**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 December 31, 2007****OR****o**
            **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,
                People’s Republic of China**
            
            **518119***(Address
                of principal executive offices)*
            
            *(Zip
                Code)*





**(86
      755) 897-70093**


*(Registrant’s
      telephone number, including area code)*







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 o





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):





Large
      Accelerated Filer o Accelerated
      Filer x Non-Accelerated
      Filer o





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





Indicate
      the number of shares outstanding of each of the issuer’s classes of common
      stock, as of the latest practicable date:  53,223,637 shares
      of
      common stock, par value $0.001 per share, outstanding on February 5 ,
      2008.












**TABLE
      OF CONTENTS**





Introductory
                CommentsPART I —
            
            FINANCIAL
                INFORMATION
            F-1Item 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
            14Item 4.
                Controls and Procedures
            14PART II —
            
            OTHER
                INFORMATION
            15Item 1. 
                Legal Proceedings
            15Item 1A. 
                Risk Factors
            16Item 2. 
                Unregistered Sales of Equity Securities and Use of
                Proceeds
            16Item 3. 
                Defaults Upon Senior Securities
            16Item 4. 
                Submission of Matters to a Vote of Security Holders
            17Item 5. 
                Other Information
            17Item 6. 
                Exhibits
            17




i


**Introductory
      Comments**





***Terminology***





Throughout
      this Report, the terms “we,” “us” and “our” refer to China BAK Battery, Inc. and
      its subsidiaries on a consolidated basis; “BAK International” refers to our Hong
      Kong subsidiary, BAK International, Ltd.; “BAK Tianjin” refers to our PRC
      subsidiary, BAK International (Tianjin) Limited; “Shenzhen BAK” refers to our
      PRC subsidiary, Shenzhen BAK Battery Co., Ltd.; “BAK Electronics” refers to our
      PRC subsidiary, BAK Electronics (Shenzhen) Co., Ltd.; “BAK Canada” refers to our
      Canadian subsidiary, BAK Battery Canada Ltd.; “BAK Europe” refers to our German
      subsidiary, BAK Europe GmbH; “China” or “PRC” refers to the People’s Republic of
      China, excluding for the purposes of this Report only, Taiwan, Hong Kong and
      Macau; “RMB” or “Renminbi” refers to the legal currency of China; and “$” or
“U.S. dollars” refers to the legal currency of the United States of
      America.





***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 (the
      “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as
      amended (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;—
            our
                future business development, results of operations and financial
                condition;—
            our
                ability to fund our operations and manage our substantial short-term
                indebtedness;—
            our
                ability to maintain or increase our market share in the competitive
                markets in which we do business;—
            our
                limited operating history in developing, manufacturing and selling
                of
                lithium-based rechargeable battery cells;—
            our
                ability to keep up with rapidly changing technologies and evolving
                industry standards, including our ability to achieve technological
                advances;—
            our
                dependence on the growth in demand for the portable electronic devices
                that are powered by our products;—
            our
                ability to diversify our product offering and capture new market
                opportunities;—
            our
                ability to obtain original equipment manufacturer (“OEM”) qualifications
                from brand names;—
            our
                ability to source our needs for skilled labor, machinery and raw
                materials
                economically;—
            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;—
            uncertainties
                with respect to the PRC legal and regulatory
                environment;—
            our
                ability to remediate any material weaknesses in our internal control
                over
                financial reporting;—
            our
                ability to maintain cost
                leadership;




ii




—
            our
                ability to acquire land use rights to our facilities;
                and—
            other
                risks identified in this Report and in our other reports filed with
                the
                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 filed with the SEC, including without limitation our
      Annual Report on Form 10-K for the fiscal year ended September 30, 2007. 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.





***Where
      You Can Find Additional Information***





We
      file
      annual, quarterly and other reports, proxy statements and other information
      with
      the SEC. You may obtain and copy any document we file with the SEC at the SEC’s
      public reference room at 100 F Street, NE, Room 1580, Washington, D.C. 20549.
      You may obtain information on the operation of the SEC’s public reference
      facilities by calling the SEC at 1-800-SEC-0330. You can request copies of
      these
      documents, upon payment of a duplicating fee, by writing to the SEC at its
      principal office at 100 F Street, NE, Room 1580, Washington, D.C. 20549-1004.
      The SEC maintains an Internet website at http://www.sec.gov that contains
      reports, proxy and information statements, and other information regarding
      issuers that file electronically with the SEC. Our SEC filings, including
      exhibits filed therewith, are accessible through the Internet at that
      website.





You
      may
      also request a copy of our SEC filings, at no cost to you, by writing or
      telephoning us at: BAK Industrial Park, No. 1 BAK Street, Kuichong Town,
      Longgang District, Shenzhen, People’s Republic of China, attention Corporate
      Secretary, telephone 011 (86-755) 8977-0093. We will not send exhibits to the
      documents, unless the exhibits are specifically requested and you pay our fee
      for duplication and delivery.





iii





**PART
      I — FINANCIAL INFORMATION**





**Item 1. 
      Financial Statements**





**China
      BAK Battery, Inc. and subsidiaries**


**Condensed
      interim consolidated balance sheets**


**As
      of September 30, 2007 and December 31, 2007**


(In
      U.S.
      dollars)





*September
                30,*
            
            *December
                31,**Note*
            
            *2007*
            
            *2007*(Audited)
            
            (Unaudited)**Assets***Current
                assets*Cash
                and cash equivalents
            
            
            
            
            $
            14,196,513
            
            $
            33,524,459Pledged
                deposits
            
            
            2
            
            
            4,594,727
            
            
            4,356,150Trade
                accounts receivable, net
            
            
            3
            
            
            63,150,872
            
            
            71,110,722Inventories
            
            
            4
            
            
            59,827,232
            
            
            62,574,853Prepayments
                and other receivables
            
            
            5
            
            
            1,656,494
            
            
            13,970,608Deferred
                tax assets
            
            
            
            
            
            502,916
            
            
            746,457Total
                current assets
            
            
            
            
            
            143,928,754
            
            
            186,283,249Property,
                plant and equipment, net
            
            
            6
            
            
            145,123,022
            
            
            154,110,778Lease
                prepayments, net
            
            
            
            
            
            17,884,436
            
            
            18,311,762Intangible
                assets, net
            
            
            
            
            
            121,038
            
            
            138,295Deferred
                tax assets
            
            
            
            
            
            171,774
            
            
            153,081Total
                assets
            
            
            
            
            $
            307,229,024
            
            $
            358,997,165




See
      accompanying notes to the condensed interim consolidated financial
      statements.




F-1




**China
      BAK Battery, Inc. and subsidiaries**


**Condensed
      interim consolidated balance sheets**


**As
      of September 30, 2007 and December 31, 2007 (continued)**


(In
      U.S.
      dollars)


**


*September
                30,*
            
            *December
                31,**Note*
            
            *2007*
            
            *2007*(Audited)
            
            (Unaudited)**Liabilities***Current
                liabilities*Short-term
                bank loans
            
            
            7
            
            $
            89,870,586
            
            $
            99,937,026Current
                maturities of long-term bank loans
            
            
            8
            
            
            —
            
            
            6,845,002Accounts
                and bills payable
            
            
            
            
            
            45,588,583
            
            
            55,766,208Accrued
                expenses and other payables
            
            
            
            
            
            15,467,192
            
            
            17,520,421Total
                current liabilities
            
            
            
            
            
            150,926,361
            
            
            180,068,657Long-term
                bank loans, less current maturities
            
            
            8
            
            
            29,291,154
            
            
            34,225,009Deferred
                tax liabilities
            
            
            
            
            
            279,597
            
            
            294,248Total
                liabilities
            
            
            
            
            
            180,497,112
            
            
            214,587,914Commitments
                and contingencies
            
            
            11**Shareholders’
                equity**Ordinary
                shares US$ 0.001 par value;100,000,000
                authorized;49,250,853
                and 52,954,603 issuedand
                outstanding as ofSeptember
                30, 2007 and December 31, 2007respectively
            
            
            
            
            
            49,251
            
            
            52,954Additional
                paid-in-capital
            
            
            
            
            
            74,310,509
            
            
            89,155,087Statutory
                reserves
            
            
            
            
            
            6,426,977
            
            
            6,516,559Retained
                earnings
            
            
            
            
            
            36,060,426
            
            
            35,030,309Accumulated
                  other comprehensiveincome
            
            
            
            
            
            9,884,749
            
            
            13,654,342Total
                shareholders’ equity
            
            
            
            
            
            126,731,912
            
            
            144,409,251Total
                liabilities and shareholders’ equity
            
            
            
            
            $
            307,229,024
            
            $
            358,997,165




See
      accompanying notes to the condensed interim consolidated financial
      statements.




