounted for
at the net book value at the time of the transaction, which was a
deficit of US$1,672.





Also on
January 20, 2005, immediately prior to consummating the share swap transaction,
BAK International executed a private placement of its common stock with
unrelated investors whereby it issued an aggregate of 8,600,433 shares of common
stock for gross proceeds of US$17,000,000. In conjunction with this financing,
Mr. Xiangqian Li, the Chairman and Chief Executive Officer of the Company,
agreed to place 2,179,550 shares of the Company's common stock owned by him into
an escrow account pursuant to an Escrow Agreement dated January 20, 2005 (the
“Escrow Agreement”). Pursuant to the Escrow Agreement, 50% of the escrowed
shares were to be released to the investors in the private placement if audited
net income of the Company for the fiscal year ended September 30, 2005 was not
at least US$12,000,000, and the remaining 50% were to be released to investors
in the private placement if audited net income of the Company for the fiscal
year ended September 30, 2006 was not at least US$27,000,000. If the audited net
income of the Company for the fiscal years ended September 30, 2005 and 2006
reached the above-mentioned targets, the 2,179,550 shares would be released to
Mr. Xiangqian Li in the amount of 50% upon reaching the 2005 target and the
remaining 50% upon reaching the 2006 target.





Under
accounting principles generally accepted in the United States of America (“US
GAAP”), escrow agreements such as the one established by Mr. Xiangqian Li
generally constitute compensation if, following attainment of a performance
threshold, shares are returned to a company officer. The Company determined that
without consideration of the compensation charge, the performance thresholds for
the year ended September 30, 2005 would be achieved. However, after
consideration of a related compensation charge, the Company determined that such
thresholds would not have been achieved. The Company also determined that, even
without consideration of a compensation charge, the performance thresholds for
the year ended September 30, 2006 would not be achieved. No compensation charge
was recorded by the Company for the years ended September 30, 2005 and
2006.





F-12


China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


1.
            Principal
      Activities, Basis of Presentation and Organization
    (continued)





Basis
of Presentation and Organization (continued)





While the
1,089,775 escrow shares relating to the 2005 performance threshold were
previously released to Mr. Xiangqian Li, Mr. Xiangqian Li executed a further
undertaking on August 21, 2006 to return those shares to the escrow agent for
the distribution to the relevant investors. However, such shares were not
returned to the escrow agent, but, pursuant to a Delivery of Make Good Shares,
Settlement and Release Agreement between the Company, BAK International and Mr.
Li entered into on October 22, 2007 (the “Li Settlement Agreement”), such shares
were ultimately delivered to the Company as described below. Because the Company
failed to satisfy the performance threshold for the fiscal year ended September
30, 2006, the remaining 1,089,775 escrow shares relating to the fiscal year 2006
performance threshold were released to the relevant investors. As Mr. Li has not
retained any of the shares placed into escrow, and as the investors party to the
Escrow Agreement are only shareholders of the Company and do not have and are
not expected to have any other relationship to the Company, the Company has not
recorded a compensation charge for the years ended September 30, 2005 and
2006.





At the
time the escrow shares relating to the 2006 performance threshold were
transferred to the investors in fiscal year 2007, the Company should have
recognized a credit to donated shares and a debit to additional paid-in capital,
both of which are elements of shareholders’ equity. This entry is not material
because total shares of common stock issued and outstanding, total shareholders’
equity and total assets do not change; nor is there any impact on income or
earnings per share. Therefore, previously filed consolidated financial
statements for the fiscal year ended September 30, 2007 have not been
restated.





In
November 2007, Mr. Xiangqian Li delivered the 1,089,775 shares related to the
2005 performance threshold to BAK International pursuant to the Li Settlement
Agreement; BAK International in turn delivered the shares to the Company. Such
shares (other than those issued to investors pursuant to the 2008 Settlement
Agreements, as described below) are now held by the Company. Upon receipt of
these shares, the Company and BAK International released all claims and causes
of action against Mr. Xiangqian Li regarding the shares, and Mr. Xiangqian Li
released all claims and causes of action against the Company and BAK
International regarding the shares. Under the terms of the Li Settlement
Agreement, the Company commenced negotiations with the investors who
participated in the Company’s January 2005 private placement in order to achieve
a complete settlement of BAK International’s obligations (and the Company’s
obligations to the extent it has any) under the applicable agreements with such
investors.





Beginning
on March 13, 2008, the Company has entered into settlement agreements (the “2008
Settlement Agreements”) with certain investors in the January 2005 private
placement.





Pursuant
to the 2008 Settlement Agreements, the Company and the settling investors have
agreed, without any admission of liability, to a settlement and mutual release
from all claims relating to the January 2005 private placement, including all
claims relating to the escrow shares related to the 2005 performance threshold
that had been placed into escrow by Mr. Xiangqian Li, as well as all claims,
including claims for liquidated damages relating to registration rights granted
in connection with the January 2005 private placement. Under the 2008 Settlement
Agreement, the Company has made settlement payments to each of the settling
investors of the number of shares of the Company’s common stock equivalent to
50% of the number of the escrow shares related to the 2005 performance threshold
these investors had claimed; aggregate settlement payments as of June 30, 2010
amounted to 368,745 shares. Share payments to date have been made in reliance
upon the exemptions from registration provided by Section 4(2) and/or other
applicable provisions of the Securities Act of 1933, as amended. In accordance
with the 2008 Settlement Agreements, the Company filed a registration statement
covering the resale of such shares which was declared effective by the SEC on
June 26, 2008.





The
Company’s condensed interim consolidated financial statements have been prepared
in accordance with US GAAP.




F-13




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


1.
            Principal
      Activities, Basis of Presentation and Organization
    (continued)





Basis
of Presentation and Organization (continued)





The
interim results of operations are not necessarily indicative of the results to
be expected for the fiscal year ending September 30, 2010. The Company’s
consolidated balance sheet as of September 30, 2009 has been taken from the
Company’s audited consolidated balance sheet as of that date. All other
financial statements contained herein are unaudited and, in the opinion of
management, contain all adjustments (consisting only of normal recurring
accruals) necessary for a fair presentation of financial position, results of
operations and cash flows for the periods presented. The Company’s accounting
policies and certain other disclosure are set forth in the notes to the
consolidated financial statements contained in the Company’s Annual Report on
Form 10-K for the year ended September 30, 2009. These financial statements
should be read in conjunction with the Company’s audited consolidated financial
statements and notes thereto.





The
preparation of financial statements in conformity with US GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting periods. Actual results could differ from those
estimates. This basis of accounting differs in certain material respects from
that used for the preparation of the books of account of the Company’s principal
subsidiaries, which are prepared in accordance with the accounting principles
and the relevant financial regulations applicable to enterprises with limited
liabilities established in the PRC, Hong Kong, India, Canada or Germany, the
accounting standards used in the places of their domicile. The accompanying
condensed interim consolidated financial statements reflect necessary
adjustments not recorded in the books of account of the Company's subsidiaries
to present them in conformity with US GAAP.




F-14




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


1.
            Principal
      Activities, Basis of Presentation and Organization
    (continued)





Recently
Issued Accounting Standards





In
October 2009, the FASB issued ASU 2009-13, “Revenue Recognition (Topic 605) –
Multiple-Deliverable Revenue Arrangements,” or ASU 2009-13. ASU 2009-13 requires
companies to allocate revenue in multiple-element arrangements based on an
element’s estimated selling price if vendor-specific or other third party
evidence of value is not available. ASU 2009-13 is to be applied on a
prospective basis for revenue arrangements entered into or materially modified
in fiscal years beginning on or after June 15, 2010, with earlier application
permitted.  The adoption of ASC 605 is not expected to have a material
effect on the Company’s financial statements.





In
January 2010, the FASB issued ASU 2010-06, “Fair Value Measurements and
Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements”,
or ASU 2010-06 that expands the required disclosures about fair value
measurements. This guidance provides for new disclosures requiring the Company
to (i) disclose separately the amounts of significant transfers in and out
of Level 1 and Level 2 fair value measurements and describe the reasons for the
transfers and (ii) present separately information about purchases, sales,
issuances and settlements in the reconciliation of Level 3 fair value
measurements. This guidance also provides clarification of existing disclosures
requiring the Company to (i) determine each class of assets and liabilities
based on the nature and risks of the investments rather than by major security
type and (ii) for each class of assets and liabilities, disclose the
valuation techniques and inputs used to measure fair value for both Level 2 and
Level 3 fair value measurements. ASU 2010-06 is effective for interim and annual
reporting periods beginning after December 15, 2009, except for the disclosures
about purchases, sales, issuances, and settlements in the roll forward of
activity in Level 3 fair value measurements. Those disclosures are effective for
fiscal years beginning after December 15, 2010, and for interim periods within
those fiscal years. Early application is permitted. The adoption of ASU 2010-06
has no material impact on the Company’s financial statements.





In
February 2010, the FASB issued ASU 2010-09, “Subsequent Events—Amendments to
Certain Recognition and Disclosure Requirements,” or ASU 2010-09. The ASU amends
the guidance on subsequent events in the FASB Accounting Standards Codification
to (1) eliminate the requirement for an SEC filer to disclose the date through
which it has evaluated subsequent events, (2) clarify the period through which
conduit bond obligors must evaluate subsequent events, and (3) refine the scope
of the disclosure requirements for reissued financial statements. All of the
amendments in ASU 2010-09 were effective upon issuance on February 24, 2010,
except for the use of the issued date for conduit debt obligors. That amendment
is effective for interim or annual periods ending after June 15, 2010. The
adoption of ASU 2009-09 has no material impact on the Company’s financial
statements.





In April
2010, the FASB issued ASU 2010-13, “Compensation-Stock Compensation (Topic 718)
- Effect of Denominating the Exercise Price of a Share-Based Payment Award in
the Currency of the Market in Which the Underlying Equity Security Trades - a
consensus of the FASB Emerging Issues Task Force,” or ASU 2010-13. ASU 2010-13
provides amendments to Topic 718 to clarify that an employee share-based payment
award with an exercise price denominated in the currency of a market in which a
substantial portion of the entity's equity securities trades should not be
considered to contain a condition that is not a market, performance, or service
condition. Therefore, an entity would not classify such an award as a liability
if it otherwise qualifies as equity. The amendments in this update do not expand
the recurring disclosures required by Topic 718. Disclosures currently required
under Topic 718 are applicable to a share-based payment award, including the
nature and the term of share-based payment arrangements. The amendments in this
update are effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2010. The Company is currently
evaluating the impact of the adoption of ASU 2010-13 on its financial
statements.




F-15




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


2
            Pledged
      Deposits





Pledged
deposits as of September 30, 2009 and June 30, 2010 consisted of the
following:





September 30,
                  
                  
                  June 30,2009
                  
                  
                  2010Pledged
      deposits with banks for:Construction
      payable
                  
                  $
                  893,603
                  
                  
                  $
                  457,133Short-term
      bank loans (Note 7)
                  
                  
                  7,137,307
                  
                  
                  
                  3,838,470Bills
      payable
                  
                  
                  23,084,199
                  
                  
                  
                  4,998,750$
                  31,115,109
                  
                  
                  $
                  9,294,353





Deposits
pledged for construction payable are generally released when the relevant
construction projects are completed.





3
            Trade
      Accounts Receivable, net





Trade
accounts receivable as of September 30, 2009 and June 30, 2010 consisted of the
following:


September 30,
                  
                  
                  June 30,2009
                  
                  
                  2010Trade
      accounts receivable
                  
                  $
                  84,133,865
                  
                  
                  $
                  96,079,947Less:
      Allowance for doubtful accounts
                  
                  
                  (13,081,331
                  )
                  
                  
                  (21,791,386
                  )71,052,534
                  
                  
                  
                  74,288,561Bills
      receivable
                  
                  
                  12,239,164
                  
                  
                  
                  5,340,055$
                  83,291,698
                  
                  
                  $
                  79,628,616








F-16




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


3
            Trade
      Accounts Receivable, net
(continued)





An
analysis of the allowance for doubtful accounts for the nine months ended June
30, 2009 and 2010 is as follows:





NinemonthsendedJune30,2009
                  
                  
                  2010Balance
      at beginning of period
                  
                  $
                  5,351,244
                  
                  
                  $
                  13,081,331Addition
      of bad debt expense, net
                  
                  
                  3,324,909
                  
                  
                  
                  8,563,300Foreign
      exchange adjustment
                  
                  
                  (10,035
                  )
                  
                  
                  146,755Balance
      at end of period
                  
                  $
                  8,666,118
                  
                  
                  $
                  21,791,386




4
            Inventories




Inventories
as of September 30, 2009 and June 30, 2010 consisted of the
following:





September 30,
                  
                  
                  June 30,2009
                  
                  
                  2010Raw
      materials
                  
                  $
                  18,476,929
                  
                  
                  $
                  18,104,970Work-in-progress
                  
                  
                  10,488,114
                  
                  
                  
                  13,638,788Finished
      goods
                  
                  
                  40,217,837
                  
                  
                  
                  42,197,16969,182,880
                  
                  
                  
                  73,940,927Provision
      for obsolete inventories
                  
                  
                  (3,647,496
                  )
                  
                  
                  (9,141,663
                  )$
                  65,535,384
                  
                  
                  $
                  64,799,264





Part of
the Company’s inventories with carrying value of US$21,973,836 and US$22,119,326
as of September 30, 2009 and June 30, 2010, respectively, was pledged as
collateral under certain loan agreements (see Note 7).





5
            Prepayments
      and Other Receivables





Prepayments
and other receivables as of September 30, 2009 and June 30, 2010 consisted of
the following:





September 30,
                  
                  
                  June 30,2009
                  
                  
                  2010Prepayments
      for raw materials and others
                  
                  $
                  1,437,115
                  
                  
                  $
                  2,476,520Other
      receivables
                  
                  
                  3,202,149
                  
                  
                  
                  3,671,770Less:
      Allowance for doubtful accounts
                  
                  
                  (6,840
                  )
                  
                  
                  (548,401
                  )$
                  4,632,424
                  
                  
                  $
                  5,599,889




F-17




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


6
            Property,
      Plant and Equipment, net





Property,
plant and equipment as of September 30, 2009 and June 30, 2010 consisted of the
following:


September 30,
                  
                  
                  June 30,2009
                  
                  
                  2010Buildings
                  
                  $
                  100,280,425
                  
                  
                  $
                  103,416,193Machinery
      and equipment
                  
                  
                  123,796,485
                  
                  
                  
                  132,526,452Office
      equipment
                  
                  
                  1,802,825
                  
                  
                  
                  2,053,491Motor
      vehicles
                  
                  
                  1,168,575
                  
                  
                  
                  1,189,439227,048,310
                  
                  
                  
                  239,185,575Accumulated
      depreciation
                  
                  
                  (42,709,026
                  )
                  
                  
                  (55,512,573
                  )Construction
      in progress
                  
                  
                  27,959,855
                  
                  
                  
                  39,582,029Prepayment
      for acquisition of property, plant and equipment
                  
                  
                  7,385,855
                  
                  
                  
                  5,848,481219,684,994
                  
                  
                  
                  229,103,512Impairment
      charge
                  
                  
                  -
                  
                  
                  
                  (5,091,233
                  )Net
      book value
                  
                  $
                  219,684,994
                  
                  
                  $
                  224,012,279





(i)
            Depreciation
      expense for the nine months ended June 30, 2009 and 2010 is included in
      the condensed interim consolidated statements of operations and
      comprehensive loss as follows:





Nine months ended June 30,2009
                  
                  
                  2010Cost
      of revenues
                  
                  $
                  8,776,477
                  
                  
                  $
                  9,302,306Research
      and development expenses
                  
                  
                  374,177
                  
                  
                  
                  485,684Sales
      and marketing expenses
                  
                  
                  346,643
                  
                  
                  
                  444,561General
      and administrative expenses
                  
                  
                  1,448,192
                  
                  
                  
                  1,898,721$
                  10,945,489
                  
                  
                  $
                  12,131,272





(ii)
Construction in Progress





Construction
in progress mainly comprises capital expenditures for construction of the
Company’s new corporate campus, including offices, factories and staff
dormitories.





For the
nine months ended June 30, 2009 and 2010, the Company capitalized interest
of US$542,884 and US$745,342 to the cost of construction in
progress.





(iii)
Pledged Property, Plant and Equipment





As of
September 30, 2009 and June 30, 2010, machinery and equipment with net book
value of US$67,873,955 and US$62,711,167 of the Company were pledged as
collateral under certain loan arrangements (see Notes 7 and 8).





(iv)
Impairment Charge





In the
quarter ended June 30, 2010, during the course of the Company's strategic review
of its operation, the Company assessed the recoverability of the carrying value
of certain fixed assets which resulted in impairment losses of $5,057,745.
These losses reflect the amounts by which the carrying values of
these assets exceed their estimated fair values determined by
their estimated future discounted cash flows. The impairment loss is recorded
as "Impairment charge" in the statement of operations and
comprehensive loss for the quarter ended June 30, 2010.




F-18




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


7
            Short-term
      Bank Loans





The
Company obtained several short-term loan facilities from financial institutions
in the PRC. In addition to the pledge of land use rights certificates by
Shenzhen BAK as disclosed below, these facilities were secured by the Company’s
assets with the following carrying values:


September 30,
                  
                  
                  June 30,2009
                  
                  
                  2010Pledged
      deposits (Note 2)
                  
                  $
                  7,137,307
                  
                  
                  $
                  3,838,470Inventories
      (Note 4)
                  
                  
                  21,973,836
                  
                  
                  
                  22,119,326Machinery
      and equipment, net (Note 6)
                  
                  
                  33,174,263
                  
                  
                  
                  28,698,933$
                  62,285,406
                  
                  
                  $
                  54,656,729





As of
September 30, 2009 and June 30, 2010, the Company had several short-term bank
loans with aggregate outstanding balances of US$139,159,380 and US$138,944,458,
respectively. The loans were primarily obtained for general working capital,
carried interest rates ranging from 0.07% to 5.58% per annum, and had maturity
dates ranging from 6 to 12 months. Each loan is guaranteed by Mr. Xiangqian Li,
who did not receive any compensation for acting as guarantor.





As of
June 30, 2010, the Company had pledged the land use rights certificate in
relation to the land on which Shenzhen BAK’s corporate campus had been
constructed for short-term bank loans amounting to US$58,984,870 borrowed from
Shenzhen Eastern Branch, Agricultural Bank of China. As of June 30, 2010, the
aggregate net book value of the buildings and land use rights in relation to the
land use rights certificate was US$103,781,336.





8
            Long-term
      Bank Loans





As of
September 30, 2009 and June 30, 2010, the Company had long-term bank loans of
US$55,667,052 and US$41,289,410, respectively. As of June 30, 2010,
US$7,373,109 was borrowed under a four-year long-term loan credit facility
from China Development Bank, bearing interest at the benchmark rate of the
People’s Bank of China (“PBOC”) for three-year to five-year long-term loans,
which is currently 5.94% per annum. This long-term bank loan is repayable on
February 28, 2016.





Two other
long-term loans totaled an aggregate borrowed amount of US$14,746,218 as of June
30, 2010. These loans were borrowed under a five-year long-term loan credit
facility from Shenzhen Eastern Branch, Agricultural Bank of China, and carry
interest at 90% of the benchmark rate of the PBOC for three-year to five-year
long-term loans. The first loan of US$5,898,487 currently carries interest at
5.184% per annum and is repayable on January 25, 2012. The second loan of
US$8,847,731 currently carries annual interest of 5.184% and is repayable in two
installments of US$7,373,109 on January 25, 2011 and US$1,474,622 on January 25,
2012, respectively.





Another
loan of US$19,170,083 as of June 30, 2010 was borrowed under a four-year
long-term loan credit facility from Tianjin Branch, Agricultural Bank of China
and carries interest at the benchmark rate of the PBOC for three-year to
five-year long-term loans, which is currently 5.76% per annum. This loan is
repayable in three installments of US$4,423,865 on December 26, 2010,
US$7,373,109 on December 26, 2011, and US$7,373,109 on May 26,
2012.





The
long-term bank loan with China Development Bank is: (i) guaranteed by Mr.
Xiangqian Li; (ii) secured by certain shares of the Company owned by Mr.
Xiangqian Li; and (iii) to be secured by the property ownership and land use
rights certificate relating to the land on which the Company’s Research and
Development Test Centre is to be constructed and the facilities to be
constructed thereon. On April 7, 2010, the pledge of the land use rights
certificate to China Development Bank was approved by the relevant government
bureau. On April 20, 2010, the relevant land use rights certificate was pledged
to China Development Bank.




F-19




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


8
            Long-term
      Bank Loans (continued)





The
long-term bank loan with Shenzhen Eastern Branch, Agricultural Bank of China is:
(i) guaranteed by Mr. Xiangqian Li; (ii) secured by the Company’s machinery and
equipment with carrying values of US$34,012,234 as of June 30, 2010 (see Note
6); and (iii) secured by the property ownership certificate and land use rights
certificate in relation to the land on which Shenzhen BAK’s corporate campus had
been constructed and any machinery and equipment purchased and used in the
campus subsequent to such construction.





The
long-term bank loan with Tianjin Branch, Agricultural Bank of China is secured
by machinery and equipment with carrying values of $6,279,896 as of June 30,
2010 purchased for the automated high-power lithium battery cells
production line in Tianjin. As of June 30, 2010, construction of the automated
high-power lithium battery cells production line was in progress.





Mr.
Xiangqian Li did not receive any compensation for pledging his shares in the
Company or acting as guarantor for the above long-term bank loans.





The
aggregate maturities of long-term bank loans as of June 30, 2010 are as
follows:





Fiscal
      years ending on June 30,2011
                  
                  $
                  11,796,9742012
                  
                  
                  22,119,3272016
                  
                  
                  7,373,109$
                  41,289,410





9
            Share-based
      Compensation





The
Company grants share options to officers and employees and restricted shares of
common stock to its non-employee directors as rewards for their
services.





Stock
Option Plan





In May
2005, the Board of Directors adopted the China BAK Battery, Inc. 2005 Stock
Option Plan (the “Plan”). The Plan originally authorized the issuance of up to
4,000,000 shares of the Company’s common stock, pursuant to stock options
granted under the Plan, or as grants of restricted stock. The exercise price of
options granted pursuant to the Plan must be at least equal to the fair market
value of the Company’s common stock at the date of the grant. Fair market value
is determined at the discretion of the designated committee on the basis of
reported sales prices for the Company’s common stock over a ten business day
period ending on the grant date. The Plan will terminate on May 16, 2055. On
July 28, 2008, the Company’s stockholders approved certain amendments to the
Plan, including an amendment increasing the total number of shares available for
issuance under the Plan to 8,000,000.





Pursuant
to the Plan, the Company granted options to purchase 2,000,000 shares of common
stock with an exercise price of US$6.25 per share on May 16, 2005. In accordance
with the vesting provisions of the grants, the options became vested and
exercisable under the following schedule:


Percentage of
                  
                  InitialNumber of Shares
                  
                  Options Issued
                  
                  Vesting Date800,000
                  
                  
                  40
                  %
                  July
      1, 2007600,000
                  
                  
                  30
                  %
                  January
      1, 2008600,000
                  
                  
                  30
                  %
                  July
      1, 20082,000,000
                  
                  
                  100
                  %




F-20


China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)




9
            Share-based
      Compensation (continued)




Subsequent
to the grant date, options to purchase 200,000 shares of common stock were
forfeited because the optionees terminated their employment with the Company. In
addition, on September 28, 2006, options to purchase a total of 1,400,000 shares
of common stock were cancelled pursuant to the Termination and Release
Agreements signed on that day.





A summary
of share option plan activity for these options during the nine months ended
June 30, 2010 is presented below:




Weighted
                      
                      
                      Weightedaverage
                      
                      
                      averageNumber of
                      
                      
                      exercise
                        price per
                      
                      
                      remainingcontractual
                      
                      
                      Aggregateintrinsicshares
                      
                      
                      share
                      
                      
                      term
                      
                      
                      value(1)Outstanding
      as of October 1, 2009
                      
                      
                      200,000
                      
                      
                      $
                      6.25Exercised
                      
                      
                      -
                      
                      
                      
                      -Forfeited
                      
                      
                      -
                      
                      
                      
                      -Cancelled
                      
                      
                      -
                      
                      
                      
                      -Outstanding
      as of June 30, 2010
                      
                      
                      200,000
                      
                      
                      $
                      6.25
                      
                      
                      0.7 years
                      
                      
                      $
                      -Exercisable
      as of June 30, 2010
                      
                      
                      200,000
                      
                      
                      $
                      6.25
                      
                      
                      0.7 years
                      
                      
                      $
                      -





(1)
Aggregate intrinsic value represents the value of the Company’s closing stock
price on June 30, 2010 (US$1.74) in excess of the exercise price multiplied by
the number of options outstanding or exercisable.





The
weighted-average grant-date fair value of options granted during 2005 was
US$3.67 per share. No non-cash share-based compensation expense was recognized
in respect of these share options for the nine months ended June 30, 2009 and
2010.





The fair
value of the above option awards was estimated on the date of grant using the
Black-Scholes Option Valuation Model together with the following
assumptions:





Expected
      volatility
                  
                  
                  59.85
                  %Expected
      dividends
                  
                  NilExpected
      life
                  
                  6
      yearsRisk-free
      interest rate
                  
                  
                  4.13
                  %





As of
June 30, 2010, there were no unrecognized compensation costs related to
non-vested share options.





Pursuant
to the Plan, the Company also granted options to purchase 1,501,500 shares of
the Company’s common stock with a weighted-average exercise price of US$3.28 per
share on June 25, 2007. In accordance with the vesting provisions of the grants,
the options will become vested and exercisable during the period from June 30,
2007 to February 9, 2012 according to each employee’s respective
agreement.




F-21




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)




9
              Share-based
      Compensation
(continued)





A summary
of share option plan activity for these options during the nine months ended
June 30, 2010 is presented below:




WeightedWeightedaverage
                        
                        averageremaining
                        
                        AggregateNumber ofShares
                        
                        
                        exerciseprice
                          pershare
                        
                        contractual
                          term
                        
                        intrinsicvalue
                          (1)Outstanding
      as of October 1, 2009
                        
                        
                        1,070,500
                        
                        
                        $
                        3.29Exercised
                        
                        
                        65,000
                        
                        
                        
                        3.27Forfeited
                        
                        
                        80,000
                        
                        
                        
                        -Cancelled
                        
                        
                        -
                        
                        
                        
                        -Outstanding
      as of June 30, 2010
                        
                        
                        925,500
                        
                        
                        $
                        3.29
                        
                        3.0
      years
                        
                        $
                        -Exercisable
      as of June 30, 2010
                        
                        
                        665,500
                        
                        
                        $
                        3.18
                        
                        2.4
      years
                        
                        $
                        -





(1)
Aggregate intrinsic value represents the value of the Company’s closing stock
price on June 30, 2010 (US$1.74) in excess of the exercise price multiplied by
the number of options outstanding or exercisable.





The
weighted-average grant-date fair value of options granted during 2007 was
US$2.15 per share. The Company recorded non-cash share-based compensation
expense of US$579,864 and US$172,115 for the nine months ended June 30, 2009 and
2010 respectively, in respect of share options granted on June 25, 2007, which
was allocated to cost of revenues, sales and marketing expenses, general and
administrative expenses and research and development expenses
respectively.





The fair
value of the above option awards granted on June 25, 2007 was estimated on the
date of grant using the Black-Scholes Option Valuation Model that uses the
following assumptions:





Expected
      volatility
                  
                  
                  69.44
                  %Expected
      dividends
                  
                  NilExpected
      life
                  
                  4 -
      10 yearsRisk-free
      interest rate
                  
                  
                  5.09
                  %





As of
June 30, 2010, there were unrecognized compensation costs of US$98,708 related
to the above non-vested share options. These costs are expected to be recognized
over a weighted average period of 0.7 years.





Pursuant
to the Plan, the Company also granted options to purchase 360,000 shares of
common stock with an exercise price of US$4.30 per share on January 28, 2008. In
accordance with the vesting provisions of the grants, the options will become
vested and exercisable during the period from April 28, 2008 to January 28, 2011
according to each employee’s respective agreement.




F-22


China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)
  9
                Share-based
      Compensation
(continued)


A summary
of share option plan activity for these options during the nine months ended
June 30, 2010 is presented below:




WeightedWeightedaverage
                      
                      averageremaining
                      
                      AggregateNumber ofShares
                      
                      
                      exerciseprice
                        pershare
                      
                      contractual
                        term
                      
                      intrinsicvalue
                        (1)Outstanding
      as of October 1, 2009
                      
                      
                      360,000
                      
                      
                      $
                      4.30Exercised
                      
                      
                      -
                      
                      
                      
                      -Forfeited
                      
                      
                      -
                      
                      
                      
                      -Cancelled
                      
                      
                      -
                      
                      
                      
                      -Outstanding
      as of June 30, 2010
                      
                      
                      360,000
                      
                      
                      $
                      4.30
                      
                      2.4 years
                      
                      $
                      -Exercisable
      as of June 30, 2010
                      
                      
                      240,000
                      
                      
                      $
                      4.30
                      
                      2.4 years
                      
                      $
                      -





(1)
Aggregate intrinsic value represents the value of the Company’s closing stock
price on June 30, 2010 (US$1.74) in excess of the exercise price multiplied by
the number of options outstanding or exercisable.





The
weighted average grant-date fair value of options granted on January 28, 2008
was US$3.59 per share. The Company recorded non-cash share-based compensation
expense of US$360,465 and US$138,451 for the nine months ended June 30, 2009 and
2010, respectively, in respect of share options granted on January 28, 2008,
which was allocated to general and administrative expenses and research and
development expenses respectively.





The fair
value of the above option awards granted on January 28, 2008 was estimated on
the date of grant using the Black-Scholes Option Valuation Model that uses the
following assumptions.





Expected
      volatility
                  
                  
                  120.23
                  %Expected
      dividends
                  
                  NilExpected
      life
                  
                  5
      yearsRisk-free
      interest rate
                  
                  
                  3.59
                  %





As of
June 30, 2010, there were unrecognized compensation costs of US$37,053 related
to the above non-vested share options. These costs are expected to be recognized
over a weighted average period of 0.3 years.





On May
29, 2008, the Compensation Committee of the Company’s Board of Directors
recommended and approved the grant of options to purchase 1,080,000 shares of
the Company’s common stock to Mr. Xiangqian Li and options to purchase 170,000
shares to five other employees, with an exercise price of US$4.18 per share. In
accordance with the vesting provisions of the grants, the options will become
vested and exercisable during the period from September 30, 2008 to May 29, 2012
according to each employee’s respective agreement.





F-23




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


9
            Share-based
      Compensation (continued)





A summary
of share option plan activity for these options during the nine months ended
June 30, 2010 is presented below:




Weighted
                          
                          
                          Weightedaverage
                          
                          
                          averageNumber of
                          
                          
                          exercise
                            price
                          
                          
                          remainingcontractual
                          
                          
                          Aggregateintrinsicshares
                          
                          
                          pershare
                          
                          
                          term
                          
                          
                          value(1)Outstanding
      as of October 1, 2009
                          
                          
                          1,250,000
                          
                          
                          $
                          4.18Exercised
                          
                          
                          -
                          
                          
                          
                          -Forfeited
                          
                          
                          -
                          
                          
                          
                          -Cancelled
                          
                          
                          -
                          
                          
                          
                          -Outstanding
      as of June 30, 2010
                          
                          
                          1,250,000
                          
                          
                          $
                          4.18
                          
                          
                          2.8 years
                          
                          
                          $
                          -Exercisable
      as of June 30, 2010
                          
                          
                          672,500
                          
                          
                          $
                          4.18
                          
                          
                          2.8 years
                          
                          
                          $
                          -





(1)
Aggregate intrinsic value represents the value of the Company’s closing stock
price on June 30, 2010 (US$1.74) in excess of the exercise price multiplied by
the number of options outstanding or exercisable.





The
weighted average grant-date fair value of options granted on May 29, 2008 was
US$2.36 per share. The Company recorded non-cash share-based compensation
expense of US$1,124,098 and US$479,598 for the nine months ended June 30, 2009
and 2010 respectively, in respect of share options granted on May 29, 2008,
which was allocated to general and administrative expenses and research and
development expenses respectively.





The fair
value of the above option awards granted on May 29, 2008 was estimated on the
date of grant using the Black-Scholes Option Valuation Model that uses the
following assumptions.





Expected
      volatility
                  
                  
                  59.48
                  %Expected
      dividends
                  
                  NilExpected
      life
                  
                  5 yearsRisk-free
      interest rate
                  
                  
                  4.01
                  %





As of
June 30, 2010, there were unrecognized compensation costs of US$266,973 related
to the above non-vested share options. These costs are expected to be recognized
over a weighted average period of 0.6 years.





On June
22, 2009, the Compensation Committee of the Company’s Board of Directors
recommended and approved the grant of options to purchase 1,928,200 shares of
the Company’s common stock to certain key employees, officers and consultants
with an exercise price of US$2.81 per share. In accordance with the vesting
provisions of the grants, the options will become vested and exercisable over
five years in twenty equal quarterly installments on the first day of each
fiscal quarter beginning on October 1, 2009.





F-24




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


9
            Share-based
      Compensation (continued)





A summary
of share option plan activity for these options during the nine months ended
June 30, 2010 is presented below:




Weighted
                        
                        
                        Weighted
                          averageaverage
                        
                        
                        remaining
                        
                        
                        AggregateNumber ofShares
                        
                        
                        exerciseprice per share
                        
                        
                        contractual
                          term
                        
                        
                        intrinsicvalue (1)Outstanding
      as of October 1, 2009
                        
                        
                        1,928,200
                        
                        
                        $
                        2.81Exercised
                        
                        
                        5,045
                        
                        
                        
                        2.81Forfeited
                        
                        
                        216,000
                        
                        
                        
                        2.81Cancelled
                        
                        
                        -
                        
                        
                        
                        -Outstanding
      as of June 30, 2010
                        
                        
                        1,707,155
                        
                        
                        $
                        2.81
                        
                        
                        5.9
      years
                        
                        
                        $
                        -Exercisable
      as of June 30, 2010
                        
                        
                        176,325
                        
                        
                        $
                        2.81
                        
                        
                        5.9
      years
                        
                        
                        $
                        -





(1)
Aggregate intrinsic value represents the value of the Company’s closing stock
price on June 30, 2010 (US$1.74) in excess of the exercise price multiplied by
the number of options outstanding or exercisable.





The
weighted average grant-date fair value of options granted on June 22, 2009 was
US$2.46 per share. The Company recorded non-cash share-based compensation
expense of US$1,003,633 for the nine months ended June 30, 2010 in respect of
share options granted on June 22, 2009, which was allocated to general and
administrative expenses and research and development expenses
respectively.





The fair
value of the above option awards granted on June 22, 2009 was estimated on the
date of grant using the Black-Scholes Option Valuation Model that uses the
following assumptions.





Expected
      volatility
                  
                  
                  111.03
                  %Expected
      dividends
                  
                  NilExpected
      life
                  
                  7 yearsRisk-free
      interest rate
                  
                  
                  3.69
                  %





As of
June 30, 2010, there were unrecognized compensation costs of US$1,911,136
related to the above non-vested share options. These costs are expected to be
recognized over a weighted average period of 2.0 years.





On June
26, 2009, the Compensation Committee of the Company’s Board of Directors
recommended and approved the grant of options to purchase 75,000 shares of the
Company’s common stock to certain key management with an exercise price of
US$3.24 per share. In accordance with the vesting provisions of the grants, the
options will become vested and exercisable over five years in twenty equal
quarterly installments on the first day of each fiscal quarter beginning on
October 1, 2009.





F-25




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


9
            Share-based
      Compensation (continued)





A summary
of share option plan activity for these options during the nine months ended
June 30, 2010 is presented below:




Weighted
                    
                    
                    Weighted
                      averageaverage
                    
                    
                    remaining
                    
                    
                    AggregateNumber ofShares
                    
                    
                    exerciseprice pershare
                    
                    
                    contractual
                      term
                    
                    
                    intrinsicvalue (1)Outstanding
      as of October 1, 2009
                    
                    
                    75,000
                    
                    
                    $
                    3.24Exercised
                    
                    
                    -
                    
                    
                    
                    -Forfeited
                    
                    
                    -
                    
                    
                    
                    -Cancelled
                    
                    
                    -
                    
                    
                    
                    -Outstanding
      as of June 30, 2010
                    
                    
                    75,000
                    
                    
                    $
                    3.24
                    
                    
                    5.9 years
                    
                    
                    $
                    -Exercisable
      as of June 30, 2010
                    
                    
                    7,500
                    
                    
                    $
                    3.24
                    
                    
                    5.9 years
                    
                    
                    $
                    -





(1)
Aggregate intrinsic value represents the value of the Company’s closing stock
price on June 30, 2010 (US$1.74) in excess of the exercise price multiplied by
the number of options outstanding or exercisable.





The
weighted average grant-date fair value of options granted on June 26, 2009 was
US$2.86 per share. The Company recorded non-cash share-based compensation
expense of US$67,320 for the nine months ended June 30, 2010 in respect of share
options granted on June 26, 2009, which was allocated to research and
development expenses.





The fair
value of the above option awards granted on June 26, 2009 was estimated on the
date of grant using the Black-Scholes Option Valuation Model that uses the
following assumptions.





Expected
      volatility
                  
                  
                  111.58
                  %Expected
      dividends
                  
                  NilExpected
      life
                  
                  7 yearsRisk-free
      interest rate
                  
                  
                  3.51
                  %





As of
June 30, 2010, there were unrecognized compensation costs of US$107,880 related
to the above non-vested share options. These costs are expected to be recognized
over a weighted average period of 2.0 years.





On March
11, 2010, the Compensation Committee of the Company’s Board of Directors
recommended and approved the grant of options to purchase 50,000 shares of the
Company’s common stock to certain key management with an exercise price of
US$2.58 per share. In accordance with the vesting provisions of the grants, the
options will become vested and exercisable over two years in two equal
installments beginning on each anniversary of the grant day on March 11,
2010.