F-2




**China
      BAK Battery, Inc. and subsidiaries**


**Condensed
      interim consolidated statements of operations**


**and
      comprehensive income**


**For
      the three months ended December 31, 2006 and 2007**


(Unaudited)


(In
      U.S.
      dollars)




*Three
                months ended*
              *December
                31,**Note*
            
            *2006*
            
            *2007*Net
                revenues
            
            
            13
            
            $
            43,082,153
            
            $
            52,787,475Cost
                of revenues
            
            
            
            
            
            (34,885,599
            )
            
            (45,681,745
            )Gross
                profit
            
            
            
            
            
            8,196,554
            
            
            7,105,730Operating
                expenses:Research
                and development costs
            
            
            
            
            
            (636,914
            )
            
            (1,319,163
            )Sales
                and marketing expenses
            
            
            
            
            
            (1,042,417
            )
            
            (1,347,877
            )General
                and administrative expenses
            
            
            
            
            
            (2,960,973
            )
            
            (4,238,035
            )Total
                operating expenses
            
            
            
            
            
            (4,640,304
            )
            
            (6,905,075
            )Operating
                income
            
            
            
            
            
            3,556,250
            
            
            200,655Finance
                costs, net
            
            
            
            
            
            (900,832
            )
            
            (2,223,477
            )Government
                grant income
            
            
            
            
            
            762,267
            
            
            901,344Other
                income
            
            
            
            
            
            169,807
            
            
            41,884Income
                / (loss) before income taxes
            
            
            
            
            
            3,587,492
            
            
            (1,079,594
            )Income
                taxes
            
            
            
            
            
            (4,740
            )
            
            139,059Net
                income / (loss)
            
            
            
            
            $
            3,582,752
            
            $
            (940,535
            )Other
                comprehensive income-
                Foreign currency translation adjustment
            
            
            
            
            
            1,544,784
            
            
            3,769,593Comprehensive
                income
            
            
            
            
            $
            5,127,536
            
            $
            2,829,058Net
                income/(loss) per share:
            
            
            10-Basic
            
            
            
            
            $
            0.07
            
            $
            (0.02
            )-Diluted
            
            
            
            
            $
            0.07
            
            $
            (0.02
            )Weighted
                  average number ofordinary shares:-Basic
            
            
            
            
            
            48,885,896
            
            
            51,425,323-Diluted
            
            
            
            
            
            48,911,340
            
            
            52,378,164




See
      accompanying notes to the condensed interim consolidated financial
      statements.





F-3




**China
      BAK Battery, Inc. and subsidiaries**


**Condensed
      interim consolidated statements of shareholders’ equity**


**For
      the three months ended December 31, 2006 and 2007**


(Unaudited)


(In
      U.S.
      dollars)





Accumulated
            
            TotalOrdinary
                shares
            
            Additional
            
            
            
            
            
            other
            
            share-Number
            
            
            
            paid
            
            Statutory
            
            Retained
            
            comprehensive
            
            holders’of
                shares
            
            amount
            
            -in-capital
            
            reserves
            
            earnings
            
            income
            
            equityBalance
                as of October 1, 2006
            
            
            48,885,896
            
            $
            48,886
            
            $
            68,126,689
            
            $
            5,791,718
            
            $
            36,212,357
            
            $
            3,448,379
            
            $
            113,628,029Net
                income
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            3,582,752
            
            
            —
            
            
            3,582,752Share-based
                compensation for employee stock option awards
            
            
            —
            
            
            —
            
            
            147,300
            
            
            —
            
            
            —
            
            
            —
            
            
            147,300Issuance
                of 914,994 shares of restricted stocks and reclassification of
                liability-classified awards
            
            
            —
            
            
            —
            
            
            3,679,934
            
            
            —
            
            
            —
            
            
            —
            
            
            3,679,934Share-based
                compensation for common stock granted to employees and non-employee
                directors
            
            
            —
            
            
            —
            
            
            60,386
            
            
            —
            
            
            —
            
            
            —
            
            
            60,386Appropriation
                to statutory reserves
            
            
            —
            
            
            —
            
            
            —
            
            
            453,179
            
            
            (453,179
            )
            
            —
            
            
            —Foreign
                currency translation adjustment
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            1,544,784
            
            
            1,544,784Balance
                as of December 31, 2006
            
            
            48,885,896
            
            $
            48,886
            
            $
            72,014,309
            
            $
            6,244,897
            
            $
            39,341,930
            
            $
            4,993,163
            
            $
            122,643,185Balance
                as of October 1, 2007
            
            
            49,250,853
            
            $
            49,251
            
            $
            74,310,509
            
            $
            6,426,977
            
            $
            36,060,426
            
            $
            9,884,749
            
            $
            126,731,912Net
                loss
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (940,535
            )
            
            —
            
            
            (940,535
            )Share-based
                compensation for employee stock awards
            
            
            —
            
            
            —
            
            
            842,334
            
            
            —
            
            
            —
            
            
            —
            
            
            842,334Exercise
                of stock options awards
            
            
            200,000
            
            
            200
            
            
            1,249,800
            
            
            —
            
            
            —
            
            
            —
            
            
            1,250,000Issuance
                of common stock to non-employee directors
            
            
            3,750
            
            
            3
            
            
            (3
            )
            
            —
            
            
            —
            
            
            —
            
            
            —Issuance
                of new common stock
            
            
            3,500,000
            
            
            3,500
            
            
            12,752,447
            
            
            —
            
            
            —
            
            
            —
            
            
            12,755,947Appropriation
                to statutory reserves
            
            
            —
            
            
            —
            
            
            —
            
            
            89,582
            
            
            (89,582
            )
            
            —
            
            
            —Foreign
                currency translation adjustment
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            3,769,593
            
            
            3,769,593Balance
                as of December 31, 2007
            
            
            52,954,603
            
            $
            52,954
            
            $
            89,155,087
            
            $
            6,516,559
            
            $
            35,030,309
            
            $
            13,654,342
            
            $
            144,409,251





See
      accompanying notes to the condensed interim consolidated financial
      statements.





F-4




**China
      BAK Battery, Inc. and subsidiaries**


**Condensed
      interim consolidated statements of cash flows**


**For
      the three months ended December 31, 2006 and 2007**


(Unaudited)


(In
      U.S.
      dollars)




*Three
                months ended*
              *December
                31,**2006*
            
            *2007***Cash
                flow from operating activities**Net
                income / (loss)
            
            $
            3,582,752
            
            $
            (940,535
            )Adjustments
                to reconcile net income/(loss) to netcash
                used in operating activities:Depreciation
                and amortization
            
            
            2,045,817
            
            
            2,782,297Bad
                debt expense
            
            
            485,407
            
            
            1,202,276Provision
                for obsolete inventories
            
            
            —
            
            
            79,217Share-based
                compensation
            
            
            262,455
            
            
            842,334Deferred
                income taxes
            
            
            (70,403
            )
            
            (195,637
            )Changes
                in operating assets and liabilities:Trade
                accounts receivable
            
            
            (3,197,709
            )
            
            (7,159,248
            )Inventories
            
            
            3,754,099
            
            
            (1,119,804
            )Prepayments
                and other receivables
            
            
            252,772
            
            
            (11,613,774
            )Accounts
                and bills payable
            
            
            (11,762,195
            )
            
            10,423,149Accrued
                expenses and other payables
            
            
            2,491,604
            
            
            1,011,959Net
                cash used in operating activities
            
            
            (2,155,401
            )
            
            (4,687,766
            )**Cash
                flow from investing activities**Purchases
                of property, plant and equipment
            
            
            (13,192,785
            )
            
            (9,158,722
            )Payment
                of lease prepayment
            
            
            —
            
            
            (20,983
            )Purchases
                of intangible assets
            
            
            (4,759
            )
            
            (31,402
            )Net
                cash used in investing activities
            
            $
            (13,197,544
            )
            $
            (9,211,107
            )




See
      accompanying notes to the condensed interim consolidated financial
      statements.




F-5




**China
      BAK Battery, Inc. and subsidiaries**


**Condensed
      interim consolidated statements of cash flows**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)


(In
      U.S.
      dollars)





*Three
                months ended*
              *December
                31,**2006*
            
            *2007***Cash
                flow from financing activities**Proceeds
                from borrowings
            
            $
            28,402,934
            
            $
            45,076,563Repayment
                of borrowings
            
            
            (12,422,042
            )
            
            (26,911,381
            )Decrease
                in pledged deposits
            
            
            3,578,657
            
            
            361,977Proceeds
                from issuance of capital stock
            
            
            —
            
            
            14,005,947Net
                cash provided by financing activities
            
            
            19,559,549
            
            
            32,533,106**Effect
                of exchange rate changes on cash and cash
                equivalents**
            
            
            **57,421**
            
            
            **693,713****Net
                increase in cash and****cash
                equivalents**
            
            
            **4,264,025**
            
            
            **19,327,946****Cash
                and cash equivalents at the beginning of period**
            
            
            **21,099,555**
            
            
            **14,196,513****Cash
                and cash equivalents at the end of period**
            
            **$**
            **25,363,580**
            
            **$**
            **33,524,459****Supplemental
                disclosure of cash flow information:**Cash
                received during the period for:Bills
                receivable discounted to bank
            
            $
            —
            
            $
            1,883,727Cash
                paid during the period for:Income
                taxes
            
            $
            —
            
            $
            45,376Interest,
                net of amounts capitalized
            
            $
            879,918
            
            $
            2,487,376




See
      accompanying notes to the condensed interim consolidated financial
      statements.




F-6




**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007**


(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
      (collectively, 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, electric bicycles,
      hybrid/electric motors and general industrial applications.





The
      shares of the Company were traded in the over-the-counter market through the
      Over-the-Counter Bulletin Board beginning in 2005. On May 31, 2006, the Company
      obtained approval to list its common stock on the National Association of
      Securities Dealers Automated Quotations (“NASDAQ”) stock market, and trading
      commenced that same date under the symbol "CBAK".





*Basis
      of Presentation and Organization*





As
      of
      December 31, 2007, the Company’s subsidiaries consist 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; and vi) BAK
      Europe GmbH (“BAK Europe”), a wholly owned limited liability company established
      in Germany on November 28, 2007.





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. Subsequently, the Company obtained
      an
      extension from the Business Administration Bureau of Beichen District, Tianjin,
      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 is required to be fully contributed no
      later than December 11, 2008. BAK Tianjin will be principally engaged in the
      manufacture of advanced lithium ion batteries for use in light electric vehicles
      and uninterruptible power supply.




F-7




**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)





*Basis
      of Presentation and Organization (continued)*





On
      November 6, 2004, BAK International, then 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.





F-8




**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)





*Basis
      of Presentation and Organization (continued)*





Also
      on
      January 20, 2005, immediately prior to and in connection with consummating
      the
      reverse acquisition of the Company, BAK International completed 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
      same
      manner: 50% upon reaching the 2005 target and the remaining 50% upon reaching
      the 2006 target.