A summary
of share option plan activity for these options during the nine months ended
June 30, 2010 is presented below:




WeightedWeightedaverage
                    
                    
                    averageremaining
                    
                    
                    AggregateNumber ofShares
                    
                    
                    exercisepricepershare
                    
                    
                    contractual
                      term
                    
                    
                    intrinsicvalue(1)Outstanding
      as of October 1, 2009
                    
                    
                    -
                    
                    
                    $
                    -Granted
      on March 11, 2010
                    
                    
                    50,000
                    
                    
                    
                    2.58Exercised
                    
                    
                    -
                    
                    
                    
                    -Forfeited
                    
                    
                    -
                    
                    
                    
                    -Cancelled
                    
                    
                    -
                    
                    
                    
                    -Outstanding
      as of June 30, 2010
                    
                    
                    50,000
                    
                    
                    $
                    2.58
                    
                    
                    3.7 years
                    
                    
                    $
                    -Exercisable
      as of June 30, 2010
                    
                    
                    -
                    
                    
                    $
                    -
                    
                    
                    
                    -
                    
                    
                    $
                    -




(1)
Aggregate intrinsic value represents the value of the Company’s closing stock
price on June 30, 2010 (US$1.74) in excess of the exercise price multiplied by
the number of options outstanding or exercisable.




F-26


China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)




The
weighted average grant-date fair value of options granted on March 11, 2010 was
US$1.51 per share. The Company recorded non-cash share-based compensation
expense of US$17,202 for the nine months ended June 30, 2010 in respect of share
options granted on March 11, 2010, which was allocated to general and
administrative expenses.





The fair
value of the above option awards granted on March 11, 2010 was estimated on the
date of grant using the Black-Scholes Option Valuation Model that uses the
following assumptions.





Expected
      volatility
                  
                  
                  76.32
                  %Expected
      dividends
                  
                  NilExpected
      life
                  
                  4 yearsRisk-free
      interest rate
                  
                  
                  3.72
                  %





As of
June 30, 2010, there were unrecognized compensation costs of US$58,250 related
to the above non-vested share options. These costs are expected to be recognized
over a weighted average period of 1.7 years.





On April
8, 2010, the Compensation Committee of the Company’s Board of Directors
recommended and approved the grant of options to purchase 100,000 shares of the
Company’s common stock to certain key management with an exercise price of
US$2.43 per share. In accordance with the vesting provisions of the grants, the
options will become vested and exercisable in eight equal installments beginning
on each quarter after September 30, 2010.





A summary
of share option plan activity for these options during the nine months ended
June 30, 2010 is presented below:




Weighted
                    
                    
                    Weighted
                      averageaverage
                    
                    
                    remaining
                    
                    
                    AggregateNumber ofShares
                    
                    
                    exercisepricepershare
                    
                    
                    contractual
                      term
                    
                    
                    intrinsicvalue
                      (1)Outstanding
      as of October 1, 2009
                    
                    
                    -
                    
                    
                    $
                    -Granted
      on April 8, 2010
                    
                    
                    100,000
                    
                    
                    
                    2.43Exercised
                    
                    
                    -
                    
                    
                    
                    -Forfeited
                    
                    
                    -
                    
                    
                    
                    -Cancelled
                    
                    
                    -
                    
                    
                    
                    -Outstanding
      as of June 30, 2010
                    
                    
                    100,000
                    
                    
                    $
                    2.43
                    
                    
                    7.5 years
                    
                    
                    $
                    -Exercisable
      as of June 30, 2010
                    
                    
                    -
                    
                    
                    $
                    -
                    
                    
                    
                    -
                    
                    
                    $
                    -





(1)
Aggregate intrinsic value represents the value of the Company’s closing stock
price on June 30, 2010 (US$1.74) in excess of the exercise price multiplied by
the number of options outstanding or exercisable.





The
weighted average grant-date fair value of options granted on April 8, 2010 was
US$1.41 per share. The Company recorded non-cash share-based compensation
expense of US$23,273 for the nine months ended June 30, 2010 in respect of share
options granted on April 8, 2010 which was allocated to research and development
expense.





F-27




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


The fair
value of the above option awards granted on April 8, 2010 was estimated on the
date of grant using the Black-Scholes Option Valuation Model that uses the
following assumptions.





Expected
      volatility
                  
                  
                  51.79
                  %Expected
      dividends
                  
                  NilExpected
      life
                  
                  7.5
      yearsRisk-free
      interest rate
                  
                  
                  3.90
                  %





As of
June 30, 2010, there were unrecognized compensation costs of US$117,887 related
to the above non-vested share options. These costs are expected to be recognized
over a weighted average period of 3.3 years.





Pursuant
to the Plan and in accordance with the China BAK Battery, Inc. Compensation Plan
for Non-Employee Directors, the Company granted 5,000 restricted shares to each
of the existing elected independent directors with a fair value of US$4.56 per
share on August 6, 2008. The eligible directors shall vest in their rights under
the restricted shares according to the following schedule:





(i) 25%
of the restricted shares granted will immediately vest on the grant date;
and





(ii) The
remaining 75% of the restricted shares will vest in three equal quarterly
installments on the last day of each subsequent quarter or in three equal
quarterly installments on the last day of each calendar quarter beginning on the
last day of the first full calendar quarter after the grant date.




F-28


China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


9
            Share-based
      Compensation (continued)





The
Company recorded non-cash share-based compensation expense of US$37,896 for the
nine months ended June 30, 2009 in respect of the restricted shares granted on
August 6, 2008, which was allocated to general and administrative expenses. No
non-cash share-based compensation expense was recognized for the nine months
ended June 30, 2010.





As of
June 30, 2010, there were no unrecognized stock-based compensation costs
associated with these restricted shares granted to non-employee directors. All
of the restricted shares were issued as fully paid shares of common stock to the
Company’s three independent directors on August 6, 2008, October 20, 2008, March
2, 2009 and April 2, 2009, respectively.





Pursuant
to the Plan, the Compensation Committee of the Company’s Board of Directors
recommended and approved the grant of 500,000 restricted shares to Chief
Executive Officer, Mr. Xiangqian Li with a fair value of US$2.81 per share on
June 22, 2009. In accordance with the vesting schedule of the grant, the
restricted shares will vest in twenty equal quarterly installments on the first
day of each fiscal quarter beginning on October 1, 2009.





The
Company recorded non-cash share-based compensation expense of US$444,132 for the
nine months ended June 30, 2010 in respect of the restricted shares granted on
June 22, 2009, which was allocated to general and administrative
expenses.





As of
June 30, 2010, there were unrecognized stock-based compensation costs of
US$696,668 associated with these restricted shares granted to Mr. Xiangqian Li.
These costs are expected to be recognized over a weighted-average period of 2.0
years.





Pursuant
to the Plan and in accordance with the China BAK Battery, Inc. Compensation Plan
for Non-Employee Directors, the Company granted 5,000 restricted shares to each
of the existing elected independent directors with a fair value of US$3.24 per
share on June 26, 2009. The eligible directors shall vest in their rights
under the restricted shares according to the following schedule:





(i) 25%
of the restricted shares granted will immediately vest on the grant date;
and





(ii) The
remaining 75% of the restricted shares will vest in three equal quarterly
installments on the last day of each subsequent quarter or in three equal
quarterly installments on the last day of each calendar quarter beginning on the
last day of the first full calendar quarter after the grant date.





The
Company recorded non-cash share-based compensation expense of US$14,073 for the
nine months ended June 30, 2010 in respect of the restricted shares granted on
June 26, 2009, which was allocated to general and administrative
expenses.





As of
June 30, 2010, there were no unrecognized stock-based compensation costs
associated with these restricted shares granted to non-employee directors. The
first, second, third and fourth 25% of the restricted shares were already issued
as fully paid shares of common stock to the Company’s three independent
directors on July 24, 2009, November 16, 2009, February 25, 2010 and April 1,
2010, respectively.





As the
Company itself is an investment holding company which is not expected to
generate operating profits to realize the tax benefits arising from its net
operating loss carried forward, no income tax benefits were recognized for such
stock-based compensation cost under the Stock Option Plan for the nine months
ended June 30, 2009 and 2010.




F-29




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


10
            Net
      Loss per Share





The
calculation of basic net loss per share is based on the net loss for the nine
months ended June 30, 2010 attributable to equity shareholders of $24,205,103
(Nine months ended June 30, 2009: $12,631,708) and the weighted average number
of shares of common stock of 62,285,862 issued and outstanding during the
nine months ended June 30, 2010 (Nine months ended June 30, 2009:
56,961,797).





The
effects of 3,000,000 shares of stock options, 3,750 shares of restricted stock
and 4,102,564 warrants outstanding during the nine months ended or as of June
30, 2009 were all anti-dilutive and the effects of 4,667,155 shares of stock
options, 500,000 shares of restricted stock and 1,447,500 warrants outstanding
during the nine months ended or as of June 30, 2010 were all anti-dilutive. As
such, basic and diluted net loss per share for the nine months ended June 30,
2009 and 2010 are the same.





11
            Fair
      Value of Financial Instruments





The fair
value of a financial instrument is the amount at which the instrument could be
exchanged in a current transaction between willing parties. The carrying amounts
of financial assets and liabilities, such as cash and cash equivalents, pledged
deposits, trade accounts receivable, other receivables, assets held for sale,
short-term bank loans, long-term bank loans, accounts and bills payable and
other payables, approximate their fair values because of the short maturity of
these instruments and market rates of interest.





12
            Commitments
      and Contingencies





(i)
            Capital
      Commitments





As of
September 30, 2009 and June 30, 2010, the Company had the following contracted
capital commitments:





September 30,
                    
                    
                    June 30,2009
                    
                    
                    2010For
      construction of buildings
                    
                    $
                    5,950,310
                    
                    
                    $
                    1,662,521For
      purchases of equipment
                    
                    
                    3,590,812
                    
                    
                    
                    2,988,775$
                    9,541,122
                    
                    
                    $
                    4,651,296





(ii)
            Property
      ownership and land use rights
certificates





According
to the relevant PRC laws and regulations, a land use rights certificate, along
with government approvals for land planning, project planning and construction,
needs to be obtained before construction of a building is commenced. A property
ownership certificate shall be granted by the government upon application under
the condition that the aforementioned certificate and government approvals have
been obtained.





The
Company did not obtain the land use right certificate and approvals for
project-planning and construction relating to the premises occupied by the
Company, BAK Industrial Park, before construction of the buildings was
commenced. On July 3, 2009, the Company had obtained the approval for
project-planning and construction from the local government of Shenzhen. As of
June 30, 2010, the Company has obtained the aforementioned land use rights
certificate and government approvals and was in the process of negotiating with
the relevant government for the application and acquisition of the appropriate
property ownership certificate.





Management
believes that the Company will ultimately be granted a property ownership
certificate, and that there should be no legal barriers for the Company to
obtain a property ownership certificate for the premises presently occupied by
the Company in BAK Industrial Park. However, in the event that the Company fails
to obtain the property ownership certificate relating to BAK Industrial Park,
there is a risk that the building constructed will need to be vacated as
illegitimate constructions and the Company might be subject to penalties and
fines. However, management believes that this possibility, while present, is
remote.




F-30




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


12
            Commitments
      and Contingencies (continued)





(ii)
            Property
      ownership and land use rights certificates
  (continued)





Pursuant
to the land use rights certificate relating to the Company’s Tianjin facility,
the Tianjin government had requested that the Company complete the construction
of the Tianjin facility before September 30, 2008. As of June 30, 2010, the
Company was in the process of negotiating with the relevant government bureau
for the extension of the completion date. If the Company fails to obtain the
approval for the extension of the completion date from the relevant government
bureau, there is a risk that the land use rights certificate relating to the
Company’s Tianjin facility will become invalid. However, management believes
that this possibility, while present, is remote.





Pursuant
to the land use rights certificate that the Company obtained relating to the
Research and Development Test Centre to be constructed in Shenzhen, the Company
must complete at least 25% of the construction of the Research and Development
Test Centre by September 30, 2008. On November 11, 2008 and May 27, 2009,
the Company has signed two supplement agreements with Shenzhen government to
increase the dimensions of the Research and Development Test Centre. According
to the supplement agreements, the Company is required to complete the
construction by May 6, 2011. According to the property ownership and land use
rights certificate, such rights may not be pledged without the approval of the
relevant government office. The Company is required to pledge its property
ownership and land use rights certificate in relation to the Research and
Development Test Centre to China Development Bank according to the loan
agreement entered into with it. On April 7, 2010, the pledge of the land use
rights certificate to China Development Bank was approved by the relevant
government bureau. On April 20, 2010, the relevant land use rights certificate
was pledged to China Development Bank.





The
Company is not able to insure its manufacturing facilities since it has not yet
received its property ownership certificates for these facilities. The Company
intends to procure such insurance once it has received the
certificates.





On
December 15, 2008, the Company purchased insurance for its manufacturing
facilities at BAK Industrial Park in Shenzhen, China. Under the insurance policy
entered into with Ping An Property & Casualty Insurance Company of China,
Ltd, the insured amount for our manufacturing facilities at BAK Industrial Park
is RMB585,373,070 (approximately $85.8 million) for the period from November 26,
2008 to August 25, 2010.





The
Company is not able to insure its Research and Development Test Centre to be
constructed in Shenzhen, China, until it receives the required property
ownership certificate. Upon receipt of such certificate, the Company intends to
procure such insurance. As discussed above, the Company has obtained the land
use rights certificate to the land relating to these facilities. The application
for a property ownership certificate is in process with respect to the Company’s
facilities in Tianjin.





F-31




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


12
            Commitments
      and Contingencies (continued)





(iii)
            Guarantees





In order
to secure the supplies of certain raw materials and equipment and upon the
request of suppliers, the Company has given guarantees to certain suppliers
which are summarized as follows:





September 30,
                
                
                June 30,2009
                
                
                2010Guaranteed
      for Shenzhen Tongli Hi-tech Co. Ltd. - a non-related party
                
                $
                2,197,384
                
                
                $
                2,211,933Guaranteed
      for Hunan Reshine New Material Ltd. - a non-related party
                
                
                5,859,690
                
                
                
                5,898,487Guaranteed
      for Nanjing Special Metal Equipment Co. Ltd. - a non-related
      party
                
                
                7,324,612
                
                
                
                11,796,974Guaranteed
      for Siping Juyuan Hanyang Plate Heat Exchanger Co. Ltd. - a non-related
      party
                
                
                4,394,767
                
                
                
                4,423,865Guaranteed
      for Shanghai Global Children Products Co. Ltd.– a non-related
      party
                
                
                -
                
                
                
                737,311Guaranteed
      for Beijing Triolion Technology Co. Ltd. – a non-related
    party
                
                
                -
                
                
                
                589,849Guaranteed
      for Shenzhen B&G Technology Development Co. Ltd. - a non-related
      party
                
                
                8,789,535
                
                
                
                8,847,731$
                28,565,988
                
                
                $
                34,506,150





Management
has assessed the fair value of the obligation arising from the above financial
guarantees and considered it immaterial to the condensed interim consolidated
financial statements. Therefore, no obligations in respect of the above
guarantees were recognized as of June 30, 2010.





(iv)
            Outstanding
      Discounted Bills and Transferred
Bills





From time
to time, the Company factors bills receivable to banks and endorses the bank
acceptance bills received to its suppliers, vendors or other parties for
settlement of its liabilities to these creditors. At the time of the factoring
and transfer, all rights and privileges of holding the receivables are
transferred to the banks and the creditors. The Company removes the assets from
its books and records a corresponding expense for the amount of the discount.
The Company remains contingently liable on the amount outstanding in the event
the bill issuer defaults.





The
Company's outstanding discounted and transferred bills as of September 30, 2009
and June 30, 2010 are summarized as follows:


September 30,
                    
                    
                    June 30,2009
                    
                    
                    2010Commercial
      bills
                    
                    $
                    439,477
                    
                    
                    $
                    -Bank
      acceptance bills
                    
                    
                    13,469,235
                    
                    
                    
                    18,055,548$
                    13,908,712
                    
                    
                    $
                    18,055,548





F-32




China
BAK Battery, Inc. and subsidiaries
 Notes
to the condensed consolidated financial statements
 For
the nine months ended June 30, 2009 and 2010
 (Unaudited)


12
            Commitments
      and Contingencies (continued)





(v)
            Litigation
      and claims





On
September 12, 2006, Hydro-Quebec, a Canadian company, and the Board of Regents
of the University of Texas System brought a federal patent infringement suit in
the United States District Court for the Northern District of Texas against the
Company. The plaintiffs alleged that by manufacturing rechargeable lithium cells
for A123Systems for use in DeWalt 36-volt cordless power tools manufactured by
Black & Decker, the Company has infringed two U.S. patents owned by and
exclusively licensed to the plaintiffs. The plaintiffs seek injunctive relief
and damages in an unspecified amount. A123Systems, Black & Decker
Corporation and Black & Decker (U.S.) Inc. have also been named as
co-defendants in this lawsuit. The court has not ruled on this lawsuit. The
Company understands that this lawsuit is a countersuit against A123Systems,
which filed a claim against Hydro-Quebec in the United States District Court of
Massachusetts in April 2006. In that suit, A123Systems sought declaratory relief
that the two said U.S. patents are invalid and that A123Systems is not
infringing either of these two patents.





Following
the filing of the lawsuit, the United States Patent and Trademark Office
reexamined the patents. The patents were re-issued with substantial modification
of the patent claims. The plaintiffs have advised that, in their view, the
lawsuit continues to be viable against the defendants, including China BAK. The
plaintiffs' position has not been tested. Currently pending is the plaintiffs’
motion to amend their complaint to take the USPTO action into
account.





On May
14, 2010, the US District Court for the Northern District of Texas issued an
order dismissing the Company without prejudice from a federal patent
infringement suit against A123Systems that had been filed in
2006.





13
            Significant
      Concentrations





(a)
            Customers
      and Credit Concentrations





No
customer individually comprised 10% or more of net revenue for the nine months
ended June 30, 2009 and 2010.





(b)
            Credit
      Risk





Financial
instruments that potentially subject the Company to a significant concentration
of credit risk consist primarily of cash and cash equivalents and pledged
deposits. As of September 30, 2009 and June 30, 2010, substantially all of the
Company’s cash and cash equivalents and pledged deposits were held by major
financial institutions located in the PRC, which management believes are of high
credit quality.





F-33




China
BAK Battery, Inc. and subsidiaries


Notes
to the condensed consolidated financial statements


For
the nine months ended June 30, 2009 and 2010


(Unaudited)




14
            Segment
      Information





The
Company currently engages in the manufacture, commercialization and distribution
of a wide variety of standard and customized lithium ion rechargeable batteries
for use in a wide array of applications. During the nine months ended June 30,
2010, the Company manufactured five types of Li-ion rechargeable batteries:
aluminum-case cell, battery pack, cylindrical cell, polymer cell and high-power
lithium battery cell. The Company's products are sold to packing plants operated
by third parties primarily for use in mobile phones and other electronic
devices. Net revenues for the nine months ended June 30, 2009 and 2010 were as
follows:





Net
revenues by product:


NinemonthsendedJune30,2009
                      
                      
                      2010%
                      
                      
                      
                      
                      
                      %Aluminum-case
      cell
                      
                      $
                      83,105,224
                      
                      
                      
                      54.11
                      
                      
                      $
                      82,981,567
                      
                      
                      
                      52.12Battery
      pack
                      
                      
                      15,833,139
                      
                      
                      
                      10.31
                      
                      
                      
                      33,582,225
                      
                      
                      
                      21.09Steel-case
      cell
                      
                      
                      4,909,017
                      
                      
                      
                      3.20
                      
                      
                      
                      -
                      
                      
                      
                      -Cylindrical
      cells
                      
                      
                      40,296,656
                      
                      
                      
                      26.24
                      
                      
                      
                      34,271,145
                      
                      
                      
                      21.53Lithium
      polymer cells
                      
                      
                      9,338,649
                      
                      
                      
                      6.08
                      
                      
                      
                      7,160,445
                      
                      
                      
                      4.50High-power
      lithium battery cells
                      
                      
                      110,321
                      
                      
                      
                      0.06
                      
                      
                      
                      1,213,131
                      
                      
                      
                      0.76$
                      153,593,006
                      
                      
                      
                      100.00
                      
                      
                      $
                      159,208,513
                      
                      
                      
                      100.00





Net
revenues by geographic area:





Nine months ended June 30,2009
                        
                        
                        2010%
                        
                        
                        
                        
                        
                        %PRC
      Mainland
                        
                        $
                        96,845,692
                        
                        
                        
                        63.05
                        
                        
                        $
                        111,314,061
                        
                        
                        
                        69.92PRC
      Taiwan
                        
                        
                        33,705,347
                        
                        
                        
                        21.94
                        
                        
                        
                        26,243,343
                        
                        
                        
                        16.48India
                        
                        
                        8,349,801
                        
                        
                        
                        5.44
                        
                        
                        
                        4,366,267
                        
                        
                        
                        2.74United
      States of America
                        
                        
                        405,422
                        
                        
                        
                        0.26
                        
                        
                        
                        531,686
                        
                        
                        
                        0.33Hong
      Kong, China
                        
                        
                        12,057,175
                        
                        
                        
                        7.85
                        
                        
                        
                        15,280,278
                        
                        
                        
                        9.60Others
                        
                        
                        2,229,569
                        
                        
                        
                        1.46
                        
                        
                        
                        1,472,878
                        
                        
                        
                        0.93$
                        153,593,006
                        
                        
                        
                        100.00
                        
                        
                        $
                        159,208,513
                        
                        
                        
                        100.00





Substantially
all of the Company’s long-lived assets are located in the PRC.


F-34


China
BAK Battery, Inc. and subsidiaries


Notes
to the condensed consolidated financial statements


For
the nine months ended June 30, 2009 and 2010


(Unaudited)




15       Subsequent
Events





Pursuant
to the Plan and in accordance with the China BAK Battery, Inc. Compensation Plan
for Non-Employee Directors, the Company granted 5,000 restricted shares to each
of the existing elected independent directors with a fair value of US$1.68 per
share on July 1, 2010. The eligible directors shall vest in their rights under
the restricted shares according to the following schedule:





(i) 25%
of the restricted shares granted will immediately vest on the grant date;
and





(ii) The
remaining 75% of the restricted shares will vest in three equal quarterly
installments on the last day of each subsequent quarter or in three equal
quarterly installments on the last day of each calendar quarter beginning on the
last day of the first full calendar quarter after the grant date.





On July
23, 2010, the Compensation Committee of the Company’s Board of Directors
recommended and approved the grant of options to purchase 80,000 shares of the
Company’s common stock to certain key management with an exercise price of
US$1.58 per share. In accordance with the vesting provisions of the grants, the
options will become vested and exercisable in eight equal installments
beginning on each quarter after September 30, 2010.




The
Company evaluated all other events or transactions that occurred after June
30, 2010 and has determined that there is no material recognizable nor
subsequent events or transactions which would require recognition
or disclosure in the financial statements.




F-35




ITEM
      2.
            MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS.




Special
Note Regarding Forward Looking Statements




Statements
contained in this Report include “forward-looking statements” within the meaning
of such term in Section 27A of the Securities Act of 1933, as amended, or the
Securities Act, and Section 21E of the Securities Exchange Act of 1934, as
amended, or the Exchange Act. Forward-looking statements involve known and
unknown risks, uncertainties and other factors which could cause actual
financial or operating results, performances or achievements expressed or
implied by such forward-looking statements not to occur or be realized.
Forward-looking statements made in this Report generally are based on our best
estimates of future results, performances or achievements, predicated upon
current conditions and the most recent results of the companies involved and
their respective industries. Forward-looking statements may be identified by the
use of forward-looking terminology such as “may,” “will,” “could,” “should,”
“project,” “expect,” “believe,” “estimate,” “anticipate,” “intend,” “continue,”
“potential,” “opportunity” or similar terms, variations of those terms or the
negative of those terms or other variations of those terms or comparable words
or expressions. Potential risks and uncertainties include, among other things,
such factors as:




·
            our
      anticipated growth strategies and our ability to manage the expansion of
      our business operations
effectively;






·
            general
      economic conditions, including the current global recession and financial
      crisis;




·
            our
      future business development, results of operations and financial
      condition; our ability to diversify our product offering and capture new
      market opportunities;




·
            our
      dependence on the growth in demand for the portable electronic devices
      that are powered by our products;




·
            our
      ability to maintain or increase our market share in the competitive
      markets in which we do business;




·
            our
      ability to keep up with rapidly changing technologies and evolving
      industry standards, including our ability to achieve technological
      advances;




·
            our
      ability to obtain original equipment manufacturer, or OEM, qualifications
      from brand names;




·
            our
      ability to maintain an efficient cost
structure;




·
            our
      ability to remediate any material weaknesses in our internal control over
      financial reporting;




·
            our
      ability to secure raw materials in the future and to manage the costs of
      raw materials or to secure alternative or substitute raw
      materials;




·
            our
      ability to source our needs for skilled labor, machinery and raw materials
      economically;




·
            our
      ability to maintain our land use rights and acquire property ownership
      rights to our PRC-based facilities;




·
            our
      ability to fund our operations and manage our substantial short-term
      indebtedness;




·
            uncertainties
      with respect to the PRC legal and regulatory environment;
    and




1




·
            other
      risks identified in this Report and in our other reports filed with the
      U.S. Securities and Exchange Commission, or
SEC.




Additional
disclosures regarding factors that could cause our results and performance to
differ from results or performance anticipated by this Report are discussed in
other reports that we file with the SEC, including without limitation our Annual
Report on Form 10-K for the fiscal year ended September 30, 2009, or the 2009
Form 10-K. Readers are urged to carefully review and consider the various
disclosures made by us in this Report and our other filings with the SEC. These
reports attempt to advise interested parties of the risks and factors that may
affect our business, financial condition and results of operations and
prospects. The forward-looking statements made in this Report speak only as of
the date hereof and we disclaim any obligation to provide updates, revisions or
amendments to any forward-looking statements to reflect changes in our
expectations or future events.




Use of Terms




Except as
otherwise indicated by the context, all references in this Report to: “we,”
“us,” “our” and the “Company” are to the combined business of China BAK Battery,
Inc. and its consolidated subsidiaries. Unless the context requires otherwise,
all references to:




·
              “BAK
      International” are to our Hong Kong subsidiary, BAK International
      Limited;
 ·
                  “BAK
      Tianjin” are to our PRC subsidiary, BAK International (Tianjin)
      Ltd.;
 ·
                      “Shenzhen
      BAK” refers to our PRC subsidiary, Shenzhen BAK Battery Co.,
      Ltd.;
 ·
                          “BAK
      Electronics” are to our PRC subsidiary, BAK Electronics (Shenzhen) Co.,
      Ltd.;
 ·
                              “BAK
      Canada” are to our Canadian subsidiary, BAK Battery Canada
      Ltd.;
 ·
                                  “BAK
      Europe” are to our German subsidiary, BAK Europe
  GmbH;
 ·
                                      “BAK
      India” are to our Indian subsidiary, BAK Telecom India Private
      Limited;
 ·
                                          “Securities
      Act” are to the Securities Act of 1933, as
  amended;
 ·
                                              “Exchange
      Act” are to the Securities Exchange Act of 1934, as
    amended;
 ·
                                                  “China,”
      “Chinese” and “PRC” are to the People’s Republic of China, excluding for
      the purposes of this Report only, Taiwan, Hong Kong and
    Macau;
 ·
                                                      “RMB” are
      to Renminbi, the legal currency of China;
and
 ·
                                                          “U.S.
      dollar,” “$” and “US$” are to the legal currency of the United States of
      America.


Overview




We are a
leading global manufacturer of lithium based battery cells. We produce battery
cells that are the principal component of rechargeable batteries commonly used
to power the following applications:




·
            cellular
      phones—customer segments include OEM customers and replacement battery
      manufacturers;




·
            notebook
      computers;




·
            light
      electric vehicles, electric vehicles, and hybrid electric vehicles,
      cordless power tools, mining lamps, uninterruptible power supplies
      and;




·
            portable
      consumer electronics, such as digital cameras, portable media players,
      portable gaming devices, and personal digital assistants, or
      PDAs.




Historically,
we have primarily manufactured prismatic lithium-ion cells for the cellular
phone replacement battery market and the OEM market. We conduct all of our
operations in China, in close proximity to China’s electronics manufacturing
base and its rapidly growing market, and have distribution offices in Taiwan,
India, Germany, and the United States where our sales representatives market and
sell our products and also provide after-sale service. Our products are packed
into batteries by third-party battery pack manufacturers in accordance with the
specifications of manufacturers of portable electronic applications. At the
request of our customers that order prismatic battery packs, we also assemble
our prismatic cells into battery packs to these customers both for the
replacement and OEM markets.




Third
Fiscal Quarter Financial Performance Highlights




Despite
continued global economic weakness, we experienced robust revenue growth. During
the third quarter of fiscal year 2010, we generated $58.6 million in net
revenues, an increase of 16.1% from $50.4 million in the second quarter 2010,
and up 31.0% from $44.7 million in the third quarter of 2009.




2




The
following achievements were accomplished in the third quarter of fiscal year
2010:




·
              Revenues
      from high power batteries sequentially doubled in the third quarter of
      fiscal year 2010 due in large part to surging orders of batteries used for
      electric buses, and electric
vehicles;




·
              The
      Company’s turn-around plan was adopted in the third quarter of fiscal year
      2010, resulting in a:





o
            reduction
      of net trade accounts receivable (by writing off uncollectable or
      doubtable accounts), and


o
            write
      off of obsolete inventories;




·
            We
      de-leveraged our balance sheet, repaying approximately $10 million of our
      short-term bank loans; We also gained better control of our capital
      expenditures, and have set a goal of saving 20% in capital expenditures as
      compared with our original budget;




·
              On
      May 14, 2010, the United States District Court for the Northern District
      of Texas issued an order dismissing the Company without prejudice from a
      federal patent infringement suit relating to production of rechargeable
      lithium battery cells for A123 Systems, Inc. (“A123Systems”). The
      plaintiffs are the Board of Regents of the University of Texas System and
      Hydro-Québec, a Canadian company. As a result of the court’s May 14, 2010
      decision, the Company will not be liable for any monetary damages. We also
      will not be required to pay royalties to engage in future
      production of rechargeable lithium cells manufactured for
      A123Systems, subject to the United States patent laws;


·
            In
      its ongoing efforts to become a major battery supplier to top tier
      automotive manufacturers, BAK Tianjin successfully completed ISO/TS16949
      certification in May 2010. ISO/TS169494 is a specification for quality
      management systems geared towards manufacturers in the supply chain for
      the automotive industry. China BAK believes that adherence to the
      principles of the ISO/TS16949 specifications will pay off in higher
      quality, lower variation and less waste, which will enable us to supply
      batteries to additional automotive
customers.




Gross
profit for the third quarter of fiscal year 2010 was negative $1.2 million, down
113% from $9.0 million last quarter and down 123.9% from $5.0 million in the
same quarter of last year. During the third quarter of fiscal year 2010, we
adopted a temporary competitive pricing strategy for cylindrical battery cells
to gain more market share in the OEM market and sales of slow-moving inventory
at discount to increase operating cash flow in the third quarter of fiscal year
2010. Furthermore, the Company recorded a provision for obsolete inventory of
$5.6 million. As a result, gross margin for the third quarter of fiscal year
2010 was negative 2.1%, compared to 17.9% last quarter and 11.3% in the same
quarter of last year. Excluding the impact of our $5.6 million inventory
write-down, non-GAAP gross margin for the third quarter of fiscal year 2010 was
2.9%, compared to 12.3% non-GAAP gross margin in the same quarter of fiscal year
2009. Please see the table set forth below which reconciles the non-GAAP
financial measures of gross margin and operating loss from operations to their
respective most directly comparable GAAP financial measures of gross margin and
loss from operations before finance costs, government grant and other income,
and income taxes.




Our net
loss in the third quarter of fiscal year 2010 was primarily a result of non-cash
assets write-downs amounting to $14.5 million of income statement expenses,
including the charge of $5.6 million for obsolete inventory noted above.
Operating cash flow in the third quarter of fiscal year 2010 was $8.2
million.




We had
access to $217.1 million in short-term credit facilities and $56.0 million in
long-term credit facilities as of June 30, 2010. As of June 30, 2010, the
principal outstanding amounts included short-term bank loans of $138.9 million,
long-term bank loans of $11.8 million maturing within one year, and long-term
bank loans of $29.5 million maturing in over one year, and bills payable of
$36.6 million, leaving $66.2 million of short-term funds available for
additional cash needs. In addition, on July 10, 2008, our $60 million shelf
registration statement was declared effective by the SEC, pursuant to which we
have raised $36.6 million in gross proceeds from sales of common stock and
issued common stock warrants exercisable for up to $21.6 million in additional
gross proceeds. As $16 million of these warrants were not exercised before their
expiration, we may raise up to an additional $17.8 million in gross proceeds
from future equity financings under this shelf registration
statement.




Financial
Statement Presentation




Net
revenues. Our net revenues represent the invoice value of our products
sold, net of value added taxes, or VAT, sales returns, trade discounts and
allowances. We are subject to VAT, which is levied on most of our products at
the rate of 17% on the invoice value of our products. Provision for sales
returns are recorded as a reduction of revenue in the same period that revenue
is recognized. The provision for sales returns represents our best estimate of
the amount of goods that will be returned from our customers based on historical
sales returns data.




3




Cost of
Revenues. Cost of revenues consists primarily of material costs, employee
remuneration for staff engaged in production activity, equity-based
compensation, depreciation and related expenses that are directly attributable
to the production of products. Cost of revenues also includes write-downs of
inventory to lower of cost or market. Cost of revenues from the sales of battery
packs includes the fees we pay to pack manufacturers for assembling our
prismatic cells into battery packs.




Research and
Development Expenses. Research and development expenses are primarily
comprised of remuneration for R&D staff, equity-based compensation,
depreciation and maintenance expenses relating to R&D equipment, and R&D
material costs.




Sales and
Marketing Expenses. Sales and marketing
expenses consist primarily of remuneration for staff involved in selling and
marketing efforts, including staff engaged in the packaging of goods for
shipment, advertising cost, depreciation, equity-based compensation and travel
and entertainment expenses. We do not pay slotting fees to retail companies for
displaying our products, engage in cooperative advertising programs, participate
in buy-down programs or similar arrangements. No material estimates are required
by management to determine our actual marketing or advertising costs for any
period.




General and
Administrative Expenses. General and administrative expenses consist
primarily of employee remuneration, equity-based compensation, professional
fees, insurance, benefits, general office expenses, depreciation, liquidated
damages, and bad debt expenses.




Property, Plant
and Equipment Impairment Charges. Impairment charges consist
primarily of impairment losses for long-lived assets.These losses reflect the
amounts by which the carrying values of these assets exceed their
estimated fair value as determined by their estimated future discounted
cash flows.




Finance Costs,
Net. Finance costs consist primarily of interest income, interest on bank
loans, net of capitalized interest, and bank charges.




Government Grant
Income / (Other Income) / Other Expenses. Income from government grants
consisted primarily of grant funds awarded to Shenzhen BAK as consideration for
its contributions to the Shenzhen area’s economy and as subsidies for land-use
rights at BAK Industrial Park. No present or future obligations arise from the
receipt of these funds.




Income
Taxes. Under PRC income tax laws and regulations, before January 1, 2008,
a foreign-invested enterprise, or FIE, was generally subject to an enterprise
income tax rate of 33.0%, which included a 30.0% state income tax and a 3.0%
local income tax. However, from at least calendar year 2002 through calendar
year 2007, an enterprise recognized as a “Manufacturing Enterprise Located in
Special Economic Zone” under PRC tax laws was entitled to a preferential income
tax rate of 15%. Moreover, a foreign-invested manufacturing enterprise, starting
from its first profitable calendar year after offset of accumulated tax losses,
was entitled to a two-year exemption from enterprise income tax followed by a
three-year 50% reduction in its enterprise income tax rate, also referred to
herein as the “tax holiday.” An enterprise qualified for such treatment may
receive a further tax rate reduction related to the size of qualified capital
contributions received. In addition, from at least calendar year 2002 through
calendar year 2007, an enterprise qualified as an “advanced technology
enterprise” under PRC tax law was also entitled to a 50% reduction of income
taxes.




On March
16, 2007, the National People’s Congress of the PRC determined to adopt the new
corporate income tax law, or the New CIT Law. The New CIT Law unifies the
application scope, tax rate, tax deduction and preferential policy for both
domestic enterprises and FIEs. The New CIT Law became effective on January 1,
2008. According to the New CIT Law, the applicable income tax rate for Shenzhen
BAK, BAK Electronics and BAK Tianjin will be 25% after their preferential tax
holidays and the transition period have ended. During the transition period, tax
rates for subject entities was 18% and 20% for the calendar years 2008 and 2009,
respectively, and is expected to be 22% and 24% for the calendar years 2010 and
2011, respectively, before the application of applicable tax holidays or other
tax preferences.




Shenzhen
BAK and BAK Electronics are both registered and operate in Shenzhen, the PRC,
and are each recognized as “Manufacturing Enterprise Located in Special Economic
Zone.” As a result, they have been entitled to a preferential enterprise income
tax rate of 15%. In accordance with the relevant income tax laws, the profits of
Shenzhen BAK and BAK Electronics were fully exempted from income tax for two
years from the first profitable calendar year of operations after offset of
accumulated taxable losses, followed by a 50% exemption for the immediate next
three calendar years.




4




The tax
holiday of Shenzhen BAK commenced in 2002, the first calendar year in which
Shenzhen BAK had assessable profit, and ended on December 31, 2006. In addition,
due to additional capital contributed by BAK International to Shenzhen BAK in
both 2005 and 2006 and Shenzhen BAK’s qualification as an advanced technology
enterprise in 2007 and 2008, Shenzhen BAK was granted a preferential income tax
rate of 7.5%, 11.8% and 12.6% for calendar years 2007, 2008 and 2009,
respectively. In accordance with the transition period of the New CIT Law and
before considering the above-mentioned tax concessions, Shenzhen BAK’s income
tax rate for calendar years 2010 and 2011 are expected to be 22% and 24%,
respectively, and starting in calendar year 2012, it is expected to be subject
to an income tax rate of 25%. Therefore, Shenzhen BAK’s income tax rates after
consideration of its tax concessions are expected to be 15% for both calendar
years 2010 and 2011and starting in calendar year 2012, it is expected to be
subject to an income tax rate of 25%.




For BAK
Electronics, established in August 2005, the same tax holiday was in effect for
calendar years 2006 and 2007, making BAK Electronics fully exempt from any
enterprise income tax. Following the tax holiday, a three-year 50% reduction in
BAK Electronics’ enterprise income tax rate commenced. Pursuant to the
transition period of the New CIT Law, BAK Electronics’ income tax rates for
calendar years 2010 and 2011 were expected to be 22% and 24%, respectively, and
starting in calendar year 2012 it was expected to be subject to an income tax
rate of 25%. Taking the 50% reduction into account, BAK Electronics’ income tax
rates are now expected to be 11% and 24% for calendar years 2010 and 2011,
respectively, with no change in its expected 2012 tax rate of 25%. BAK
Electronics did not incur any enterprise income tax for the calendar year 2009
due to the current tax losses carried forward from calendar year
2008.