Under
      generally accepted accounting principles in the United States of America (“US
      GAAP”), the contribution
      of Mr. Li’s shares into the escrow account was viewed as a recapitalization by
      Mr. Li similar to a reverse stock split of the Company’s common stock. However,
      as the escrowed shares remained legally outstanding, there was no accounting
      journal required to effect said reverse split on common stock and additional
      paid-in capital. In addition, under US GAAP the escrow arrangement
      constitutes a compensatory plan to Mr. Li such that a compensation
      charge is required to be recorded in the financial statements of the Company
      should shares be released from escrow to Mr. Li. However
      the escrow arrangement is not presumed to be compensatory if the escrowed shares
      are released to a person who has no relationship to the Company other than
      as a
      shareholder, and that person is not expected to have any other relationship
      to
      the Company in the future.




The
      Company determined that, without consideration of the compensation charge should
      the shares be released to Mr. Li, the performance thresholds for the year ended
      September 30, 2005 would be achieved. However, under
      US
      GAAP, such charge is required to be recognized in the calculation of net income
      and was not permitted to be disregarded under the terms of the Escrow Agreement.
      Accordingly,after consideration of the related compensation charge, the
      Company determined that such thresholds would not be achieved. The Company
      also determined that, even without consideration of the compensation charge,
      the
      performance thresholds for the year ended September 30, 2006 were not
      achieved.





While
      the
      1,089,775 escrow shares relating to the 2005 performance threshold were
      previously released to Mr. Li, Mr. 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 the Settlement Agreement described below, are being held by
      the
      Company. 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.





On
      October 22, 2007, the Company entered into a Delivery of Make Good Shares,
      Settlement and Release Agreement (the “Settlement Agreement”) with Mr. Xiangqian
      Li and BAK International. Pursuant to the Settlement Agreement, in November
      2007, Mr. Xiangqian Li delivered the 1,089,775 shares related to the 2005
      performance threshold to BAK International; BAK International in turn delivered
      the shares to the Company. Such shares are now held by the Company as treasury
      shares. 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
      Settlement Agreement, the Company is obligated to commence 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.





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





F-9




**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)





*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, 2008. The Company’s
      consolidated balance sheet as of September 30, 2007 has been taken from the
      Company’s audited 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
      period 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, 2007.
      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 period. 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, Canada or Germany, the accounting standards
      used in the places of their respective 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.




***Recently
      Issued Accounting Standards***





*FASB
      Interpretation No. 48 “Accounting for Uncertainty in Income Taxes-an
      Interpretation of FASB Statement No. 109”*





In
      July
      2006, the FASB issued FIN 48 “Accounting for Uncertainty in Income Taxes-an
      Interpretation of FASB Statement No. 109” ** which
      clarifies the accounting for uncertainty in tax positions. This Interpretation
      requires that the Company recognizes in its consolidated financial statements
      the impact of a tax position if that position is more likely than not of being
      sustained on audit, based on the technical merits of the position. The
      provisions of FIN 48 became effective for the Company on October 1, 2007. The
      adoption of FIN 48 has no material impact on the Company’s financial
      statements.





*SFAS
      157 “Fair Value Measurements”*





In
      September 2006, the FASB issued SFAS 157 “Fair Value Measurements” which defines
      fair value *,* establishes a framework for measuring fair value in generally accepted
      accounting principles, and expands disclosures about fair value measurements.
      SFAS 157 applies under other accounting pronouncements that require or permit
      fair value measurements, where fair value is the relevant measurement attribute.
      The standard does not require any new fair value measurements. SFAS 157 is
      effective for financial statements issued for fiscal years beginning after
      November 15, 2007, and interim periods within those fiscal years. The management
      is in the process of evaluating the impact SFAS 157 will have on the Company’s
      financial statements upon adoption.





F-10




**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)





*SFAS
      159 “The Fair Value Option for Financial Assets and Financial
      Liabilities-Including an Amendment of FASB Statement No. 115”*





In
      February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial
      Assets and Financial Liabilities - Including an Amendment of FASB Statement
      No.
      115”. SFAS 159 permits entities to choose to measure many financial instruments
      and certain other items at fair value. Entities that elect the fair value option
      will report unrealized gains and losses in earnings at each subsequent reporting
      date. The fair value option may be elected on an instrument-by-instrument basis,
      with a few exceptions. SFAS 159 also establishes presentation and disclosure
      requirements to facilitate comparisons between entities that choose different
      measurement attributes for similar assets and liabilities. The requirements
      of
      SFAS 159 are effective for the Company’s fiscal year beginning on October 1,
      2008. The management is in the process of evaluating the impact SFAS 159 will
      have on the Company’s financial statements upon adoption.





*SFAS
      160 “Noncontrolling Interests in Consolidated Financial Statements-an amendment
      of ARB No. 51”*





In
      December 2007, the FASB issued SFAS No. 160 “Noncontrolling Interests in
      Consolidated Financial Statements - an amendment of ARB No. 51.” SFAS 160
      establishes accounting and reporting standards for the noncontrolling interest
      in a subsidiary and for the deconsolidation of a subsidiary. The guidance will
      become effective for the fiscal year beginning after December 15, 2008. The
      management is in the process of evaluating the impact SFAS 160 will have on
      the
      Company’s financial statements upon adoption.





*SFAS
      141(Revised) “Business Combinations”*





In
      December 2007, the FASB issued SFAS No. 141 (Revised) “Business Combinations”.
      SFAS 141 (Revised) establishes principles and requirements for how the acquirer
      of a business recognizes and measures in its financial statements the
      identifiable assets acquired, the liabilities assumed, and any noncontrolling
      interest in the acquiree. The statement also provides guidance for recognizing
      and measuring the goodwill acquired in the business combination and determines
      what information to disclose to enable users of the financial statements to
      evaluate the nature and financial effects of the business combination. The
      guidance will become effective for the fiscal year beginning after December
      15,
      2008. The management is in the process of evaluating the impact SFAS 141
      (Revised) will have on the Company’s financial statements upon
      adoption.





**2**
            **Pledged
                Deposits**





Pledged
      deposits as of September 30, 2007 and December 31, 2007 consist of the
      following:





*September
                30,*
            
            *December
                31,**2007*
            
            *2007*Pledged
                deposits with banks for bills payable
            
            $
            4,594,727
            
            $
            4,356,150





F-11




**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)





**3**
            **Trade
                Accounts Receivable, net**




Trade
      accounts receivable as of September 30, 2007 and December 31, 2007 consist
      of
      the following:





*September
                30,*
            
            *December31,**2007*
            
            *2007*Trade
                accounts receivable
            
            $
            57,928,281
            
            $
            66,959,331Less:
                Allowance for doubtful accounts
            
            
            (3,021,617
            )
            
            (4,332,263
            )54,906,664
            
            
            62,627,068Bills
                receivable
            
            
            8,244,208
            
            
            8,483,654$
            63,150,872
            
            $
            71,110,722




An
      analysis of the allowance for doubtful accounts for the three months ended
      December 31, 2006 and 2007 is as follows:





*Three
                months ended*
              *December
                31,**2006*
            
            *2007*Balance
                at beginning of period
            
            $
            1,063,285
            
            $
            3,021,617Addition
                of bad debt expense, net
            
            
            494,238
            
            
            1,204,376Foreign
                exchange adjustment
            
            
            17,161
            
            
            106,270Balance
                at end of period
            
            $
            1,574,684
            
            $
            4,332,263




**4**
            **Inventories**





Inventories
      as of September 30, 2007 and December 31, 2007 consist of the
      following:





*September
                30,*
            
            *December
                31,**2007*
            
            *2007*Raw
                materials
            
            $
            15,245,732
            
            $
            18,221,819Work-in-progress
            
            
            5,698,017
            
            
            10,104,405Finished
                goods
            
            
            40,776,958
            
            
            36,276,15261,720,707
            
            
            64,602,376Provision
                for obsolete inventories
            
            
            (1,893,745
            )
            
            (2,027,523
            )$
            59,827,232
            
            $
            62,574,853




Part
      of
      the Company’s inventories with carrying value of US$19,971,241 and US$20,535,005
      as of September 30, 2007 and December 31, 2007, respectively, was pledged as
      collateral under certain loan agreements (see Note 7).





F-12


**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)





**5**
            **Prepayments
                and Other Receivables**





Prepayments
      and other receivables as of September 30, 2007 and December 31, 2007 consist
      of
      the following:





*September
                30,*
            
            *December
                31,**2007*
            
            *2007*Prepayments
                for raw materials and others
            
            $
            925,187
            
            $
            13,028,756Other
                receivables
            
            
            740,088
            
            
            948,744Less:
                Allowance for doubtful accounts
            
            
            (8,781
            )
            
            (6,892
            )$
            1,656,494
            
            $
            13,970,608




**6**
            **Property,
                Plant and Equipment, net**





Property,
      plant and equipment as of September 30, 2007 and December 31, 2007 consist
      of
      the following:





*September
                30,*
            
            *December
                31,**2007*
            
            *2007*Buildings
            
            $
            70,380,985
            
            $
            87,636,322Machinery
                and equipment
            
            
            59,405,092
            
            
            68,888,399Office
                equipment
            
            
            1,088,032
            
            
            2,173,670Motor
                vehicles
            
            
            1,135,616
            
            
            1,215,423132,009,725
            
            
            159,913,814Accumulated
                depreciation
            
            
            (19,301,165
            )
            
            (22,560,324
            )Construction
                in progress
            
            
            12,578,715
            
            
            1,750,005Prepayment
                for acquisition of property, plant and equipment
            
            
            19,835,747
            
            
            15,007,283$
            145,123,022
            
            $
            154,110,778




*(i)*
            Depreciation
                expense for the three months ended December 31, 2006 and 2007 is
                included
                in the consolidated statements of operations and comprehensive income
                as follows:




*Three
                months ended*
              *December
                31,**2006*
            
            *2007*Cost
                of revenues
            
            $
            1,435,902
            
            $
            2,034,088Research
                and development costs
            
            
            72,308
            
            
            92,026Sales
                and marketing expenses
            
            
            154,765
            
            
            156,800General
                and administrative expenses
            
            
            360,692
            
            
            384,940$
            2,023,667
            
            $
            2,667,854




F-13




**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)




*(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
      three months ended December 31, 2006 and 2007, the Company capitalized interest
      of approximately US$48,854 and US$275,735, respectively, to the cost of
      construction in progress.




*(iii)*
            *Pledged
                Property, Plant and Equipment*





As
      of
      September 30, 2007 and December 31, 2007, machinery and equipment with net
      book
      value of US$34,090,267 and US$34,827,023 of the Company were pledged as
      collateral under certain loan arrangements (see Notes 7 and 8).





**7**
            **Short-term
                Bank Loans**





The
      Company obtained several short-term loan facilities from financial institutions
      in the PRC. These facilities were secured by the Company’s assets with the
      following carrying values:





*September
                30,*
            
            *December
                31,**2007*
            
            *2007*Inventories
                (Note 4)
            
            $
            19,971,241
            
            $
            20,535,005Machinery
                and equipment, net (Note 6)
            
            
            18,299,368
            
            
            18,815,937$
            38,270,609
            
            $
            39,350,942





As
      of
      September 30, 2007 and December 31, 2007, the Company had several short-term
      bank loans with aggregate outstanding balances of US$89,870,586 and
      US$99,937,026 respectively. The loans were primarily obtained for general
      working capital, carried interest rates ranging from 5.751% to 7.722% 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.





The
      Company also committed to pledge the property ownership and land use rights
      certificate to be obtained in relation to the land on which the Company’s
      corporate campus had been constructed for short-term bank loans amounting to
      approximately US$24,642,000 borrowed from Shenzhen Eastern Branch, Agricultural
      Bank of China. The aggregate net book value of the buildings and land use right
      in relation to the property ownership and land use rights certificate as of
      December 31, 2007 was approximately US$83,492,000.





The
      Company is subject to certain covenants, which require the Company to comply
      with certain financial ratio, for its loan facilities which are tested on a
      monthly basis. If the Company fails to meet the requirements, the outstanding
      bank loans, including interest and penalties due thereunder, will accelerate
      and
      become immediately due and payable.





F-14


**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)





**8**
            **Long-term
                Bank Loans**





As
      of
      September 30, 2007 and December 31, 2007, the Company had long-term bank loans
      of US$29,291,154 and US$41,070,011, respectively. As of each date, the amount
      of
      US$13,690,004 was outstanding under a four-year long-term loan credit facility
      from China Development Bank, bearing interest at the benchmark rate of the
      PBOC
      for three-year to five-year long-term loans which is currently 6.48% per annum.
      The long-term bank loan is repayable in three instalments of US$4,107,001 on
      November 20, 2008, US$4,107,001 on November 20, 2009 and US$5,476,002 on
      December 26, 2010.





The
      other
      three loans with aggregate amount of US$27,380,007 as of December 31, 2007,
      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 loan of
      US$5,476,001 currently carries interest at 5.832% per annum is repayable on
      January 25, 2012. The second loan of US$10,952,003 with current annual interest
      rate of 6.237% is repayable in three instalments of US$2,738,001 on January
      25,
      2010, US$6,845,002 on January 25, 2011 and US$1,369,000 on January 25, 2012
      respectively. The third loan of US$10,952,003 with current annual interest
      rate
      of 7.65% is repayable in three instalments of US$2,738,001 on January 25, 2008,
      US$4,107,001 on January 25, 2009 and US$4,107,001 on January 25,
      2010.





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) secured by the property ownership and land use rights
      certificate of the Company’s Research and Development Test Centre and the future
      facilities to be constructed thereon.





The
      long-term bank loan with 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$16,011,086 as of December 31, 2007 (Note 6); and (iii)
      secured by the property ownership and land use rights certificate to be obtained
      in relation to the land on which the Company’s corporate campus had been
      constructed and the future machinery and equipment to be purchased and used
      in
      the campus.





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





**9**
            **Share-based
                Compensation**





The
      Company grants share options to officers and employees and restricted ordinary
      shares to its non-employee directors to reward for 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 authorizes the issuance of up to 4,000,000
      shares of the Company’s common stock. The exercise price of the 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. The Plan will terminate on May
      16, 2055.




F-15




**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)





Pursuant
      to the Plan, the Company issued 2,000,000 options 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 will become vested and exercisable under the following
      schedule:





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




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. Details of the cancellation of stock options
      and
      the relevant replacement awards are set out below under “Employee Restricted
      Stock Awards.”





A
      summary
      of share option plan activity for the three months ended December 31, 2007
      is
      presented below:





Number
                of shares
            
            Weighted
                average exercise price per share
            
            Weighted
                average remaining contractual term
            
            Aggregate
                Intrinsic Value (1)Outstanding
                as of October 1, 2007
            
            
            400,000
            
            $
            6.25Granted
            
            
            —
            
            
            —Exercised
            
            
            200,000
            
            
            6.25Forfeited
            
            
            —
            
            
            —Cancelled
            
            
            —
            
            
            —Outstanding
                as of December 31, 2007
            
            
            200,000
            
            $
            6.25
            
            
            4
                years
            
            $
            —Exercisable
                as of December 31, 2007
            
            
            80,000
            
            $
            6.25
            
            
            4
                years
            
            $
            —





(1)
            Aggregate
                intrinsic value represents the value of the Company’s closing stock price
                on December 31, 2007 (US$6.25) 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. The Company recorded non-cash share-based compensation
      expense of US$147,300 and US$38,842 for the three months ended December 31,
      2006
      and 2007 respectively in respect of share options granted in 2005. The expense
      of the three months ended December 31, 2007 was allocated to research and
      development costs, and that of the three months ended December 31, 2006 was
      allocated to general and administrative expenses and research and development
      costs respectively.




F-16




**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)





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
      December 31, 2007, there were unrecognized compensation costs of approximately
      US$35,000 related to non-vested share options. These costs are expected to
      be
      recognized over a weighted average period of 0.5 year.





Pursuant
      to the Plan, the Company also issued 1,501,500 options 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
      of
      the employee’s respective grant agreement.





A
      summary
      of share option plan activity for the quarter ended December 31, 2007 is
      presented below:





*Number
                of Shares*
            
            *Weighted
                average exercise price per share*
            
            *Weighted
                average remaining contractual term*
            
            *Aggregate
                Intrinsic Value (1)**Outstanding
                as of October 1, 2007*
            
            
            *1,418,500*
            
            *$*
            *3.28**Exercised*
            
            
            *—*
            
            
            *—**Forfeited*
            
            
            *3,500*
            
            
            *3.28**Cancelled*
            
            
            *—*
            
            
            *—**Outstanding
                as of December 31, 2007*
            
            
            *1,415,000*
            
            *$*
            *3.28*
            
            
            *6
                years*
            
            *$*
            *4,202,550**Exercisable
                as of December 31, 2007*
            
            
            *30,000*
            
            *$*
            *3.35*
            
            
            *5
                years*
            
            *$*
            *87,000*





(1)
            Aggregate
                intrinsic value represents the value of the Company’s closing stock price
                on December 31, 2007 (US$6.25) 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 25, 2007
      was
      US$2.15 per share. The Company recorded non-cash share-based compensation
      expense of US$496,804 for the quarter ended December 31, 2007 in respect of
      these share options, which was allocated to cost of revenues, sales and
      marketing expenses, general and administrative expenses and research and
      development costs respectively.




F-17




**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)





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
      December 31, 2007, there were unrecognized compensation costs of US$2,035,442
      related to the above non-vested share options. These costs are expected to
      be
      recognized over a weighted average period of 2 years.





Pursuant
      to the Plan, the Company also granted 5,000 restricted shares to each of the
      two
      newly elected independent directors with a fair value of US$3.35 per share
      on
      June 25, 2007 and granted 5,000 restricted shares to one of the existing
      independent directors with a fair value of US$4.33 per share on July 17, 2007.




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
      instalments on the last day of each subsequent quarter or in three equal
      quarterly instalments 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 expenses of US$11,968 in
      respect of the restricted shares granted in June and July 2007 for the three
      months ended December 31, 2007, which was allocated to general and
      administrative expenses.





As
      of
      December 31, 2007, the Company had unrecognized stock-based compensation of
      US$5,000 associated with these restricted shares granted to non-employee
      directors. These costs are expected to be recognised over a weighted average
      period of 0.2 year. As of December 31, 2007, the first and second 25% of the
      restricted shares were already issued as fully paid ordinary shares to the
      three
      independent directors on August 23, 2007 and October 25, 2007.





As
      the
      Company itself is a 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 stock option plan for the three months ended December
      31, 2007.





F-18


**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)




**Employee
      Restricted Stock Awards**





On
      September 22, 2006, the Compensation Committee approved the form of Termination
      and Release Agreement covering the cancellation of 1,400,000 shares of stock
      options granted to the optionees who are residents of the PRC. The Compensation
      Committee also consented to adopt the terms and provisions for Restricted Stock
      Grant Agreement covering the issuance of restricted shares, and committed to
      determine an appropriate number of shares of restricted stock that would be
      granted to these optionees under the Plan (the “Replacement Awards”) during the
      first quarter of fiscal year 2007. In addition, the Compensation Committee
      also
      approved the officer of the Company to authorize delivery of the restricted
      shares to the employees. 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. The Replacement Awards were classified
      as
      liability-classified awards as of September 30, 2006.