Shenzhen
BAK and BAK Electronics received in aggregate a tax benefit of $9,000 pursuant
to their tax holiday and preferential tax rate for the nine months ended June
30, 2010, or $0.0002 per basic share.




BAK
Tianjin is currently paying no enterprise income tax due to cumulative tax
losses.




Our
Canadian, German, Indian, and Hong Kong subsidiaries—BAK Canada, BAK Europe, BAK
India, and BAK International—are subject to profits taxes in their respective
countries at rates of 38%, 25%, 30%, and 16.5% respectively. However, because
they do not have any assessable income derived from or arising in those
countries, they have not paid any such tax.




Our
effective tax benefit rate was 8.0% for the nine months ended June 30, 2010 and
our effective tax benefit rate was 2.9% for the nine months ended June 30,
2009.




Pursuant
to the Provisional Regulation of China on Value Added Tax and its implementing
rules, all entities and individuals that are engaged in the sale of goods, the
provision of repairs and replacement services and the importation of goods in
China are generally required to pay VAT at a rate of 17.0% of the gross sales
proceeds received, less any deductible VAT already paid or borne by the
taxpayer. Further, when exporting goods, the exporter is entitled to some or all
of the refund of VAT that it has already paid or borne. Our imported raw
materials that are used for manufacturing export products and are deposited in
bonded warehouses are exempt from import VAT.




Results
of Operations




Comparison of Three Months
Ended June 30, 2010 and June 30, 2010





The
following table sets forth key components of our results of operations for the
periods indicated. All amounts, other than percentages, are in thousands of U.S.
dollars.




ThreeMonthsEndedJune
                  30,2010
                
                
                2009
                
                
                $Change
                
                
                %ChangeNet
      revenues
                
                $
                58,557
                
                
                $
                44,689
                
                
                $
                13,869
                
                
                
                31.0Cost
      of revenues
                
                
                59,764
                
                
                
                39,641
                
                
                
                20,124
                
                
                
                50.8Gross
      profit / (loss)
                
                
                (1,207
                )
                
                
                5,048
                
                
                
                (6,255
                )
                
                
                (123.9
                )Operating
      expenses:Research
      and development expenses
                
                
                2,130
                
                
                
                1,472
                
                
                
                658
                
                
                
                44.7Sales
      and marketing expenses
                
                
                2,587
                
                
                
                1,581
                
                
                
                1,006
                
                
                
                63.7General
      and administrative expenses
                
                
                7,429
                
                
                
                5,551
                
                
                
                1,878
                
                
                
                33.8Property,
      plant and equipment impairment charges
                
                
                5,057
                
                
                
                -
                
                
                
                5,057
                
                
                
                -Total
      operating expenses
                
                
                17,203
                
                
                
                8,604
                
                
                
                8,599
                
                
                
                99.9Operating loss
                
                
                (18,410
                )
                
                
                (3,556
                )
                
                
                (14,854
                )
                
                
                417.7Finance
      costs, net
                
                
                (2,022
                )
                
                
                (1,897
                )
                
                
                (125
                )
                
                
                6.6Government
      grant income
                
                
                59
                
                
                
                222
                
                
                
                (163
                )
                
                
                (73.6
                )Other
      income / (expense)
                
                
                107
                
                
                
                (353
                )
                
                
                460
                
                
                
                (130.4
                )Income
      tax benefit
                
                
                2,004
                
                
                
                413
                
                
                
                1,590
                
                
                
                385.1Net
      loss
                
                $
                (18,262
                )
                
                $
                (5,171
                )
                
                $
                (13,092
                )
                
                
                253.2


5




Net
Revenues. Net revenues increased to $58.6 million for the three months
ended June 30, 2010 as compared to $44.7 million for the same period of the
prior year, an increase of $13.9 million or 31.0%. The following sets forth the
breakdown of our net revenues by battery cell type for the periods
indicated.




ThreeMonthsEnded
                  June30,2010
                
                
                2009(in thousands)Prismatic
      cellsAluminum-case
      cells
                
                $
                30,538
                
                
                $
                22,506Battery
      packs
                
                
                12,277
                
                
                
                5,714Steel-case
      cells
                
                
                -
                
                
                
                350Cylindrical
      cells
                
                
                12,771
                
                
                
                12,690Lithium
      polymer cells
                
                
                2,274
                
                
                
                3,348High-power
      lithium battery cells
                
                
                697
                
                
                
                80Total
                
                $
                58,557
                
                
                $
                44,688




·
              Net
      revenues from sales of aluminum-case cells increased to $30.5 million in
      the three months ended June 30, 2010, from $22.5 million in the same
      period in fiscal year 2009, an increase of $8.0 million or 35.7%,
      resulting from sales volume of 31.4% driven by increase sales to the OEM
      market in the PRC and an increase of 3.2% in our average selling
      price.


·
              Net
      revenues from sales of battery packs increased to $12.3 million in the
      three months ended June 30, 2010, from $5.7 million in the same period in
      fiscal year 2009, an increase of $6.6 million or 114.9%. This resulted
      from an increase in sales volume of 159.9% due to increased export sales
      and domestic market sales in the PRC, offset by a 14.0% decrease in
      average selling price.


·
            Net
      revenues from sales of cylindrical cells slightly increased to $12.8
      million in the three months ended June 30, 2010, from $12.7 million in the
      same period in fiscal year 2009, an increase of $81,000 or 0.6%. This
      result was the net effect of an 11.3% increase in sales volume driven
      primarily by increased sales to laptop manufacturers, offset by a decrease
      in our average selling prices of 2.7%due to our
      competitive pricing strategy for the cylindrical battery cells to increase
      our market share in the OEM market.




·
              We
      sold $350,000 in steel-case cells for the three months ended June 30, 2009
      as compared to no sales for the three months ended June 30, 2010. This
      change was attributable primarily to our long-term strategic reduction and
      suspension of steel-case cell production in January 2009 which was
      designed to increase our production capacity of aluminum-case cells for
      sale to the OEM market and to take advantage of the greater sales
      prospects and lower costs of aluminum-case cells.


·
            We
      sold $2.3 million in lithium polymer cells in the three months ended June
      30, 2010, compared to $3.3 million in lithium polymer cells in the same
      period in fiscal year 2009, a decrease of $1.1 million or 32.l%, resulting
      from a 75.6% decrease in sales volume and a 0.8% decrease in average
      selling price as result of fierce
competition.




·
            We
      also sold approximately $697,000 in high-power lithium battery cells in
      the three months ended June 30, 2010, as compared to $80,000 in high-power
      lithium-phosphate cells in the same period of fiscal year 2009, due to our
      sale of sample products used in electric buses, electric vehicles,
      electric bicycles, power tools, uninterruptible power supplies, and other
      applications from our Tianjin
facility.


6




Cost of
Revenues. Cost of revenues increased to $59.8 million for the three
months ended June 30, 2010, as compared to $39.6 million for the same period in
fiscal year 2009, an increase of $20.2 million or 50.8%. The increase in cost of
revenues correlates to an increase in sales volume over the three months ended
June 30, 2010, and a write-down of obsolete inventory of $5.6
million.





As a
result, gross loss for the three months ended June 30, 2010 was $1.2 million, or
negative 2.1% of net revenues, as compared to gross profit of $5.0 million, or
11.3% of net revenues, for the same period in fiscal year 2009. In addition to
our write-down of obsolete inventory of $5.6 million, the decrease in gross
profit as a percentage of net revenues was primarily due to a decrease in the
average selling price of cylindrical battery cells, resulting from the temporary
competitive-pricing strategy implemented in order to maintain and increase our
market share in the OEM market and sales of slow-moving inventories at
discount.





Research and
Development Costs. Research and development costs increased to $2.1
million for the three months ended June 30, 2010, as compared to $1.5 million
for the same period in fiscal year 2009, an increase of $657,000 or 44.7%.
Salaries and benefits related to R&D staff increased by $501,000 primarily
due to increased basic salaries and benefits in response to guidance issued to
Shenzhen-based companies by relevant local government authorities during the
three months ended June 30, 2010 and effective July 1, 2010. The cost of
research materials also increased by $239,000 due to additional research
projects in the high-power lithium battery cells in Tianjin.




Sales and
Marketing Expenses. Sales and marketing expenses increased to $2.6
million for the three months ended June 30, 2010, as compared to $1.6 million
for the same period in fiscal year 2009, an increase of $1.0 million, or 63.7%,
primarily due to increased packing expenses of $104,000 and advertising expenses
of $105,000 related to more intensive sales effort during the three months ended
June 30, 2010. Salaries and welfare increased $498,000 primarily due to
increased basic salaries and benefits in response to guidance issued to
Shenzhen-based companies by relevant local government authorities during the
three months ended June 30, 2010 and effective July 1, 2010. As a percentage of
revenues, sales and marketing expenses have increased to 4.4% for the three
months ended June 30, 2010 from 3.5% for the same period in 2009, due to the
significant increase in revenues from sales.





General and
Administrative Expenses. General and administrative expenses increased to
$7.4 million, or 12.7% of revenues, for the three months ended June 30, 2010, as
compared to $5.5 million, or 12.7% of revenues, for the same period in fiscal
year 2009, an increase of $1.9 million, or 33.8%. Bad debt expenses increased,
during the three months ended June 30, 2010, by $2.5 million due to the
additional expense resulting from our assessment of the collectability of
accounts receivables from customers. Salaries and welfare increased $1.0 million
primarily due to increased basic salaries and benefits in response to guidance
issued to Shenzhen-based companies by relevant local government authorities
during the three months ended June 30, 2010 and effective July 1, 2010. We also
recognized the exchange loss of $563,000 for the three months ended June 30,
2010, compared with exchange gain of $345,000 for the three months ended June
30, 2009.





Property, Plant
and Equipment Impairment Charges. A property, plant
and equipment impairment charge of $5.1 million was recognized for the
three months ended June 30, 2010. During the course of our strategic review of
our operations during the third quarter of fiscal year 2010, we assessed the
recoverability of the carrying value of certain property, plant
and equipment as inflated by $5.1 million, which we wrote down in
accordance with US GAAP.





Operating
Loss. As a result of the above, operating loss totaled $18.4 million for
the three months ended June 30, 2010, as compared to $3.6 million for the same
period of the prior year. Excluding the impact of non-cash expenses, including
provisions for doubtful debts, obsolete inventories and impairment charges
related to strategic review of business operations, adjusted operating loss
totaled $3.9 million for the fiscal quarter ended June 30, 2010, as compared to
adjusted operating loss of $37,000 during the fiscal quarter ended June 30,
2009.





Finance Costs,
Net. Finance costs, net, increased to $2.0 million for the three months
ended June 30, 2010, as compared to $1.9 million for the same period of the
prior fiscal year, a slight increase of $125,000 or 6.6%. This increase mainly
was due to an increase in discounts charged for bills receivable recognized
during the three months ended June 30, 2010.





Government Grant
Income / Other Income / (Other Expenses).We
had deferred revenue from government grant income of $59,000and other income of
$107,000for the
three-month period ended June 30, 2010, as compared to government grant income
of $222,000 and other expenses of $353,000 for the same period of the prior
fiscal year. The government grant income for the three months ended June 30,
2010 and June 30, 2009 mainly consisted of subsidies to pay for the land use
rights to our corporate campus at BAK Industrial Park. No present or future
obligation will arise from the receipt of such income.


7




Income Tax
Benefits. Income tax benefits were $2.0 million for the three months
ended June 30, 2010, as compared to income tax benefits of $413,000 for the same
period of 2009. The change was the result of an increased loss for the quarter
ended June 30, 2010.





Net Loss.
As a result of the foregoing, we had a net loss of $18.3 million for the three
months ended June 30, 2010 compared to $5.2 million for the same period of
2009.





Comparison of Nine Months
Ended June 30, 2010 and June 30, 2009





The
following table sets forth key components of our results of operations for the
periods indicated. All amounts, other than percentages, are in thousands of U.S.
dollars.




NineMonths
                  EndedJune30,2010
                
                
                2009
                
                
                $Change
                
                
                %ChangeNet
      revenues
                
                $
                159,209
                
                
                $
                153,593
                
                
                $
                5,616
                
                
                
                3.7Cost
      of revenues
                
                
                141,853
                
                
                
                134,930
                
                
                
                6,923
                
                
                
                5.1Gross
      profit
                
                
                17,355
                
                
                
                18,663
                
                
                
                (1,307
                )
                
                
                (7.0
                )Operating
      expenses:Research
      and development expenses
                
                
                5,523
                
                
                
                4,014
                
                
                
                1,509
                
                
                
                37.6Sales
      and marketing expenses
                
                
                6,321
                
                
                
                4,334
                
                
                
                1,986
                
                
                
                45.8General
      and administrative expenses
                
                
                20,885
                
                
                
                16,427
                
                
                
                4,458
                
                
                
                27.1Property,
      plant and equipment impairment charge
                
                
                5,058
                
                
                
                -
                
                
                
                5,058
                
                
                
                -Total
      operating expenses
                
                
                37,786
                
                
                
                24,775
                
                
                
                13,011
                
                
                
                52.5Operating  loss
                
                
                (20,431
                )
                
                
                (6,113
                )
                
                
                (14,318
                )
                
                
                234.2Finance
      costs, net
                
                
                (6,366
                )
                
                
                (7,101
                )
                
                
                735
                
                
                
                (10.3
                )Government
      grant income
                
                
                493
                
                
                
                393
                
                
                
                100
                
                
                
                25.5Other
      income / (expenses)
                
                
                (32
                )
                
                
                (189
                )
                
                
                158
                
                
                
                (83.6
                )Income
      tax benefit / (expense)
                
                
                2,130
                
                
                
                378
                
                
                
                1,752
                
                
                
                463.4Net
      loss
                
                $
                (24,205
                )
                
                $
                (12,632
                )
                
                $
                (11,573
                )
                
                
                91.6





Net
Revenues. Net revenues increased to $159.2 million for the nine months
ended June 30, 2010 as compared to $153.6 million for the same period of the
prior year, an increase of $5.6 million or 3.7%. The following sets forth the
breakdown of our net revenues by battery cell type for the periods
indicated.





NineMonthsEnded
                  June30,2010
                
                
                2009
                
                $
      Change
                
                %
      Change(in thousands)Prismatic
      cellsAluminum-case
      cells
                
                $
                82,982
                
                
                $
                83,105
                
                (123
                )
                (0.2
                )Battery
      packs
                
                
                33,582
                
                
                
                15,833
                
                17,749
                
                112.10Steel-case
      cells
                
                
                -
                
                
                
                4,909
                
                (4,909
                )
                -Cylindrical
      cells
                
                
                34,271
                
                
                
                40,297
                
                (6,026
                )
                (15.0
                )Lithium
      polymer cells
                
                
                7,160
                
                
                
                9,339
                
                (2,179
                )
                (23.3
                )High-power
      lithium battery cells
                
                
                1,213
                
                
                
                110
                
                1,103
                
                1002.7Total
                
                $
                159,208
                
                
                $
                153,593
                
                5,615
                
                3.7




·
            Net
      revenues from sales of aluminum-case cells slightly decreased to $83.0
      million in the nine months ended June 30, 2010, from $83.1 million in the
      same period in fiscal year 2009, a decrease of $123,000 or 0.2%. This
      resulted from an increase in sales volume of 7.6% driven by increased
      sales to the OEM market in the PRC, offset by a 6.7% decrease in average
      selling price as we sold slow-moving inventories at discount to improve
      our operating cash flow.




·
            Net
      revenues from sales of battery packs increased to $33.6 million in the
      nine months ended June 30, 2010, from $15.8 million in the same period in
      fiscal year 2009, an increase of $17.7 million or 112.1%. This resulted
      from an increase in sales volume of 148.3% from increased export and
      domestic market (PRC) sales, offset by a 13.5% decrease in average selling
      price.


8




·
            Net
      revenues from sales of cylindrical cells decreased to $34.3 million in the
      nine months ended June 30, 2010, from $40.3 million in the same period in
      fiscal year 2009, a decrease of $6.0 million or 15.0%, due to a decrease
      in our average selling prices of 14.7% due to implementing a temporary
      pricing competition strategy to maintain and increase our market share in
      the OEM market, offset by a 2.4% increase in sales
  volume.




·
              We
      sold $4.9 million in steel-case cells for the nine months ended June 30,
      2009 as compared to no sales for the nine months ended June 30, 2010. This
      change was primarily attributable to our long- term strategic reduction
      and suspension of steel-case cell production in January 2009 to focus on
      the sale of aluminum-case cells for sale to the OEM market and to take
      advantage of the greater sales prospects and lower costs of aluminum-case
      cells.


·
            We
      sold $7.2 million in lithium polymer cells in the nine months ended June
      30, 2010, compared to $9.3 million in lithium polymer cells in the same
      period in fiscal year 2009, a decrease of $2.2 million or 23.3%, resulting
      from a decrease of 40.0% in sales volume, offset by a 0.5% increased
      average selling price as we began to sell the high capacity lithium
      polymer cells with higher prices.





·
            We
      also sold approximately $1.2 million in high-power lithium battery cells
      in the nine months ended June 30, 2010, as compared to $110,000 in
      high-power lithium-phosphate cells in the same period of fiscal year 2009,
      due to sale of sample products used in electric buses, electric vehicles,
      electric bicycles, power tools, uninterruptible power supplies, and other
      applications from our Tianjin
facility.





Cost of
Revenues. Cost of revenues increased to $141.9 million for the nine
months ended June 30, 2010, as compared to $135.0 million for the same period in
fiscal year 2009, an increase of $6.9 million or 5.1%. The increase in cost of
revenues correlates to an increase in sales volume over the nine months ended
June 30, 2010, and a significant write down of obsolete inventory.





As a
result, gross profit for the nine months ended June 30, 2010 was $17.4 million,
or 10.9% of net revenues, as compared to gross profit of $18.7 million, or 12.2%
of net revenues, for the same period in fiscal year 2009. Our decrease in gross
profit as a percentage of net revenues was primarily due to the decrease in
average selling price of prismatic battery cells and cylindrical battery cells
resulting in lower gross margin during the nine months ended June 30, 2010,
because we adopted a temporary competitive pricing strategy for cylindrical
battery cells to increase their market share in the OEM market and sold
slow-moving inventories at discount to improve our operating cash
flow.





Research and
Development Costs. Research and development costs increased to $5.5
million for the nine months ended June 30, 2010, as compared to $4.0 million for
the same period in fiscal year 2009, an increase of $1.5 million or 37.6%.
Salaries and welfare related to R&D staffs increased $1.1 million primarily
due to increased basic salaries and benefits in response to guidance issued to
Shenzhen-based companies by relevant local government authorities during the
three months ended June 30, 2010 and effective July 1, 2010. The cost of
research materials also increased by $265,000, due to increased research
projects required to support the development of high-power lithium battery
cells.





Sales and
Marketing Expenses. Sales and marketing expenses increased to $6.3
million for the nine months ended June 30, 2010, as compared to $4.3 million for
the same period in fiscal year 2009, an increase of $2.0 million, or 45.8%,
primarily due to increased packing expenses of $138,000 and advertising expenses
of $103,000, resulting from more intensive sales effort during the nine months
ended June 30, 2010. Salaries and welfare increased $818,000 primarily due to
increased basic salaries and benefits in response to guidance issued to
Shenzhen-based companies by relevant local government authorities during the
three months ended June 30, 2010 and effective July 1, 2010. Equity-based
compensation included in sales and marketing expenses increased by 169,000 due
to compensation charges applied to the grant of stock options to employees in
our sales department. As a percentage of revenues, sales and marketing expenses
have increased to 3.9% for the nine months ended June 30, 2010 from 2.8% for the
same period in 2009, primarily due to the significant increase in revenues
supported by marketing and sales.