The
      Company has estimated the fair value of the Replacement Awards to be US$4.27
      per
      share as of December 26, 2006, based on the estimated fair value of the
      cancelled options using the Black-Scholes Option Valuation Model together with
      the following assumptions.





Expected
                volatility
            
            
            89.51
            %Expected
                dividends
            
            
            NilExpected
                life
            
            
            4.4
                yearsRisk-free
                interest rate
            
            
            4.61
            %




On
      December 26, 2006, pursuant to the restricted stock grant agreements signed
      between the Company’s officers and the relevant optionees and based on the
      closing market price of the Company’s listed common stock on that date, i.e.
      US$6.25 per share, a total of 914,994 shares of restricted stock were granted
      as
      Replacement Awards to the employees who gave up their stock options and
      continued to be employed by the Company on that date. Fair value of the
      Replacement Awards granted to each optionee approximated that of the employee’s
      terminated stock options. The Compensation Committee ratified the grants on
      January 15, 2007.





Prior
      to
      vesting, the shares of restricted stock granted to each employee pursuant to
      the
      Replacement Awards are subject to restrictions on transferability and will
      be
      forfeited if the grantee’s employment with the Company is terminated. In
      accordance with the vesting provisions of the grants, the shares of restricted
      stock will become vested and shall no longer be subject to forfeiture under
      the
      following schedule:





Number
                of Shares
            
            Percentage
                of Options Issued
            
            Initial
                Vesting Date365,998
            
            
            40
            %
            
            July
                1, 2007274,498
            
            
            30
            %
            
            January
                1, 2008274,498
            
            
            30
            %
            
            July
                1, 2008914,994
            
            
            100
            %





Upon
      the
      grant of restricted stock, the Company has reclassified share-based payment
      liabilities of US$3,679,934 to shareholders’ equity. The restricted stock grant
      is treated as equity-classified awards and the unrecognized compensation costs
      are recognized over the vesting period. The Company recognized share-based
      compensation expense of US$54,770 for the period from October 1, 2006 to
      December 26, 2006 in respect of the liability-classified award, and US$31,186
      for the period from December 26, 2006 to December 31, 2006 and US$294,720 for
      the quarter ended December 31, 2007 in respect of the equity-classified award.
      These share-based compensation costs were allocated to cost of revenues, sales
      and marketing expenses, general and administrative expenses and research and
      development costs respectively.




F-19




**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)




A
      summary
      of the restricted stock grant activity for the three months ended December
      31,
      2007 is presented below:





*Weighted
                average**Number
                of*
            
            *exercise
                price**shares*
            
            *per
                share*Non-vested
                as of October 1, 2007
            
            
            530,560
            
            $
            6.25Vested
            
            
            —
            
            
            —Forfeited
            
            
            —
            
            
            —Non-vested
                as of December 31, 2007
            
            
            530,560
            
            $
            6.25





As
      such
      share-based compensation is not deductible for income tax purpose in the PRC,
      no
      income tax benefits were recognized in this respect for the three months ended
      December 31, 2007.




As
      of
      December 31, 2007, there were unrecognized compensation costs of US$266,000
      related to the restricted stock granted. These costs are expected to be
      recognized over a weighted average period of 0.5 year.




**Compensation
      Plan for Non-employee Directors**




On
      May
      12, 2006, the Board of Directors adopted the China BAK Battery, Inc.
      Compensation Plan for Non-employee Directors (the “Plan 2006”). The Plan 2006
      authorizes the issuance of 5,000 restricted shares of the Company’s common stock
      to each of the three eligible directors in addition to their annual retainer
      fee. Such restricted shares entitle the relevant non-employee directors to
      all
      rights of ordinary share ownership except that the shares may not be sold,
      transferred, pledged, exchanged or otherwise disposed of during the vesting
      period.





On
      May
      12, 2006, the Company granted 5,000 restricted shares to each of the three
      newly
      elected independent directors with a fair value of US$11.5 per share pursuant
      to
      the Plan 2006. 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
      instalments on the last day of each subsequent quarter or in three equal
      quarterly instalments 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 expenses of US$11,980 for
      the
      three months ended December 31, 2006 in respect of the above restricted shares
      granted to non-employee directors, which was allocated to general and
      administrative expenses. No non-cash share-based compensation expense was
      recognized in respect of the above restricted shares for the three months ended
      December 31, 2007.





As
      the
      Company 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 recognised for such share-based compensation cost for the three
      months ended December 31, 2007.




F-20




**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)





As
      of
      December 31, 2007, there was no unrecognized stock-based compensation associated
      with these restricted shares granted to non-employee directors. Each of the
      25%
      of the restricted shares were issued as fully paid ordinary shares to the three
      independent directors on July 19, 2006, August 16, 2006, January 8, 2007 and
      March 28, 2007, respectively.





**10**
            **Net
                Income / (Loss) per Share**





The
      calculation of basic net loss per share is based on the net loss for the three
      months ended December 31, 2007 attributable to equity shareholders of $940,535
      (Net income for the three months ended December 31, 2006: $3,582,752) and the
      weighted average number of ordinary shares of 51,425,323 in issue during the
      three months ended December 31, 2007 (three months ended December 31, 2006:
      48,885,896).





The
      calculation of diluted net loss per share is based on the net loss for the
      three
      months ended December 31, 2007 attributable to equity shareholders of $940,535
      (Net income for the three months ended December 31, 2006: $3,582,752) and the
      weighted average number of ordinary shares of 52,378,164 in issue during the
      three months ended December 31, 2007 (three months ended December 31, 2006:
      48,911,340) after adjusting for the number of 952,841 dilutive potential
      ordinary shares. Restricted stock granted to employees and to non-employee
      directors are included in the computation of diluted net loss / income per
      share
      for the three months ended December 31, 2007 and 2006 respectively. The share
      warrants granted to external financial advisors and stock options granted to
      employees are excluded from the computation of diluted net loss / income per
      share as the warrant and stock options were both anti-dilutive.





**11**
            **Commitments
                and Contingencies**





*(i)*
            *Capital
                Commitments*





As
      of
      September 30, 2007 and December 31, 2007, the Company had the following capital
      commitments:





*September
                30,*
            
            *December
                31,**2007*
            
            *2007*For
                purchases of equipment
            
            $
            12,312,763
            
            $
            6,391,416





*(ii)*
            *Land
                Use Rights and Property Ownership
                Certificate*





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 has not yet obtained the land use rights certificate relating to the
      premises occupied by the Company, BAK Industrial Park. However, the Company
      had
      obtained the approvals for project planning and construction from the government
      of Shenzhen on June 20, 2007 and is in the process of applying for the land
      use
      rights certificate.





F-21




**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)





Management
      believes that the Company will ultimately be granted a land use rights
      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 land use rights certificate relating to BAK Industrial Park,
      there
      is a risk that the buildings 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.





The
      Company is not able to insure its manufacturing facilities since it has not
      yet
      received its land use rights certificate. The Company intends to procure such
      insurance once it has received the certificate.





*(iii)*
              *Guarantees*





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




*September
                    30,*
                  *2007*
              
              *December
                    31,*
                  *2007*Guaranteed
                    for Hunan Reshine New Material Ltd. - a non-related
                    party
              
              $
              5,325,664
              
              $
              5,476,001Guaranteed
                    for Nanjing Special Metal Equipment Co. Ltd. - a non-related
                    party
              
              
              1,331,416
              
              
              1,369,000$
              6,657,080
              
              $
              6,845,001




Management
      has assessed the fair value of the obligation arising from the above financial
      guarantees and considered it is immaterial to the consolidated financial
      statements. Therefore, no obligations in respect of the above guarantees were
      recognized as of December 31, 2007.





*(iv)*
              *Outstanding
                  Discounted Bills*





From
      time
      to time, the Company factors bills receivable to banks. At the time of the
      factoring, all rights and privileges of holding the receivables are transferred
      to the banks. The Company does not retain control over the transferred
      receivables and cannot cause the banks to return them, nor does the Company
      have
      the right or obligation to repurchase or redeem the receivables. Each bank
      is
      entitled to pledge or exchange the receivables factored to it. The Company
      removes the asset 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 bills as of September 30, 2007 and December
      31,
      2007 are summarized as follows:


*September
                  30,*
              
              *December
                  31,**2007*
              
              *2007*Bank
                  acceptance bills
              
              $
              17,851,850
              
              $
              12,387,960




F-22


**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)





*(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 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 seek injunctive
      relief and damages in an unspecified amount. If the court issues an adverse
      decision, the Company may be required to pay the plaintiffs substantial monetary
      damages, and the Company may be prohibited from future production of
      rechargeable lithium cells manufactured for A123Systems or be required to pay
      royalties to engage in any such production. The court has not yet issued a
      decision on this matter and the Company is unable to quantify the extent of
      any
      possible award of damages that might become payable by the Company.





**12**
            **Significant
                Concentrations**





**(a)**
            **Customers
                and Credit Concentrations**





The
      Company had two customers that individually comprised 10% or more of net revenue
      for the three months ended December 31, 2006 as follows:


*Three
                  months ended December 31,**2006*
              
              *2007*%
              
              
              
              %A123
                  Systems, Inc.
              
              $
              6,398,903
              
              
              15
              
              $
              —
              
              
              —Shenzhen
                  Chaolitong Electronics Co. Ltd.
              
              
              4,291,576
              
              
              10
              
              
              3,514,974
              
              
              7$
              10,690,479
              
              
              25
              
              $
              3,514,974
              
              
              7




No
      customer individually comprised 10% or more of the Company’s net revenue for the
      three months ended December 31, 2007.





Approximately
      10% and 7% of gross trade accounts receivable were due from Shenzhen Chaolitong
      Elecronics Co. Ltd. as of September 30, 2007 and December 31, 2007 respectively.





As
      of
      September 30, 2007, approximately 3% of gross trade accounts receivable was
      due
      from A123 Systems, Inc. The Company did not have balance of gross trade accounts
      receivable due from this customer as of December 31, 2007. On August 30, 2007,
      the Company’s agreement with this customer terminated in accordance with its
      terms. The Company believes the termination of this business relationship has
      no
      material impact on the Company’s results of operations and financial
      condition.




F-23




**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)





**(b)**
            **Credit
                Risk**





Financial
      instruments that potentially subject the Company to significant concentration
      of
      credit risk consist primarily of cash and cash equivalents and pledged deposits.
      As of September 30, 2007 and December 31, 2007, 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.





**13**
            **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. The Company manufactures six types
      of
      Li-ion rechargeable batteries: steel-case cell, aluminium-case cell, battery
      pack, cylindrical cell, polymer cell and high-power lithium-phosphate 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 three months ended December 31, 2006 and 2007 were as
      follows:





*Net
      revenues by product:*


*Three
                  months ended December 31,**2006*
              
              *2007*%
              
              
              
              %Steel-case
                  cell
              
              $
              15,031,595
              
              
              34.89
              
              $
              9,756,758
              
              
              18.48Aluminium-case
                  cell
              
              
              17,202,935
              
              
              39.93
              
              
              30,059,952
              
              
              56.95High-power
                  lithium-phosphate
                  cell
              
              
              6,398,903
              
              
              14.85
              
              
              —
              
              
              —Battery
                  pack
              
              
              2,413,126
              
              
              5.61
              
              
              5,000,622
              
              
              9.47Cylindrical
                  cell
              
              
              854,744
              
              
              1.98
              
              
              2,568,673
              
              
              4.87Polymer
                  cell
              
              
              1,180,850
              
              
              2.74
              
              
              5,401,470
              
              
              10.23$
              43,082,153
              
              
              100.00
              
              $
              52,787,475
              
              
              100.00




*Net
      revenues by geographic area:*


*Three
                  months ended December 31,**2006*
              
              *2007*%
              
              
              
              %PRC
                  Mainland
              
              $
              31,419,765
              
              
              72.93
              
              $
              45,507,991
              
              
              86.22United
                  States of America
              
              
              6,404,559
              
              
              14.87
              
              
              65,054
              
              
              0.12Hong
                  Kong, China
              
              
              1,943,612
              
              
              4.51
              
              
              1,827,494
              
              
              3.46India
              
              
              —
              
              
              —
              
              
              1,606,362
              
              
              3.04Others
              
              
              3,314,217
              
              
              7.69
              
              
              3,780,574
              
              
              7.16$
              43,082,153
              
              
              100.00
              
              $
              52,787,475
              
              
              100.00





F-24




**China
      BAK Battery, Inc. and subsidiaries**


**Notes
      to the condensed interim consolidated financial statements**


**For
      the three months ended December 31, 2006 and 2007
      (continued)**


(Unaudited)





**14**
            **Subsequent
                events**





Pursuant
      to the Plan, the Company also issued 360,000 options 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 April 28, 2011 according to each of the employee’s
      agreement respectively.





The
      weighted-average grant-date fair value of options granted on January 28, 2008
      was US$3.59 per share. 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
      January 28, 2008, there were total unrecognized compensation costs of
      US$1,294,000 related to the above non-vested share options. These costs are
      expected to be recognized over a weighted average period of 3.8
      years.




F-25




**Item 2. 
      Management’s Discussion and Analysis of Financial Condition and Results of
      Operations**





The
      following discussion should be read in conjunction with the condensed interim
      consolidated financial statements and notes included in Item 1 of Part I of
      this Report. Except for the historical information contained herein, this Report
      contains forward-looking statements that involve risks and uncertainties. Our
      actual results may differ materially from those indicated by such
      forward-looking statements. See “Introductory Comments — Forward-Looking
      Statements” above.





**Overview**





During
      the first quarter of fiscal 2008, we generated $52.8 million in net revenues,
      our highest quarterly net revenues since our inception. This increase was
      primarily driven by the sustained quarter-to-quarter increase in revenues from
      our aluminum-case cells, cylindrical cells and polymer cells. The revenues
      from
      cylindrical cells and polymer cells increased approximately 100% over the fourth
      quarter of fiscal 2007, and approximately 300% over the quarter ended December
      31, 2006. We were able to achieve this growth in revenue despite this quarter
      being the first full fiscal period following the August 2007 termination of
      our
      contract with A123 Systems, Inc. (“A123Systems”), which had been a significant
      customer. We also continued to make progress in expanding our manufacturing
      capability into first-tier OEM capabilities, and in working through the
      qualification processes of targeted first-tier OEMs. Our achievements during
      the
      first quarter of fiscal 2008 include the following:





—
            We
                closed a $13.65 million private placement of shares of our common
                stock,
                the proceeds of which were used for the expansion of current business
                and
                for working capital;—
            Our
                batteries passed all safety, reliability and performance tests by
                Hewlett
                Packard Company (“HP”) designated battery pack manufacturers, a
                significant step in our efforts, pursuant to our non-binding Letter
                of
                Intent with HP, to reach a definitive agreement to supply lithium
                ion
                battery cells to HP;—
            We
                were awarded “China Top Brand” by the General Administration of Quality
                Supervision, Inspection and Quarantine of the People's Republic of
                China,
                which is valid for three years; this designation, in recognition
                of our
                product quality, exempts us from certain quality checks and customs
                inspections and automatically classifies our products as priority
                products
                for protection against counterfeiting; and—
            We
                were recognized as one of the Top 30 Most Innovational Enterprises
                in
                China by the November 2007 issue of*Manager*,
                a
                leading China business magazine.





As
      in
      previous periods, we continue to face pressure due to increased costs of raw
      materials, particularly lithium cobalt dioxide, the main raw materials in our
      products, and higher overhead related to the expansion of our manufacturing
      capabilities in fiscal 2007. This has resulted in lower profit margins for
      the
      three months ended December 31, 2007, as compared to the same period in fiscal
      2006, as our increased costs cannot be fully reflected in increased prices.





In
      the
      near-term, we anticipate that we will continue to experience pressure due to
      increased costs, including the costs of raw materials and overhead, as well
      as
      the costs of additional anticipated capital improvements as we transition from
      predominantly a replacement market to global first tier OEM capabilities. In
      response to this challenge, while we believe that we remain among the low cost
      manufacturers in the industry, we are seeking to reduce the purchase costs
      of
      raw materials and other unit costs of production while pursuing opportunities
      to
      raise selling prices where it would benefit our financial results. In addition,
      we are seeking to identify alternative raw materials suppliers to the extent
      there are viable alternatives and to expand our use of alternative raw
      materials. Among other things, we have successfully developed the technology
      to
      use substitute materials to reduce the amount of lithium cobalt dioxide used
      in
      the manufacture of lithium-based cells. Lithium cobalt dioxide is the most
      expensive ingredient currently required to make lithium-based cells because
      cobalt is not renewable. We have also restructured our operations in an effort
      to streamline corporate resources and improve internal efficiency, with a
      particular focus on manufacturing and sales.





From
      a
      long-term perspective, we believe that our investment in building our first
      tier
      OEM capabilities and increasing our production capacity will ultimately improve
      our profitability and competitiveness as increased volume absorbs the higher
      fixed overhead costs of the investment in applicable equipment and
      infrastructure once we have completed the qualification processes of applicable
      first tier OEM companies.





To
      help
      us finance and expand our operations, we have access to $239.6 million in
      short-term credit facilities and $41.1 million in long-term credit facilities.
      As of December 31, 2007, the principal outstanding amounts under our credit
      facilities included short-term bank loans of $99.9 million, long-term bank
      loans
      of $6.8 million maturing within one year and long-term bank loans of $34.2
      million maturing in over one year, and bills payable of $31.9 million, leaving
      $109.5 million of short-term funds available for additional cash
      needs.




1





**Our
      Business**





We
      are
      one of the largest manufacturers of lithium-ion battery cells in the world,
      as
      measured by production output. 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;—
            portable
                consumer electronics, such as digital cameras, portable media players,
                portable gaming devices and personal digital assistants, or PDAs;
                and—
            other
                applications, such as miner's
                lamps.





We
      conduct all of our operations in China, in close proximity to China’s
      electronics manufacturing base and its rapidly growing market. Historically,
      we
      have primarily manufactured prismatic lithium-ion cells for the cellular phone
      replacement battery market and the OEM market. 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 engage
      pack
      battery manufacturers to assemble our prismatic cells into batteries for a
      fee
      and then sell battery packs to these customers both for the replacement and
      OEM
      markets.





**Financial
      Statement Presentation**





*Net
      revenues* .
      Our net
      revenues represent the invoiced 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 invoiced
      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.





The
      following table sets forth the breakdown of our net revenues by battery cell
      type for the periods indicated.





**Three
                Months Ended**
              **December
                31,****2006**
            
            **2007****(in
                thousands)**Prismatic
                cellsSteel-case
                cells
            
            $
            15,031
            
            $
            9,757Aluminum-case
                cells
            
            
            17,203
            
            
            30,060Battery
                packs
            
            
            2,413
            
            
            5,000Cylindrical
                cells
            
            
            855
            
            
            2,569High-power
                lithium-phosphate cells
            
            
            6,399
            
            
            -Lithium
                polymer cells
            
            
            1,181
            
            
            5,401Total
            
            $
            43,082
            
            $
            52,787





Our
      net
      revenues have increased during the three months ended December 31, 2007, in
      part
      because of increased shipments as we ramped up our production capacity to meet
      customer demands for our products.