General and
Administrative Expenses. General and administrative expenses increased to
$20.9 million, or 13.1% of revenues, for the nine months ended June 30, 2010, as
compared to $16.4 million, or 10.7% of revenues, for the same period in fiscal
year 2009, an increase of $4.5 million, or 27.1%. Bad debt expenses increased by
$3.2 million due to the provision charged following an assessment of account
collectability in the third quarter of 2010. Salaries and welfare increased $1.3
million primarily due to increased basic salaries and benefits under guidance
from the relevant local governments during the nine months ended June 30,
2010.We also recognized an exchange loss of $829,000 for the nine months ended
June 30, 2010, compared with exchange loss of 410,000 for the nine months ended
June 30, 2009.


9




Property, Plant
and Equipment Impairment Charges. Property, plant and
equipment impairment charges totaled $5.1 million for the nine months ended
June 30, 2010. During the course of our strategic review of our operations in
the quarter ended June 30, 2010, we assessed the recoverability of the carrying
value of certain property, plant and equipment which resulted in impairment
losses of $5.1 million. There was no similar charge during the nine months ended
June 30, 2009.





Operating
Loss. As a result of the above, operating loss totaled $20.4 million for
the nine months ended June 30, 2010, as compared to $6.1 million for the same
period of the prior year, an increase of $14.3 million, or 234.2%.





Finance Costs,
Net. Finance costs, net, decreased to $6.4 million for the nine months
ended June 30, 2010, as compared to $7.1 million for the same period of the
prior fiscal year, a decrease of $734,000 or 10.3%. We have $138.9 million in
short-term bank loans maturing in less than one year, $11.8 million in long-term
bank loans maturing within one year, and $29.5 million in other long-term bank
loans maturing in more than one year, outstanding as of June 30, 2010, as
compared to $135.8 million in short-term bank loans maturing in less than one
year, $16.1 million in long-term bank loans maturing within one year, and $39.5
million in other long-term bank loans maturing in more than one year,
outstanding as of June 30, 2009. The decrease in net finance costs is mainly
attributable to a decrease in debt outstanding and a decrease in the average
bank loan interest rates on both our short-term and long-term bank
loans.




Government Grant
Income / Other Income / (Other Expenses).We
had deferred revenue from government grant income of $493,000and other expenses of
$32,000for the
nine months ended June 30, 2010, as compared to government grant income of
$393,000 and other expense of $189,000 for the same period of the prior
fiscal year. The government grant income for the nine months ended June 30, 2010
mainly consisted of subsidies to pay for the land use rights to our corporate
campus at BAK Industrial Park and government grant funds to subsidize a new
high-technology project in the calendar year 2009. Government grant income for
the nine months ended June 30, 2009 mainly consisted of government grant funds
which subsidized our interest expenses in prior years for research and
development activities and to refund the value-added tax paid by Shenzhen BAK in
prior years in light of Shenzhen BAK’s qualification as a new and
high-technology enterprise.





Income Tax
Benefit. Income tax benefits were $2.1 million for the nine months ended
June 30, 2010, as compared to income tax benefits of $378,000 for the same
period of 2009. The change was the result of an increase in our deferred tax
provision during the nine months ended June 30, 2010.





Net Loss.
As a result of the foregoing, we had a net loss of $24.2 million for the nine
months ended June 30, 2010 compared to $12.6 million for the same period of
2009.





Reconciliation of Non-GAAP to
US GAAP Measures




The
following table sets forth a summary of our reconciliation of non-GAAP to US
GAAP measures for the periods indicated:




Reconciliation of Non-GAAP to
US GAAP Measures


(All
amounts in thousands of U.S. dollars)





For the quarter ended
                      June 30, 2010
                    
                    
                    For the quarter
                      ended
                      June 30, 2009Gross
      Margin as reported under US GAAP
                    
                    
                    (1,207,145
                    )
                    
                    
                    5,047,796Add:
      Provision for obsolete inventories
                    
                    
                    5,573,979
                    
                    
                    
                    425,929Non-GAAP
      Gross Margin
                    
                    
                    4,366,834
                    
                    
                    
                    5,473,725Operating
      Income / (Loss) as reported under US GAAP
                    
                    
                    (18,410,448
                    )
                    
                    
                    (3,556,284
                    )Add:
      Provision for doubtful debts
                    
                    
                    3,447,312
                    
                    
                    
                    2,538,670Add:
      Provision for obsolete inventories
                    
                    
                    5,573,979
                    
                    
                    
                    425,929Add:
      Share-based compensation costs
                    
                    
                    414,912
                    
                    
                    
                    553,848Add:
      Impairment charge
                    
                    
                    5,057,745
                    
                    
                    
                    -Non-GAAP
      Operating Income / (Loss)
                    
                    
                    (3,916,500
                    )
                    
                    
                    (37,837
                    )


10




Note:
This report includes financial information that excludes the impact of the
specified non-cash expenses set forth above, a financial measure not permitted
under US GAAP. The Company has provided the table above which includes a
reconciliation of gross margin and operating income / (loss) excluding the
impact of the non-cash expense items indicated in the above table, to the
figures as reported under US GAAP. The Company uses the non-GAAP information in
its internal performance measures to analyze performance between periods,
develop internal projections and measure management performance. The Company's
management believes that the presentation of these non-GAAP financial
information provides useful information regarding the Company’s results of
operations because it assists in measuring operating results which are
comparable with subsequent periods.




Liquidity
and Capital Resources





We have
historically financed our liquidity requirements from a variety of sources,
including short-term bank loans, long-term bank loans and bills payable under
bank credit agreements, sale of bills receivable and issuance of capital stock.
As of June 30, 2010, we had cash and cash equivalents of $24.9 million, as
compared to $30.7 million as of September 30, 2009 and $29.6 million as of the
nine months ended June 30, 2009. In addition, we had pledged deposits amounting
to $9.3 million and $31.1 million as of June 30, 2010 and September 30, 2009,
respectively. Typically, our banks require their borrowers to maintain deposits
of approximately 10% to 100% of the outstanding loan balances and bills payable.
The individual bank loans have maturities ranging from six to twelve months
which coincides with the periods the cash remains pledged to the
banks.





We had
access to $217.1 million in short-term credit facilities and $56.0 million in
long-term credit facilities as of June 30, 2010. As of June 30, 2010, the
principal outstanding amounts included short-term bank loans of $138.9 million,
long-term bank loans of $11.8 million maturing within one year, and long-term
bank loans of $29.5 million maturing in over one year, and bills payable of
$36.6 million, leaving $66.2 million of short-term funds available for
additional cash needs. In addition, on July 10, 2008, our $60.0 million shelf
registration statement was declared effective by the SEC, pursuant to which we
have raised $36.6 million in gross revenue from common stock purchases and
issued common stock warrants exercisable for up to $21.6 million in additional
gross proceeds. As $16.0 million of these warrants were not exercised before
their expiration, we may raise up to an additional $17.8 million in gross
proceeds from future equity financings under this shelf registration
statement.





The
following table sets forth a summary of our cash flows for the periods
indicated:




Cash
Flow


(All
amounts in thousands of U.S. dollars)





Nine Months Ended
                  June 30,2010
                
                
                2009Net
      cash (used in) provided by / operating activities
                
                $
                (10,685
                )
                
                $
                32,612Net
      cash used in investing activities
                
                
                (20,252
                )
                
                
                (34,828
                )Net
      cash used in financing activities
                
                
                25,832
                
                
                
                (3,572
                )Effect
      of exchange rate on cash and cash equivalents
                
                
                (698
                )
                
                
                (280
                )Net
      decrease in cash and cash equivalents
                
                
                (5,803
                )
                
                
                (6,068
                )Cash
      and cash equivalents at beginning of the period
                
                
                30,678
                
                
                
                35,707Cash
      and cash equivalents at end of period
                
                
                24,875
                
                
                
                29,639





Operating
Activities




Net cash
used in operating activities was $10.7 million in the nine months ended June 30,
2010, compared to $32.6 million of net cash provided by operating activities in
the same period in fiscal year 2009. The decrease of $43.3 million in operating
activities was mainly attributable to an increase in prepayments to our lithium
cobalt dioxide suppliers. We purchased more lithium cobalt dioxide, the main raw
material in our products, in anticipation of the higher future cost of lithium
cobalt dioxide as of June 30, 2010, and in the expectation of increased sales in
the coming months.


11




Investing
Activities




Net cash
used in investing activities was $20.3 millionin the nine months ended
June 30, 2010, compared to $34.8 million of net cash used in investing
activities in the same period in fiscal year 2009. The net cash used in
investing activities during the period ended June 30, 2010 was mainly used for
procurement of machinery and equipment for cylindrical cell line and prismatic
cell production line and construction of the Research and Development Test
Centre in Shenzhen.





Financing
Activities




Net cash
provided by financing activities was $25.8 million in the nine months ended June
30, 2010, compared to $3.6 million net cash used in financing activities in the
same period in 2009. This was mainly attributable to (i) net proceeds of $19.6
million from a private placement of our common stock completed in October 2009,
(ii) a $47.0 million increase in cash deposits at banks as collateral in the
nine months ended June 30, 2010, and (iii) decreased borrowings, net of
repayments, of $37.2 million in the nine months ended June 30,
2010.





As of
June 30, 2010, the principal amounts outstanding under our credit facilities and
lines of credit were as follows:




Maximum
                  Amount
                  Available
                
                
                Amount
                  Borrowed
                  (includes
                  bankloans
                  andbills
                  payable)(in thousands)Short-term credit
      facilities:Agricultural
      Bank of China
                
                $
                58,985
                
                
                $
                58,985Shenzhen
      Development Bank
                
                
                29,492
                
                
                
                22,119China
      CITIC Bank
                
                
                11,797
                
                
                
                11,797Bank
      of China
                
                
                66,358
                
                
                
                49,469China
      Everbright Bank
                
                
                14,746
                
                
                
                4,491Guangdong
      Development Bank
                
                
                14,746
                
                
                
                -Tianjin
      Branch, Bank of Dalian
                
                
                5,899
                
                
                
                5,566Industrial
      Bank
                
                
                9,216
                
                
                
                7,373Tianjin
      Branch, China Bohai Bank
                
                
                5,899
                
                
                
                5,898Subtotal—Short-term
      credit facilities
                
                $
                217,138
                
                
                $
                165,699Long-term credit
      facilities:Agricultural
      Bank of China
                
                
                14,746
                
                
                
                14,746China
      Development Bank
                
                
                22,120
                
                
                
                7,373Agricultural
      Bank of China, Tianjin Jinxin Branch
                
                
                19,170
                
                
                
                19,170Subtotal—Long-term
      credit facilities
                
                $
                56,036
                
                
                $
                41,289Lines of
      Credit:Agricultural
      Bank of China
                
                
                
                
                
                
                524Bank
      of China
                
                
                
                
                
                
                6,893Shanghai
      Pudong Development Bank
                
                
                
                
                
                
                2,471Subtotal—Lines
      of credit
                
                
                
                
                
                $
                9,888Total
      Principal Outstanding
                
                $
                273,174
                
                
                $
                216,876


12




The above
principal outstanding amounts under credit facilities and lines of credit
included short-term bank loans of $138.9 million, long-term bank loans of $11.8
million maturing within one year and long-term bank loans of $29.5million maturing in over
one year, and bills payable of $36.6 million.




For the
purpose of presentation, the effect of increases in bills payable balances is
included in operating activities in the statements of cash flows.




During
the three months ended June 30, 2010, we entered into a new comprehensive credit
facility agreement for a maximum loan amount of $14.7 million with Shenzhen
Longgang Branch, Guangdong Development Bank, renewed our comprehensive credit
facility agreement for a maximum loan amount of $14.7 million with Shenzhen
Branch, China CITIC Bank, repaid seven loans totaling $62.7 million, and entered
into six new short-term bank loan agreements totaling $47.2 million. The
material financing terms of these loans are described below.




On May
14, 2010, we entered into a comprehensive credit facility agreement with
Shenzhen Longgang Branch, Guangdong Development Bank to provide a maximum loan
amount of RMB 100 million (approximately $14.7 million). Discount business may
be offered at any time over the one-year period from May 14, 2010 to May 14,
2011, and the floating discount rate is in line with the discount rate issued by
Guangdong Development Bank on the date of discount. As of June 30, 2010, we had
no discount business under this credit facility.




As of
June 30, 2010, we had six outstanding short-term loans under the comprehensive
credit facility with Agricultural Bank – Shenzhen Branch totaling approximately
$59.0 million, carrying annual interest at 4.86%, 4.617%, 5.31% and 5.0445%,
adjusted quarterly. The first loan, of approximately $11.0 million, currently
carries annual interest of 5.31% and is due on January 6, 2011. The second loan,
of approximately $7.4 million, currently carries annual interest at 5.31% and is
due on January 21, 2011. The third loan, of approximately $7.4 million,
currently carries annual interest at 5.31% and is due on January 22, 2011. The
fourth loan, of approximately $8.8 million, currently carries annual interest
at5.0445% and is due on April 20, 2011. The fifth loan, of approximately $11.1
million, currently carries annual interest at 5.0445% and is due on April 22,
2011. The sixth loan, of approximately $13.3 million, currently carries annual
interest at 5.04454% and is due on April 19, 2011. Each of the loan agreements
specifically provides for acceleration of repayment of the loan under certain
conditions, as well as other penalties and remedies. We also had borrowed $0.5
million of notes payable separate from our credit agreement with Agricultural
Bank – Shenzhen Branch.




As of
June 30, 2010, we also had two five-year term loans totaling approximately $14.7
million under the Agricultural Bank – Shenzhen Branch comprehensive credit
facility carrying interest at 90% of the benchmark rate of the People’s Bank of
China, or PBOC, for three-year to five-year long-term loans. The first loan, of
approximately $5.9 million, currently carries annual interest of 5.184% and is
due on January 25, 2012. The second loan, of approximately $8.8 million,
currently carries annual interest of 5.184% and is due in two installments of
approximately $7.3 million on January 25, 2011, and approximately $1.5 million
on January 25, 2012, respectively. These five-year term loans are specifically:
(i) guaranteed by Mr. Xiangqian Li; (ii) secured by Shenzhen BAK’s machinery and
equipment with carrying values of approximately $37.3 million as of June 30,
2010; and (iii) secured by the property ownership and land use rights
certificates with an aggregate net book value of $105.1 million as of June 30,
2010 in relation to the land on which Shenzhen BAK’s corporate campus had been
constructed and any machinery and equipment purchased and used at the campus
subsequent to such construction.




On May
12, 2010, we renewed a credit facility with Shenzhen Branch, China CITIC Bank to
provide a maximum loan amount of RMB 80 million (approximately $11.8 million).
This credit facility was guaranteed by BAK International and Mr. Xiangqian Li.
As of June 30, 2010, we had borrowed $11.8 million under two loans at floating
interest rate of 5.0445%, with a rate in line with the benchmark interest rate
adjustment of The People’s Bank of China under this credit facility. The first
loan, of approximately $5.9 million, carried floating interest of 5.0445% and is
repayable on June 11, 2011. The second loan, of approximately $5.9 million, also
carried floating interest of 5.0445% and is also repayable on June 11,
2011.




As of
June 30, 2010, we had also borrowed $0.2 million of notes payable outside any
credit facility in Bank of China, Tianjin Branch.




On March
8, 2010, we renewed our credit facility agreement with Bank of China to provide
a maximum loan amount of RMB 450 million (approximately $65.9 million). This
credit facility was guaranteed by BAK International and Mr. Xiangqian Li, and
also is secured by machinery and equipment with carrying values of approximately
$24.2 million as of June 30, 2010. As of June 30, 2010, we had borrowed $22.1
million under one loans carrying annual interest at 5.31% that is payable on
March 11, 2011, and $27.3 million of notes payable under this credit facility
agreement. We had also borrowed $4.0 million of short-term bank loans and $2.7
million of notes payable separate from the credit facility.




13




On
January 19, 2010, we entered into a comprehensive credit facility agreement with
Tianjin Branch, China Bohai Bank to provide a maximum loan amount of RMB 40
million (approximately $5.9 million). This credit facility agreement is
guaranteed by Shenzhen BAK Battery Co., Ltd. Under the terms of the agreement,
loans may be drawn at any time from January 19, 2010 to January 19, 2011. As of
June 30, 2010, we had borrowed approximately $5.9millionunder the loan agreement
which bears a floating interest rate equal to the benchmark rate of the PBOC on
the date of the loan agreement and adjusted annually, and which is repayable on
January 18, 2011.




On
December 31, 2009, we renewed our comprehensive credit facility agreement with
Shenzhen Development Bank, Longgang Branch, or Shenzhen Development Bank, to
provide a maximum loan amount of RMB 200 million (approximately $29.5 million).
Loans may be drawn at any time over the one-year period beginning December 31,
2009 and will be due based on each loan agreement. This credit facility
agreement is guaranteed by BAK International, BAK Tianjin and Mr. Xiangqian Li,
and is also secured by $22.1 million of inventory and $1.2 million of machinery
and equipment. As of June 30, 2010, we had three outstanding short-term loans
under the comprehensive credit facility with Shenzhen Development Bank totaling
approximately $22.1 million. The first loan was approximately $2.9 million, is
dated December 31, 2009, bears a floating interest rate equal to 95% of the
benchmark rate of the People’s Bank of China, or PBOC, on the date of the loan
agreement and adjusted quarterly, and is repayable on December 31, 2010. The
second loan of approximately $8.8 million is dated January 4, 2010, bears a
floating interest rate equal to 95% of the benchmark rate of the People’s Bank
of China, or PBOC, on the date of the loan agreement and adjusted quarterly, and
is repayable on January 4, 2011. The third loan was approximately $10.3 million,
is dated February 3, 2010, bears a floating interest rate equal to 90% of the
benchmark rate of the PBOC on the date of the loan agreement and adjusted
quarterly, and is repayable on February 3, 2011.




On
December 30, 2009, we entered into a six-year long-term loan agreement of RMB
150 million (approximately $22.0 million) with Shenzhen Branch, China
Development Bank, or China Development Bank. The long-term loan is secured by
Shenzhen BAK’s pledge of its land use rights certificates, property ownership
and equipment built-up by use of this long-term loan pursuant to the loan
agreement. According to the property ownership and land use rights certificate
that we obtained in relation to this facility, the certificate may not be
pledged without the approval of the relevant government office. On April 7,
2010, the pledge of the land use rights certificate to China Development Bank
was approved by the relevant government bureau. For further discussion regarding
the status of property ownership rights relating to this facility, please see
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations – Capital Expenditures.” The obligations of Shenzhen BAK under this
loan agreement are guaranteed by Mr. Xiangqian Li. We had borrowed approximately
$7.3million under
a loan agreement dated March 1, 2010, bearing annual interest of 5.90%, adjusted
monthly, and repayable within 72 months.