*Cost
      of Revenues* .
      Cost of
      revenues consists primarily of materials costs, employee remuneration for staff
      engaged in production activity, share-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.




2





The
      cost
      of raw materials for aluminum-case cells is generally higher than that of
      steel-case cells. Cost of revenues from the sales of battery packs also includes
      the fees we pay to pack manufacturers for assembling our prismatic cells into
      battery packs.





The
      average unit costs of our products was higher in the three months ended December
      31, 2007, as compared to the three months ended December 31, 2006, because
      the
      purchase cost of lithium cobalt dioxide increased, which increase was only
      partially offset by higher prices for our products in the three months ended
      December 31, 2007, as compared to the same period of the prior year. Lithium
      cobalt dioxide is the main material in our products, rechargeable lithium
      batteries. As a result, our gross profit, as a percentage of net revenues,
      decreased from 19.0% for the three months ended December 31, 2006 to 13.5%
      for
      the three months ended December 31, 2007. We expect that the price of lithium
      cobalt dioxide, which increased approximately 30% during the fiscal year ended
      September 30, 2007 from the prior year’s price, will fluctuate but that the
      overall trend will be for the price to continue to increase over time. To the
      extent that we are not able to fully reflect these increased costs in our prices
      or use alternative less costly materials, our gross profit, as a percentage
      of
      net revenues, may decrease.





*Research
      and Development Costs* .
      Research and development costs primarily comprise remuneration for R&D
      staff, share-based compensation, depreciation and maintenance expenses relating
      to R&D equipment and R&D material costs.





*Sales
      and Marketing* .
      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, share-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* .
      General
      and administrative expenses consist primarily of employee remuneration,
      share-based compensation, professional fees, insurance, benefits, general office
      expenses, depreciation, liquidated damage charge and bad debt
      expenses.





*Government
      Grant Income / Other Income.* Other
      income for the three months ended December 31, 2007 mainly consisted of
      government grant funds to subsidize the interest expenses incurred by the
      Company 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. No present or future
      obligation will arise from the receipt of such amount.





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





*Income
      Taxes* .
      Under
      applicable income tax laws and regulations, an enterprise located in Shenzhen,
      including the district where our operations are located, is subject to a 15%
      enterprise income tax. Further, according to PRC laws and regulations, foreign
      invested manufacturing enterprises, starting from their first profitable year,
      are entitled to a two-year exemption from enterprise income tax followed by
      a
      three-year 50% reduction in its enterprise income tax rate. Our PRC
      subsidiaries, Shenzhen BAK, BAK Electronics and BAK Tianjin, are each entitled
      to a two-year exemption from enterprise income tax and a reduced enterprise
      income tax rate of 7.5% for the following three years from its first profitable
      year. As such, for the first two calendar years ended December 31, 2003,
      Shenzhen BAK was exempted from any enterprise income tax. Between January 1,
      2004 and December 31, 2006, Shenzhen BAK is subject to the enterprise income
      tax
      rate of 7.5%. BAK Electronics, established in August 2005, is eligible for
      the
      same preferential tax treatment applicable to Shenzhen BAK and currently is
      in
      the tax holiday and fully exempt from any enterprise income tax for the calendar
      year 2006 and 2007. Between January 1, 2008 and December 31, 2010, BAK
      Electronics is subject to a 7.5% tax rate. Beginning January 1, 2011, BAK
      Electronics will be subject to the full corporate income tax rate which, in
      accordance with the PRC’s new income tax law discussed below, will be 25%. BAK
      Tianjin is currently exempt from any enterprise income tax due to cumulative
      tax
      losses. Shenzhen BAK and BAK Electronics received in aggregate a tax benefit
      of
      $181,000 pursuant to the tax holiday for the quarter ended December 31, 2007,
      or
      $0.004 per basic share.




3





In
      addition, due to the additional capital invested in Shenzhen BAK in both 2005
      and 2006, Shenzhen BAK was granted a preferential income tax rate of 3.82%
      and
      6.12% in calendar years 2006 and 2007, respectively.





Furthermore,
      to encourage foreign investors to introduce advanced technologies to China,
      the
      PRC government has offered additional tax incentives to enterprises that are
      classified as a foreign-invested enterprise with advanced technologies.
      According to an official notice issued by the Shenzhen Municipal Trade and
      Industry Bureau, Shenzhen BAK received such designation in August 2005. As
      a
      result, as long as Shenzhen BAK maintains this designation, it may apply to
      the
      tax authority to extend the preferential status of its enterprise income tax
      rate for another three years, until December 31, 2009. Beginning January 1,
      2010, Shenzhen BAK will be subject to the full corporate income tax rate of
      25%.





On
      March
      16, 2007, the National People’s Congress of the PRC determined to adopt a new
      corporate income tax law in its fifth plenary session. The new corporate income
      tax law unifies the application scope, tax rate, tax deduction and preferential
      policy for both domestic and foreign-invested enterprises. The new corporate
      income tax law became effective on January 1, 2008. According to the new
      corporate income tax law, the applicable income tax rate for our operating
      subsidiaries will be 25% after the current preferential taxes holiday have
      ended.





Our
      company is subject to U.S. tax at the statutory rate of 35%. We have not made
      provisions for any U.S. tax because we have determined that we have no U.S.
      taxable income.





Our
      Canada subsidiary, BAK Canada, is subject to Canada profits tax at the rate
      of
      36.1%. However, because it does not have any assessable income derived from
      or
      arising in Canada, it has not paid any Canada profits tax.





Our
      German subsidiary, BAK Europe, is subject to Germany’s profits tax at the rate
      of 25%. However, because it does not have any assessable income derived from
      or
      arising in Germany, it has not paid any German profits tax.





Our
      Hong
      Kong subsidiary, BAK International, is subject to Hong Kong profits tax at
      the
      rate of 17.5%. However, because it does not have any assessable income derived
      from or arising in Hong Kong, it has not paid any Hong Kong profits
      tax.





Our
      effective tax rate was 0.1% for the three months ended December 31, 2006 and
      our
      effective tax benefit rate was 12.9% for the three months ended December 31,
      2007.




4


**Results
      of Operations**





***For
      the three months ended December 31, 2007 as compared to the three months ended
      December 31, 2006.***





**Three****Months****Ended**
              **December
                31,****2007**
            
            **2006**
            
            **$
                Change**
            
            **%
                Change****(In
                thousands, except percentages)**Statement
                of Operations data:Net
                revenues
            
            $
            52,787
            
            $
            43,082
            
            $
            9,705
            
            
            22.5
            %Cost
                of revenues
            
            
            45,681
            
            
            34,886
            
            
            10,795
            
            
            30.9Gross
                profit
            
            
            7,106
            
            
            8,196
            
            
            (1,090
            )
            
            (13.3
            )Operating
                expenses:Research
                and development costs
            
            
            1,319
            
            
            637
            
            
            682
            
            
            107.1Sales
                and marketing expenses
            
            
            1,348
            
            
            1,041
            
            
            307
            
            
            29.5General
                and administrative expenses
            
            
            4,238
            
            
            2,961
            
            
            1,277
            
            
            43.1Total
                operating expenses
            
            
            6,905
            
            
            4,639
            
            
            2,266
            
            
            48.8Operating
                income
            
            
            201
            
            
            3,557
            
            
            (3,356
            )
            
            (94.3
            )Finance
                costs, net
            
            
            2,223
            
            
            901
            
            
            1,322
            
            
            146.7Government
                grant income
            
            
            901
            
            
            762
            
            
            139
            
            
            18.2Other
                income
            
            
            42
            
            
            170
            
            
            (128
            )
            
            (75.3
            )Income
                tax expense / (benefit)
            
            
            (139
            )
            
            5
            
            
            (144
            )
            
            N/ANet
                income / (loss)
            
            $
            (940
            )
            $
            3,583
            
            $
            (4,523
            )
            
            N/A
            %





*Net
      Revenues.* Net
      revenues increased to $52.8 million for the three months ended December 31,
      2007
      as compared to $43.1 million for the same period of the prior year.





—
            Net
                revenues from the sales of aluminum-case cells increased to $30.1
                million
                in the three months ended December 31, 2007 from $17.2 million in
                the same
                period in 2006, an increase of $12.9 million or 74.7%, due to an
                increase
                in sales volume of 48.0% driven by increased sales to OEM market
                in the
                PRC and an increase in average selling price by 18.1% as the result
                of the
                change of type of the aluminum-case cells.—
            Net
                revenues from the sales of steel-case cells decreased to $9.8 million
                in
                the three months ended December 31, 2007 from $15.0 million in the
                same
                period in 2006, a decrease of $5.2 million or 35.1%. This decrease
                was due
                to a fall in sales volume of 32.0%, which was primarily attributable
                to
                our strategic reduction of steel-case cell production to increase
                our
                aluminum-case cell production capacity for purposes of our transition
                from
                the secondary market to the OEM market and to take advantage of the
                greater benefits and lower costs of aluminum-case cells. During the
                three
                months ended December 31, 2007, the price and profit margin of steel-case
                cells were lower than those of aluminum-case cells. In addition,
                market
                demand for aluminum-case cells was stronger than for steel-case cells
                because of the former’s higher safety and performance quality as compared
                to steel-case cells. As a result, we expect to continue to increase
                our
                production of aluminum-case cells and decrease the production of
                steel-case cells. We expect that our revenue will be positively impacted
                by this shift.—
            Net
                revenues from sales of battery packs increased to $5.0 million in
                the
                three months ended December 31, 2007 from $2.4 million in the same
                period
                in 2006, an increase of $2.6 million or 107.2%, due to an increase
                in
                sales volume of 37.1% and in our average selling price of 51.2% driven
                by
                increased sales to the OEM market in the PRC.—
            We
                also sold $5.4 million of lithium polymer cells and $2.6 million
                of
                cylindrical cells in the three months ended December 31, 2007, compared
                to
                $1.2 million of lithium polymer cells and $0.9 million of cylindrical
                cells in the same period in 2006, due to our ability to satisfy additional
                demand with our new production line.—
            We
                had no sales of high-power lithium-ion cells in the three months
                ended
                December 31, 2007, compared to $6.4 million in the same period in
                2006,
                due primarily to the termination in August 2007 of our manufacturing
                agreement with A123Systems. Currently, we are actively seeking new
                applications for our high-power lithium-ion cells, such as electric
                drills, miner’s lamps, electric bicycles and hybrid electric
                vehicles.