On
December 25, 2009, we entered into a comprehensive credit facility agreement
with Shenzhen Hi-Tech District Branch, Industrial Bank, or Industrial Bank, for
a maximum loan amount of RMB 62.5 million (approximately $9.2 million). This
credit facility agreement is guaranteed by BAK International, BAK Tianjin and
Mr. Xiangqian Li. Loans may be drawn at any time from March 31, 2010 to December
31, 2010. As of June 30, 2010, we had borrowed approximately $7.4million under a loan
agreement dated January 6, 2010 bearing fixed interest of 4.779%, and which is
repayable on December 31, 2010 under this credit facility
agreement.




On
November 27, 2009, we entered into a comprehensive credit facility agreement
with Tianjin Branch, Bank of Dalian, or Bank of Dalian, for a maximum loan
amount of RMB 40 million (approximately $5.9 million). If we increase paid-up
capital by $20 million, then an additional RMB 10 million of credit facilities
would be available. If we pay up 50% of our total registered capital, then
another additional RMB 10 million of credit facilities would be available. If we
pay up all our registered capital, the total amount of available credit under
this facility would be RMB 80 million (approximately $11.8 million). This credit
facility agreement is guaranteed by Shenzhen BAK and Mr. Xiangqian Li. Loans may
be drawn at any time from November 27, 2009 to November 26, 2010. As of June 30,
2010, we had borrowed approximately $5.2million under two loan
agreements. The first loan was approximately $3.0 million, is dated November 27,
2009, bears annual interest of 5.31%, adjusted monthly, and is repayable on
November 26, 2010. The second loan was approximately $2.2 million, is dated
April 27, 2010, bears annual interest of 5.5755%, adjusted monthly, and is
repayable on November 26, 2010. In addition, $0.4 million of notes payable was
issued under this credit facility agreement as of June 30, 2010.




14




On
November 26, 2009, we renewed our comprehensive credit facility agreement with
Agricultural Bank of China, Shenzhen Eastern Branch, or Agricultural Bank –
Shenzhen Branch, to provide a maximum loan amount of RMB 550 million
(approximately $80.6 million), including RMB 400 million (approximately $58.6
million) of one-year term credit facilities and RMB 150 million (approximately
$22.0 million) of five-year term credit facilities. This comprehensive credit
facility agreement renewed a predecessor credit facility agreement between
Shenzhen BAK and Agricultural Bank – Shenzhen Branch dated November 27, 2008 and
governs all loans that were subject to the predecessor agreement at the time of
the renewal. New loans may be drawn under this credit facility from November 26,
2009 through November 22, 2010, with the term of the loan established at the
time each new loan is drawn, except as to funds borrowed under a loan agreement
between Shenzhen BAK and Agricultural Bank – Shenzhen Branch dated November 23,
2006 and effective December 18, 2006, or under the 2006 Loan Agreement, which
may be drawn at any time within five years of December 18, 2006, and which will
mature five years after such funds are drawn. Pursuant to the comprehensive
credit facility, Shenzhen BAK must obtain prior approval from Agricultural Bank
– Shenzhen Branch to renew long-term loans that are subject to this credit
facility. In addition, Shenzhen BAK undertook to ensure that the percentage of
certain business conducted with Agricultural Bank – Shenzhen Branch relative to
such business it conducts with all financial institutions combined be at least
equal to the percentage of its indebtedness to Agricultural Bank – Shenzhen
Branch relative to its indebtedness to all financial institutions combined
(referred to as the “Percentages Undertaking”). The “business” referred to in
the preceding sentence refers to the volume of transactional payments that are
drawn from Shenzhen BAK’s accounts with Agricultural Bank – Shenzhen Branch or
applicable financial institutions and the amount of foreign currencies deposited
with Agricultural Bank – Shenzhen Branch or applicable financial institutions.
Shenzhen BAK also undertook not to issue any dividends without the written
consent of Agricultural Bank – Shenzhen Branch prior to the expiration of all
loans under this credit facility (this undertaking and the Percentages
Undertaking are collectively referred to as the “Undertakings”). The obligations
of Shenzhen BAK under this comprehensive credit facility are guaranteed by Mr.
Xiangqian Li, BAK Tianjin, and BAK International. Shenzhen BAK’s obligations
under this credit facility agreement are also guaranteed by Shenzhen BAK’s
pledge of the property ownership and land use rights certificates relating to
its manufacturing and other facilities in Shenzhen, PRC, known as BAK Industrial
Park. In the event that Shenzhen BAK breaches any of the Undertakings or any
guaranteed party breaches any of its guaranty obligations, Agricultural Bank –
Shenzhen Branch may, in addition to exercising any other applicable remedies
under the applicable agreements, accelerate repayment of all loan amounts
governed by this credit facility.




On
September 28, 2009, we entered into a guaranty contract with Shanghai Pudong
Development Bank to provide guaranty for the loans drawn from September 28, 2009
to August 31, 2010, and the maximum amount for all loans will be less than RMB
30 million (approximately $4.4 million). As of June 30, 2010, we had borrowed
approximately $1.5 million under a loan agreement dated October 9, 2009 bearing
fixed interest of 5.31%, which is repayable on October 8, 2010, and $1.0 million
of notes payable outside any credit facility.




On
January 21, 2009, we entered into a comprehensive credit facility agreement with
Shenzhen Nanshan Branch, China Everbright Bank, or China Everbright Bank, to
provide a maximum loan amount of RMB 100 million (approximately $14.7 million).
Loans may be drawn at any time from March 30, 2009 to March 30, 2010. As of June
30, 2010, we had borrowed $4.5 million of notes payable under this
facility.




On May
26, 2008, we entered into a four-year, long-term loan agreement of RMB 160
million (approximately $23.4 million) with Agricultural Bank of China, Tianjin
Branch, or Agricultural Bank – Tianjin Branch. This loan agreement is secured by
the machinery and equipment purchased for the automated high-power lithium
battery cells production line at our Tianjin facility. As of June 30, 2010, we
had borrowed $19.2 million under this loan agreement, payable in three
installments: (i) RMB 30 million (approximately $4.4 million) on December 26,
2010; (ii) RMB 50 million (approximately $7.4 million) on December 26, 2011; and
(iii) RMB 50 million (approximately $7.4 million) on May 26, 2012.




We had
negative working capital of $59.1 million as of June 30, 2010, as compared to
negative working capital of $46.3 million as of September 30, 2009. Current
assets as of June 30, 2010 were $193.1 million compared with $220.0 million as
of September 30, 2009, a decrease of $26.9 million.  Current liabilities as
of June 30, 2010 were $252.2 million compared with $266.3 million as of
September 30, 2009, a decrease of $14.0 million.  We had short-term bank
loans maturing in less than one year of $138.9 million and long-term bank loans
maturing within one year of $11.8 million as of June 30, 2010, or a total of
$150.7 million of loans maturing within one year, as compared to a total of
$151.9 millionof
such loans as of June 30, 2009, a decrease of $1.2 million. We had long-term
bank loans maturing in over one year of $29.5 million as of June 30, 2010, as
compared to $39.6 million of such loans as of September 30, 2009, a decrease of
$10.1 million.




We
believe that our current cash and cash equivalents and anticipated cash flow
from operations will be sufficient to meet our anticipated cash needs, including
our cash needs for working capital and capital expenditures for at least the
next 12 months. We may, however, require additional cash due to changing
business conditions or other future developments, including any investments or
acquisitions we may decide to pursue. If our existing cash and amount available
under existing credit facilities is insufficient to meet our requirements, we
may seek to sell additional equity securities, debt securities or borrow from
lending institutions. We can make no assurances that financing will be available
in the amounts we need or on terms acceptable to us, if at all. The sale of
additional equity securities, including convertible debt securities, would
dilute the interests of our current shareholders. The incurrence of debt would
divert cash for working capital and capital expenditures to service debt
obligations and could result in operating and financial covenants that restrict
our operations and our ability to pay dividends to our shareholders. If we are
unable to obtain additional equity or debt financing as required, our business
operations and prospects may suffer.




15




Capital
Expenditures




We made
capital expenditures of $20.3 million and $34.8 million in the nine months ended
June 30, 2010 and 2009, respectively. Our capital expenditures were used
primarily to purchase plant and equipment to expand our production
capacity.




The
following table sets forth the breakdown of our capital expenditures by use for
the periods indicated.




Nine Months Ended
                  June 30,2010
                
                
                2009(in thousands)Construction
      costs
                
                $
                1,179
                
                
                $
                6,000Lease
      payments
                
                
                -
                
                
                
                1,076Purchase
      of equipment
                
                
                19,073
                
                
                
                27,752Total
      capital expenditures
                
                $
                20,252
                
                
                $
                34,828





We
estimate that our total capital expenditures in fiscal year 2010 will reach
approximately $40.0 million, to purchase manufacturing equipment for the
expansion of our production lines and for the construction of our Research and
Development Test Centre at our Shenzhen facility.




We have
completed the construction and put into use facilities measuring 218,178 square
meters comprised of manufacturing facilities, warehousing and packaging
facilities, dormitory space, dining halls and administrative offices at the BAK
Industrial Park in Shenzhen. Of that space, approximately 81,411 square meters
are manufacturing facilities. We have also completed the construction and put
into use facilities measuring 65,127 square meters comprised of manufacturing
facilities, dormitory space, dining halls and other facilities in Tianjin. Of
that space, approximately 44,129 square meters are manufacturing facilities. The
primary reasons for our continuing investments in the facilities in Tianjin are
to realize the benefits of our prior investment in these facilities, to position
the Company to capitalize on our knowledge of and experience with established
markets for lithium-phosphate technology, such as electric bicycles, cordless
power tools, and mining lamps, and to penetrate emerging consuming markets for
this technology, such as light electric vehicles and hybrid electric vehicles.
The first trial shipment of its lithium-phosphate cells was used in electric
bicycles, cordless power tools, uninterruptible power supplies and mining lamps.
We have received positive market feedback to these samples. We expect interest
in light electric vehicles and hybrid electric vehicles to increase demand for
our rechargeable lithium-based batteries substantially. We have been engaged in
the research and development of lithium-phosphate cells specifically for use in
light electric vehicles and hybrid electric vehicles. As indicated above, our
Tianjin facility is the nexus for all such research and
development.




According
to the relevant PRC laws and regulations, a land use right certificate, along
with government approvals for land planning, project planning, and construction
must be obtained before the construction of any building is commenced. An
ownership certificate will be granted by the government upon application under
the condition that the aforementioned certificate and government approvals are
obtained. We recently obtained the land use right to the tract of property on
which we have constructed and on which we plan further construction of our
manufacturing facilities and other related facilities in Shenzhen. While we have
been constructing and have completed a substantial part of the construction of
our facilities with the approval of the local government of Kuichong Township of
Longgang District of Shenzhen, we understand it did not have the authority to
grant us the land use rights certificate. However, the Company obtained approval
for project planning and construction from the government of Shenzhen on June
20, 2007. Under an agreement with the government of Shenzhen for the acquisition
of the land use rights to BAK Industrial Park dated June 29, 2007, effective
June 2008, the government agreed to provide us with the land use rights
certificate relating to BAK Industrial Park on the condition that the Company
would pay it an additional $11,819,841. According to a notice received from the
government of Shenzhen on June 6, 2008, the Company obtained government grants
of $7,889,991 to subsidize this additional payment. As of September 30, 2008,
the Company had fully paid the remaining cost of $3,929,850 and had obtained the
land use rights certificate for BAK Industrial Park.


16




We have
insurance for our manufacturing facilities for Shenzhen BAK Battery Co., Ltd
located in BAK Industrial Park and our manufacturing facilities at our Tianjin
facility. However, we are not able to insure our new Research and Development
Test Centre to be constructed in Shenzhen, China, until we receive the required
certificate of property ownership. Upon receipt of the certificate of property
ownership, we intend to procure such insurance. The applications for the related
certificates of property ownership rights are in process with respect to our
facilities at BAK Industrial Park and Tianjin (see discussion of our Research
and Development Test Centre below). As we have been granted the land use rights
certificate to the premises presently occupied by the Company in BAK Industrial
Park, there should be no legal barriers for us to obtain a property ownership
certificate for this property. However, it is possible that the Shenzhen
government may determine that even with our land use rights certificate, the
buildings constructed at BAK Industrial Park were still constructed without the
proper authority and must be vacated as illegitimate constructions, and we might
be subject to penalties and fines. However, we believe that this possibility,
while present, is remote.




As of
September 30, 2007, we had fully paid the lease prepayment amount of $14.1
million for the acquisition of land use rights regarding our Tianjin facility.
As of September 30, 2008, we had obtained the relevant land use rights
certificate to this facility. As of June 30, 2010, we were in the process of
obtaining the relevant property ownership rights certificate to this facility.
Pursuant to our land use rights certificate relating to our Tianjin facility,
the Tianjin government had originally requested that we complete construction of
the Tianjin facility before September 30, 2008. As of September 30, 2008, we had
not done so. Notwithstanding this requirement, we have obtained an extension
from the Business Administration Bureau of Beichen District, Tianjin, to make
the remaining contribution of the registered capital by December 11, 2009, which
we have interpreted as an extension of the completion date of construction to
this date. As of June 30, 2010, we are in discussions with the authorities
regarding an extension of this deadline and no action has been taken by the
authorities.




As of
September 30, 2007, we had paid the lease prepayment amount of $717,000 for the
acquisition of land use rights for a new Research and Development Test Centre to
be constructed in Shenzhen, China. As of September 30, 2008, we had obtained the
relevant property ownership and land use rights certificate. Pursuant to the
property ownership and land use rights certificate, we are required to complete
at least 25% of the construction of the new Research and Development Test Centre
facility by September 30, 2008. As of September 30, 2008, we had not done so.
Notwithstanding this requirement, the Shenzhen government has agreed to increase
the dimensions of the Research and Development Test Centre and signed two
supplemental agreements with us. According to the supplemental agreements, we
are required to complete the construction by May 6, 2011. In addition, according
to the property ownership and land use rights certificate, the certificate may
not be pledged without the approval of the relevant government office. We are
required to pledge our property ownership and land use rights certificate in
relation to the new Research and Development Test Centre to China Development
Bank pursuant to the loan agreement entered into with it. On April 7, 2010, the
pledge of the land use rights certificate to China Development Bank was approved
by the relevant government bureau. In addition, the so-named “property ownership
and land use rights certificate” relating to this facility that we were issued
lacks certain terms relating to property ownership rights, which appears to
indicate that the granting government has so far only granted us the relevant
land use rights. As a result, this certificate may not be adequate evidence of
our property ownership rights to this property. We anticipate that the
government will re-grant this certificate with adequate property ownership
indicia after we have satisfied the above construction requirement and followed
certain procedures.





Contractual
Obligations and Commercial Commitments




Please
refer to Item 7, “Management’s Discussion and Analysis of Financial Condition
and Results of Operations – Contractual Obligations and Commercial Commitments”
in the 2009 Form 10-K for a discussion of our contractual obligations and
commercial commitments as of September 30, 2009. There were no material changes
outside the ordinary course of our business in our contractual obligations and
commercial commitments for the quarter ended June 30, 2010.




Off-Balance
Sheet Transactions




In the
ordinary course of business practices in China, we enter into transactions with
banks or other lenders where we guarantee the debt of other parties. These
parties may be related to or unrelated to us. Conversely, our debt with lenders
may also be guaranteed by other parties which may be related or unrelated to
us.





Under
U.S. GAAP, these transactions may not be recorded on our balance sheet or may be
recorded in amounts different than the full contract or notional amount of the
transaction. Our primary off-balance sheet arrangements would result from our
loan guaranties in which Shenzhen BAK, BAK International, BAK Tianjin, and/or
Mr. Xiangqian Li, our director, Chairman, President, and Chief Executive
Officer, would provide contractual assurance of the debt, or guarantee the
timely re-payment of principal and interest of the guaranteed party. Neither
Shenzhen BAK, BAK International, BAK Tianjin, nor Mr. Xiangqian Li received, nor
is entitled to receive, any consideration for the above-referenced guarantees,
and we are not independently obligated to indemnify any of those guarantors for
any amounts paid by them pursuant to any guarantee.




17




Typically,
no fees are received for this service. Thus, in those transactions, Shenzhen BAK
would have a contingent obligation related to the guarantee of payment in the
event the underlying loan is in default.





Transactions
described above require accounting treatment under ASC Topic 460 “Guarantees”.
Under that standard, we would be required to recognize the fair value of
guarantees issued or modified after December 31, 2002, for non-contingent
guarantee obligations, and also a liability for contingent guarantee obligations
based on the probability that the guaranteed party will not perform under the
contractual terms of the guaranty agreement.





We have
assessed the contingent liabilities arising from the above-described guarantees
and have considered them immaterial to the consolidated financial statements.
Therefore, no liabilities in respect of the guarantees were recognized as of
June 30, 2010. As of June 30, 2010, we provided a guarantee for a non-related
party, Nanjing Special Metal Equipment Co., Ltd., of one-year short-term bank
loans with Evergrowing Bank with a maturity of August 6, 2010. We also provided
the guarantees for four other non-related parties, Hunan Reshine New Material
Ltd, Shenzhen Tongli Hi-tech Co. Ltd., Shenzhen B&G Technology Development
Co. Ltd., Shanghai Global Children Products Co. Ltd. and Siping Juyuan Hanyang
Plate Heat Exchanger Co. Ltd. The maximum amount of our exposure for these
guarantees was $34.5 million and $28.6 million at June 30, 2010 and September
30, 2009, respectively.




Critical
Accounting Policies




Our
consolidated financial information has been prepared in accordance with U.S.
GAAP, which requires us to make judgments, estimates and assumptions that affect
(1) the reported amounts of our assets and liabilities, (2) the disclosure of
our contingent assets and liabilities at the end of each fiscal period and (3)
the reported amounts of revenues and expenses during each fiscal period. We
continually evaluate these estimates based on our own historical experience,
knowledge and assessment of current business and other conditions, our
expectations regarding the future based on available information and reasonable
assumptions, which together form our basis for making judgments about matters
that are not readily apparent from other sources. Since the use of estimates is
an integral component of the financial reporting process, our actual results
could differ from those estimates. Some of our accounting policies require a
higher degree of judgment than others in their application.





When
reviewing our financial statements, the following should also be considered: (1)
our selection of critical accounting policies, (2) the judgment and other
uncertainties affecting the application of those policies, and (3) the
sensitivity of reported results to changes in conditions and assumptions. We
believe the following accounting policies involve the most significant judgment
and estimates used in the preparation of our financial statements.





Recoverability
of Long-Lived Assets




Our
business is capital intensive and has required, and will continue to require,
significant investments in property, plant and equipment. As of June 30, 2010
and September 30, 2009, the carrying amount of property, plant and equipment,
net was $224.0 million and $219.7 million, respectively. We assess the
recoverability of property, plant and equipment to be held and used by a
comparison of the carrying amount of an asset or group of assets to the future
net undiscounted cash flows expected to be generated by the asset or group of
assets. If such assets are considered impaired, the impairment recognized is
measured as the amount by which the carrying amount of the assets exceeds the
fair value of the assets.





A
prolonged general economic downturn and, specifically, a continued downturn in
the battery cell industry as well as other market factors could intensify
competitive pricing pressure, create an imbalance of industry supply and demand,
or otherwise diminish volumes or profits. Such events, combined with changes in
interest rates, could adversely affect our estimates of future net cash flows to
be generated by our long-lived assets. Consequently, it is possible that our
future operating results could be materially and adversely affected by
additional impairment charges related to the recoverability of our long-lived
assets.




We have
recognized impairment charges of $5.1 million for the long-lived assets for the
three months ended June 30, 2010.


18




Inventory
Obsolescence




We review
our inventory for potential impairment on a quarterly or more frequent basis as
deemed necessary. Such review includes, but is not limited to, reviewing the
levels of inventory versus customer requirements and obsolescence. The review
and evaluation also considers the potential sale of impaired inventory at lower
than market prices. At each balance sheet date, we identify inventories that are
worth less than cost and write them down to their net realizable value and the
difference is charged to our cost of revenues of that period. Though management
considers such write-down of inventories adequate and proper, changes in sales
volumes due to unexpected economic or competitive conditions are among the
factors that could materially affect the adequacy of such
write-down.




Allowance
for Doubtful Accounts




The
allowance for doubtful accounts is our best estimate of the amount of probable
credit losses in our accounts receivable. We determine the allowance based on
historical write-off experience, customer specific facts and economic
conditions. Bad debt expense is included in the general and administrative
expenses. We review outstanding account balances individually for
collectability. Account balances are charged off against the allowance after all
means of collection have been exhausted and the potential for recovery is
considered remote. As of June 30, 2010 and September 30, 2009, we had not
charged off any balances as we had yet to exhaust all means of collection.
However, as of June 30, 2010, we significantly increased our allowance for
doubtful accounts and this amount is included in expenses on our fiscal year
2010 third quarter income and cash flow results, as well as on the balance sheet
dated June 30, 2010.





Equity-Based
Compensation




We
adopted the provisions of ASC Topic 718 “Compensation – Stock Compensation,”
which requires the use of the fair value method of accounting for share-based
compensation. Under the fair value based method, compensation cost related to
employee stock options or similar equity instruments is measured at the grant
date based on the value of the award and is recognized over the service period,
which is usually the vesting period. ASC Topic 718 also requires measurement of
cost of a liability-classified award based on its current fair value. The fair
value of the liability-classified award will be subsequently re-measured at each
reporting date through the settlement date. Change in fair value during the
requisite service period will be recognized as compensation cost over that
period.





We
determine fair value using the Black-Scholes model. Under this model, certain
assumptions, including the risk-free interest rate, the expected life of the
options and the estimated fair value of our ordinary shares and the expected
volatility, are required to determine the fair value of the options. If
different assumptions had been used, the fair value of the options would have
been different from the amount we computed and recorded, which would have
resulted in either an increase or decrease in the compensation
expense.




Pursuant
to ASC Topic 718, we have recognized compensation costs of $415,000 in relation
to stock-based awards to our employees and non-employee directors for the three
months ended June 30, 2010, as an increase in both the operating costs and
shareholder’s equity.




Recently
Issued Accounting Pronouncements




In
October 2009, the FASB issued ASU 2009-13, “Revenue Recognition (Topic 605) –
Multiple-Deliverable Revenue Arrangements,” or ASU 2009-13. ASU 2009-13 requires
companies to allocate revenue in multiple-element arrangements based on an
element’s estimated selling price if vendor-specific or other third party
evidence of value is not available. ASU 2009-13 is to be applied on a
prospective basis for revenue arrangements entered into or materially modified
in fiscal years beginning on or after June 15, 2010, with earlier application
permitted. The adoption of ASC 605 is not expected to have a material effect on
our financial statements.




In
January 2010, the FASB issued ASU 2010-06, “Fair Value Measurements and
Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements”,
or ASU 2010-06 that expands the required disclosures about fair value
measurements. This guidance provides for new disclosures requiring the Company
to (i) disclose separately the amounts of significant transfers in and out
of Level 1 and Level 2 fair value measurements and describe the reasons for the
transfers and (ii) present separately information about purchases, sales,
issuances and settlements in the reconciliation of Level 3 fair value
measurements. This guidance also provides clarification of existing disclosures
requiring the Company to (i) determine each class of assets and liabilities
based on the nature and risks of the investments rather than by major security
type and (ii) for each class of assets and liabilities, disclose the
valuation techniques and inputs used to measure fair value for both Level 2 and
Level 3 fair value measurements. ASU 2010-06 is effective for interim and annual
reporting periods beginning after December 15, 2009, except for the disclosures
about purchases, sales, issuances, and settlements in the roll forward of
activity in Level 3 fair value measurements. Those disclosures are effective for
fiscal years beginning after December 15, 2010, and for interim periods within
those fiscal years. Early application is permitted. The adoption of ASU 2010-06
has no material impact on our financial statements.


19




In
February 2010, the FASB issued ASU 2010-09, “Subsequent Events—Amendments to
Certain Recognition and Disclosure Requirements” or ASU 2010-09. The ASU amends
the guidance on subsequent events in the FASB Accounting Standards Codification
to (1) eliminate the requirement for an SEC filer to disclose the date through
which it has evaluated subsequent events, (2) clarify the period through which
conduit bond obligors must evaluate subsequent events, and (3) refine the scope
of the disclosure requirements for reissued financial statements. All of the
amendments in ASU 2010-09 were effective upon issuance on February 24, 2010,
except for the use of the issued date for conduit debt obligors. That amendment
is effective for interim or annual periods ending after June 15, 2010. The
adoption of ASU 2009-09 has no material impact on our financial
statements.





In April
2010, the FASB issued ASU 2010-13, “Compensation-Stock Compensation (Topic 718)
- Effect of Denominating the Exercise Price of a Share-Based Payment Award in
the Currency of the Market in Which the Underlying Equity Security Trades - a
consensus of the FASB Emerging Issues Task Force,” or ASU 2010-13. ASU 2010-13
provides amendments to Topic 718 to clarify that an employee share-based payment
award with an exercise price denominated in the currency of a market in which a
substantial portion of the entity's equity securities trades should not be
considered to contain a condition that is not a market, performance, or service
condition. Therefore, an entity would not classify such an award as a liability
if it otherwise qualifies as equity. The amendments in this update do not expand
the recurring disclosures required by Topic 718. Disclosures currently required
under Topic 718 are applicable to a share-based payment award, including the
nature and the term of share-based payment arrangements. The amendments in this
update are effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2010. We are currently evaluating the
impact of the adoption of ASU 2010-13 on our financial statements.





Exchange
Rates




The
financial records of Shenzhen BAK, BAK Electronics and BAK Tianjin are
maintained in RMB. In order to prepare our financial statements, we have
translated amounts in RMB into amounts in U.S. dollars. The amounts of our
assets and liabilities on our balance sheets are translated using the closing
exchange rate as of the date of the balance sheet. Revenues, expenses, gains and
losses are translated using the average exchange rate prevailing during the
period covered by such financial statements. Adjustments resulting from the
translation, if any, are included in our cumulative other comprehensive
income/(loss) in our stockholders’ equity section of our balance sheet. All
other amounts that were originally booked in RMB and translated into U.S.
dollars were translated using the closing exchange rate on the date of
recognition. Consequently, the exchange rates at which the amounts in those
comparisons were computed varied from year to year.





The
exchange rates used to translate amounts in RMB into U.S. dollars in connection
with the preparation of our financial statements were as follows:




RMB per U.S. Dollar2010
                
                
                2009Balance
      sheet items as of June 30
                
                
                6.7814
                
                
                
                6.8336Amounts
      included in the statement of operations and comprehensive income,
      statement of changes in stockholders’ equity and statement of cash flows
      for the nine months ended June 30
                
                
                6.8263
                
                
                
                6.8376Balance
      sheet items as of September 30
                
                
                -
                
                
                
                6.8263





ITEM
      3.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.





Interest
Rate Risk




We are
exposed to interest rate risk primarily with respect to our short-term bank
loans and long-term bank loans. Although the interest rates, which are based on
the banks’ prime rates with respect to our short-term loans are fixed for the
terms of the loans, the terms are typically three to twelve months for
short-term bank loans and interest rates are subject to change upon renewal.
There were no material changes in interest rates for short-term bank loans
renewed during the three months ended June 30, 2010.




20




Please
refer to Item 2, “Management’s Discussion and Analysis of Financial Condition
and Results of Operations — Liquidity and Capital Resources — Financing
Activities” for a discussion of our credit facilities and loan
agreements.




A
hypothetical 1.0% increase in the annual interest rates for all of our credit
facilities under which we had outstanding borrowings at June 30, 2010, would
increase net loss before provision for income taxes by approximately $1.8
million, or 6.9%, for the nine months ended June 30, 2010.Management monitors the
banks’ prime rates in conjunction with our cash requirements to determine the
appropriate level of debt balances relative to other sources of funds. We have
not entered into any hedging transactions in an effort to reduce our exposure to
interest rate risk.




Foreign
Exchange Risk




Although
our reporting currency is the U.S. dollar, the financial records of our
operating subsidiaries are maintained in their local currency, the RMB, which is
our functional currency. Approximately 98.9% of our revenues and 96.7% of our
costs and expenses for the three months ended June 30, 2010 are denominated in
RMB, with the balance denominated in U.S. dollars. Approximately 99.5% of our
assets except for cash were denominated in RMB as of June 30, 2010. As a result,
we are exposed to foreign exchange risk as our revenues and results of
operations may be affected by fluctuations in the exchange rate between U.S.
dollars and RMB. If the RMB depreciates against the U.S. dollar, the value of
our RMB revenues, earnings and assets as expressed in our U.S. dollar financial
statements will decline. Assets and liabilities of our operating subsidiaries
are translated into U.S. dollars at the exchange rate at the balance sheet date,
their equity accounts are translated at historical exchange rates, and their
income and expenses items are translated using the average rate for the period.
Any resulting exchange differences are recorded in accumulated other
comprehensive income or loss. An average appreciation (depreciation) of the RMB
against the U.S. dollar of 5% would increase (decrease) our comprehensive income
by $9.5 million based on our outstanding revenues, costs and expenses, assets,
and liabilities denominated in RMB as of June 30, 2010. As of June 30, 2010, our
accumulated other comprehensive income was $25.8 million. We have not entered
into any hedging transactions in an effort to reduce our exposure to foreign
exchange risk.





Inflation
Risk




Inflationary
factors such as increases in the cost of our products and overhead costs may
adversely affect our operating results. Although we do not believe that
inflation has had a material impact on our financial position or results of
operations to date, a high rate of inflation in the future may have an adverse
effect on our ability to maintain current levels of gross margin and selling and
general and administrative expenses as a percentage of net revenues if the
selling prices of our products do not increase with these increased
costs.




ITEM
4.      CONTROLS AND PROCEDURES.




Disclosure
Controls and Procedures




As
required by Rule 13a-15 under the Exchange Act, our management has carried out
an evaluation, with the participation and under the supervision of our chief
executive officer and chief financial officer, of the effectiveness of the
design and operation of our disclosure controls and procedures as of June 30,
2010. Disclosure controls and procedures refer to controls and other procedures
designed to ensure that information required to be disclosed in the reports we
file or submit under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the rules and forms of the SEC and
that such information is accumulated and communicated to our management,
including our chief executive officer and chief financial officer, as
appropriate, to allow timely decisions regarding required disclosure. In
designing and evaluating our disclosure controls and procedures, management
recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives, and management is required to apply its judgment in evaluating and
implementing possible controls and procedures.




Management
conducted its evaluation of disclosure controls and procedures under the
supervision of our chief executive officer and our chief financial officer.
Based upon, and as of the date of this evaluation, our chief executive officer
and chief financial officer concluded that our disclosure controls and
procedures were not effective, because of the material weaknesses described in
Item 9A, “Controls and Procedures” of the 2009 Form 10-K, which we are still in
the process of remediating. Investors are directed to Item 9A of the 2009 Form
10-K for the description of these weaknesses.




21




Remediation
Measures for Material Weaknesses




We are
continuing to remediate the material weaknesses described in our 2009 Form 10-K
and implemented the new measures described below in our ongoing efforts to
address these internal control deficiencies.




We
further developed policies and procedures governing the hiring and training of
personnel to better assure sufficient personnel with the requisite knowledge,
experience and training in the application of generally accepted accounting
principles commensurate with our financial reporting and U.S. GAAP requirements.
We utilized qualified accounting advisors and supervisors to ensure that our
staff has adequate professional knowledge and monitored the need for additional
or better-qualified staff. In addition, we utilized appropriate training
programs on accounting principles and procedures to better ensure the adequacy
of our accounting and finance personnel.




We
continued to develop our corporate culture toward emphasizing the importance of
internal controls and to ensure that all personnel involved in maintaining
proper internal controls recognize the importance of strictly adhering to
accounting principles generally accepted in the United States of
America.




We
continued to provide additional training to the Company’s internal auditor on
appropriate controls and procedures necessary to document and evaluate our
internal control procedures.




We
further enhanced the self-assessment of our internal control over financial
reporting by increasing our periodic independent testing, which would evaluate
the adequacy of the design and effectiveness of our internal control procedures.
The self-assessment procedures are conducted under the supervision of
our chief executive officer and our chief financial officer.




We also
implemented procedures to maintain effective control over the accounting for
construction in progress assets and the determination of depreciation expense
when the assets are ready for their intended use, including the
following:




·
            We
      provided additional training to finance managers to review any applicable
      accounting entry and time of
transfer;




·
            We
      further trained our finance department to transfer construction in
      progress to cost of property, plant and equipment when it is ready for its
      intended use, at which time depreciation charges shall commence thereon.
      The criteria used to determine when an asset is ready for intended use are
      based on policies that are consistent with U.S.
  GAAP.




In
addition, we have hired a new Chief Financial Officer, Mr. Jun Zou, who has more
than 16 years of international financial management and capital market
experience. We believe Mr. Jun Zou's leadership will strengthen our internal
control management practices.





We
believe that we are taking the steps necessary for remediation of the remaining
material weaknesses identified above, and we will continue to monitor the
effectiveness of these steps and to make any changes that our management deems
appropriate.




Changes
in Internal Control over Financial Reporting




Other
than the remediation measures described above, there were no changes in our
internal controls over financial reporting after June 30, 2010 that have
materially affected, or are reasonably likely to materially affect our internal
control over financial reporting.




PART
II


OTHER
INFORMATION





ITEM
1.      LEGAL PROCEEDINGS.




On May
14, 2010, the United States District Court for the Northern District of Texas
issued an order granting plaintiffs’ motion to dismiss without prejudice the
Company from a federal patent infringement suit. The plaintiffs are the Board of
Regents of the University of Texas System and Hydro-Québec, a Canadian
company.


22




As
previously disclosed, this suit was brought against the Company on September 12,
2006. The Company had an agreement with A123 Systems, Inc. (“A123Systems”),
which, as amended on August 18, 2005, terminated in accordance with its terms on
August 30, 2007, under which the Company had agreed to manufacture products for
A123Systems according to the specifications furnished by, and using the finished
electrodes and other materials consigned by, A123Systems to the Company. The
plaintiffs alleged that, by manufacturing rechargeable lithium cells for
A123Systems for use in DeWalt 36-volt cordless power tools manufactured by Black
& Decker Corporation, the Company had infringed two U.S. patents owned by
and exclusively licensed to the plaintiffs. The plaintiffs sought injunctive
relief and damages in an unspecified amount. A123Systems, Black & Decker
Corporation and Black & Decker (U.S.) Inc. were also named as co-defendants
in this lawsuit. The Company understands that this lawsuit was a countersuit
against A123Systems, which filed a claim against Hydro-Québec in the United
States District Court of Massachusetts in April 2006. In that suit, A123Systems
sought declaratory relief that the two said U.S. patents are invalid and that
A123Systems is not infringing either of these two patents.




Following
the filing of the lawsuit, the United States Patent and Trademark Office
reexamined the patents. The patents were re-issued with substantial modification
of the patent claims. The plaintiffs initially advised that, in their view, the
lawsuit continued to be viable against the defendants, including the
Company.




As a
result of the court’s May 14, 2010 decision, the Company will not be liable for
any monetary damages. The Company will also not be prohibited, subject to the
United States patent laws, from future production of rechargeable lithium cells
manufactured for A123Systems. The Company will not, again subject to the United
States patent laws, be required to pay royalties to engage in any such
production.




ITEM
      1A.
            RISK
      FACTORS.


There
have been no material changes to the risk factors disclosed in our 2009 Form
10-K. Investors are directed to Item 1, “Risk Factors” of the 2009 Form
10-K.


ITEM
      2.
            UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS.





None.




ITEM
      3.
              DEFAULTS
      UPON SENIOR SECURITIES.





None.





ITEM
      4.
            (REMOVED
      AND RESERVED).





ITEM
      5.
            OTHER
      INFORMATION.





We have
no information to disclose that was required to be in a report on Form 8-K
during the period covered by this Report, but was not reported. There have been
no material changes to the procedures by which security holders may recommend
nominees to our board of directors.





ITEM
      6.
            EXHIBITS.




The
following exhibits are filed as part of this report or incorporated by
reference:




Exhibit No.
                    
                    Description31.1
                    
                    Certifications
      of Principal Executive Officer filed pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
                    
                    Certifications
      of Principal Financial Officer filed pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
                    
                    Certifications
      of Principal Executive Officer furnished pursuant to 18 U.S.C. Section
      1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.32.2
                    
                    Certifications
      of Principal Financial Officer furnished pursuant to 18 U.S.C. Section
      1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.


23




Exhibit
      No.
                    
                    Description99.1
                    
                    Comprehensive
      Credit Facility Agreement of Maximum Amount (English summary), dated May
      14, 2010, between Shenzhen BAK Battery Co., Ltd. and Shenzhen Longgang
      Branch, Guangdong Development Bank.99.2
                    
                    Comprehensive
      Credit Facility Agreement of Maximum Amount (English summary), dated May
      12, 2010, between Shenzhen BAK Battery Co., Ltd. and Shenzhen Branch,
      China CITIC Bank.99.3
                    
                    Loan
      Agreement (English summary), dated June 11, 2010, between Shenzhen BAK
      Battery Co., Ltd. and Shenzhen Branch, China CITIC Bank Co.,
      Ltd.99.4
                    
                    Loan
      Agreement (English summary), dated June 11, 2010, between Shenzhen BAK
      Battery Co., Ltd. and Shenzhen Branch, China CITIC Bank Co.,
      Ltd.99.5
                    
                    Guaranty
      Contract of Maximum Amount (English summary), dated May 31, 2010, between
      Xiangqian Li and Shenzhen Branch, China CITIC Bank.99.6
                    
                    Guaranty
      Contract of Maximum Amount (English summary), dated May 12, 2010, between
      BAK International Limited and Shenzhen Branch, China CITIC
      Bank.99.7
                    
                    Loan
      Agreement (English summary), dated May 21, 2010, between Shenzhen BAK
      Battery Co., Ltd. and Shenzhen Eastern Branch, Agricultural Bank of
      China.99.8
                    
                    Loan
      Agreement (English summary), dated May 19, 2010, between Shenzhen BAK
      Battery Co., Ltd. and Shenzhen Eastern Branch, Agricultural Bank of
      China.99.9
                    
                    Loan
      Agreement (English summary), dated May 17, 2010, between Shenzhen BAK
      Battery Co., Ltd. and Shenzhen Eastern Branch, Agricultural Bank of
      China.99.10
                    
                    Loan
      Agreement (English summary), dated April 27, 2010, between BAK
      International (Tianjin) Ltd. and Tianjin Branch, Bank of
      Dalian.




24




SIGNATURES





In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.





Date:
      August 9, 2010
                CHINA
      BAK BATTERY, INC.By:
                /s/
      Xiangqian LiXiangqian
      Li, Chief Executive Officer(Principal
      Executive Officer)




By:
                  /s/ Jun
      ZouJun
      Zou, Chief Financial Officer(Principal
      Financial Officer and Principal
                    Accounting
      Officer)