5




*Cost
      of Revenues* .
      Cost of
      revenues increased to $45.7 million for the three months ended December 31,
      2007, as compared to $34.9 million for the same period in 2006. The increase
      in
      cost of revenues was mainly attributable to a significant increase in the
      purchase cost of the main raw material in our products, lithium cobalt
      dioxide.





As
      a
      result, gross profit for the three months ended December 31, 2007 was $7.1
      million or 13.5% of net revenues as compared to gross profit of $8.2 million
      or
      19.0% of net revenues for the same period in 2006.





*Research
      and Development Costs* .
      Research and development costs increased to $1.3 million for the three months
      ended December 31, 2007, as compared to $637,000 for the same period in 2006.
      Share-based compensation included in research and development expenses was
      $306,000 for the three months ended December 31, 2007, as compared to $159,000
      for the same period of the prior year, an increase of $147,000 or 92.1%, mainly
      due to new stock options granted to the employees in research and development
      department on June 25, 2007. Research and development material expenses
      increased by $257,000 due to certain new research projects of BAK Canada.
      Salaries related to research increased to $377,000 from $227,000 for the same
      period of the prior year, an increase primarily due to our hiring of additional
      research professionals.





*Sales
      and Marketing Expenses* .
      Sales
      and marketing expenses increased to $1.3 million for the three-month period
      ended December 31, 2007 as compared to $1.0 million for the same period in
      2006.
      Share-based compensation included in sales and marketing expenses increased
      by
      $122,000 due to new stock options granted to the employees in sales department
      on June 25, 2007. Packing expenses increased by $68,000 as the result of
      increased cost of packing materials. As a percentage of net revenues, sales
      and
      marketing expenses increased to 2.6% for the three months ended December 31,
      2007, from 2.4% for the same period in 2006.





*General
      and Administrative Expenses* .
      General
      and administrative expenses increased to $4.2 million or 8.0% of net revenues
      for the three months ended December 31, 2007, as compared to $3.0 million or
      6.0% of net revenues for the same period in 2006. Share-based compensation
      included in general and administrative expenses increased by $268,000 due to
      new
      stock options granted to the employees in departments of general administration
      on June 25, 2007. Salaries increased by $110,000 as a result of an increase
      in
      average salaries and of the number of employees as part of our expansion. Bad
      debt expenses increased by $717,000 primarily due to the provision charged
      in
      line with increased sales after we had assessed the collection of accounts
      receivables from customers during the three months ended December 31, 2007.
      Also, in the three-month period ended December 31, 2006, we recognized in
      general and administrative expenses an amount of $197,000 for liquidated damages
      related to a registration rights agreement with certain shareholders. There
      was
      no comparable expense in the same period in 2007.





*Operating
      Income* .
      As a
      result of the above, operating income totaled $201,000 for the three months
      ended December 31, 2007 as compared to operating income of $3.6 million for
      the
      same period of the prior year. As a percentage of net revenues, operating income
      was 0.4% for the three months ended December 31, 2007, as compared to 8.2%
      for
      the same period of the prior year.





*Finance
      Costs, Net* .
      Finance
      costs, net increased to $2.2 million for the three-month period ended December
      31, 2007, as compared to $901,000 for the same period of the prior year. We
      have
      $99.9 million in short-term bank loans maturing in less than one year, $6.8
      million in long-term bank loans maturing within one year, and $34.2 million
      in
      other long-term bank loans as of December 31, 2007, as compared to $71.1 million
      in short-term bank loans and $12.8 million in long-term bank loans,
      respectively, outstanding as of December 31, 2006. The increase in net finance
      costs is also attributable to the increase in the average bank loan interest
      rates on our short-term bank loans and long-term bank loans and the increase
      of
      our short-term bank loans and long-term bank loans.





*Government
      Grant Income* .
      Government grant income was $901,000 for the three months ended December 31,
      2007 as compared to $762,000 for the same period of 2006. Government grant
      income for the three months ended December 31, 2007, mainly represented receipt
      of grant funds to subsidize the interest expenses we incurred in prior years
      for
      research and development activities. Government grant income for the three
      months ended December 31, 2006, consisted mainly of government subsidy given
      as
      recognition of our contribution to the economic development of the area. No
      present or future obligation arises from the receipt of these government
      subsidies.




6





*Income
      Tax Expense / (Benefit)* .
      Income
      tax benefit was $139,000 for the three months ended December 31, 2007, as
      compared to an income tax expense of $5,000 for the same period of 2006. The
      change was mainly due to decreased profit before tax and deferred tax provision
      during the three months ended December 31, 2007.





*Net
      Income / (Loss)* .
      As a
      result of the foregoing, we had a net loss of $940,000 for the three months
      ended December 31, 2007 as compared to a net income of $3.6 million for the
      same
      period in 2006.





**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 December 31, 2007, we had cash and cash equivalents of $33.5 million,
      as
      compared to $14.2 million as of September 30, 2007. In addition, we had pledged
      deposits amounting to $4.4 million and $4.6 million as of December 31, 2007
      and
      September 30, 2007, respectively. Typically, banks will require borrowers to
      maintain deposits of approximately 20% 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.





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





**Three
                Months Ended December 31,****2007**
            
            **2006****(in
                thousands)**Net
                cash used in operating activities
            
            $
            (4,688
            )
            $
            (2,155
            )Net
                cash used in investing activities
            
            
            (9,211
            )
            
            (13,198
            )Net
                cash provided by financing activities
            
            
            32,533
            
            
            19,560Effect
                of exchange rate changes on cash and cash equivalents
            
            
            694
            
            
            57Net
                increase in cash and cash equivalents
            
            
            19,328
            
            
            4,264Cash
                and cash equivalents at the beginning of period
            
            
            14,196
            
            
            21,100Cash
                and cash equivalents at the end of period
            
            
            33,524
            
            
            25,364





***Operating
      Activities***





Net
      cash
      used in operating activities was $4.7 million in the three months ended December
      31, 2007 compared with net cash used in operating activities of $2.2
      million in the same period in 2006. The increase of $2.5 million in operating
      activities was mainly attributable to increased prepayments to certain raw
      materials suppliers to increase our purchases of the main raw materials in
      our
      products, lithium cobalt dioxide, in anticipation of a future increase in its
      cost.





***Investing
      Activities***




Net
      cash
      used in investing activities decreased from $13.2 million in the three months
      ended December 31, 2006 to $9.2 million in the same period in 2007. The net
      cash
      used in investing activities during the period ended December 31, 2007 was
      mainly used for purchases of equipment for a new automated cylindrical cell
      production line and a new automated prismatic cell production line.





***Financing
      Activities***





Net
      cash
      provided by financing activities was $32.5 million in the three months ended
      December 31, 2007, compared to $19.6 million in the same period in 2006. This
      was mainly attributable to (i) net proceeds of $12.8 million from a private
      placement of our common stock completed in November 2007, (ii) a $1.2 million
      increase in net proceeds from our issuance of capital stock in the three months
      ended December 31, 2007, (iii) a $3.2 million decrease in cash deposits at
      banks
      as collateral in the three months ended December 31, 2007 and (iv) additional
      borrowings, net of repayments, of $2.2 million.




7





As
      of
      December 31, 2007, the principal amounts outstanding under our credit facilities
      and lines of credit were as follows:




**Maximum**
              **Amount**
              **Available**
            
            **Amount**
              **Borrowed****(in
                thousands)****Short—term
                credit facilities:**Agricultural
                Bank of China
            
            $
            82,140
            
            $
            30,582Shenzhen
                Development Bank
            
            
            20,535
            
            
            20,535Shenzhen
                Ping An Bank
            
            
            27,380
            
            
            20,535China
                CITIC Bank
            
            
            27,380
            
            
            24,354China
                Construction Bank
            
            
            20,535
            
            
            —Bank
                of China
            
            
            61,605
            
            
            34,041Subtotal
                - short term credit facilities
            
            $
            239,575
            
            $
            130,047**Long—term
                credit facilities:**Agricultural
                Bank of China
            
            $
            27,380
            
            $
            27,380China
                Development Bank
            
            
            13,690
            
            
            13,690Subtotal
                - long-term credit facilities
            
            $
            41,070
            
            $
            41,070**Lines
                of Credit:**Agricultural
                Bank of China
            
            
            
            
            $
            975China
                Merchants Bank
            
            
            
            
            
            841Subtotal
                - lines of credit
            
            
            
            
            $
            1,816Total
                Principal Outstanding
            
            
            
            
            $
            172,933





The
      above
      principal outstanding amounts under credit facilities included short-term bank
      loans of $99.9 million, long-term bank loans of $6.8 million maturing within
      one
      year and long-term bank loans of $34.2 million maturing in over one year, and
      bills payable of $31.9 million.





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





During
      the three months ended December 31, 2007, we repaid two short-term bank loans
      totaling $27.4 million with Shenzhen Branch, Bank of China and Shenzhen Pingshan
      Branch, Shenzhen Development Bank, and borrowed five new short-term bank loans
      totaling $34.9 million with Shenzhen Branch, Bank of China, Shenzhen Pingshan
      Branch, Shenzhen Development Bank, and Shenzhen Shuibei Branch, Shenzhen Ping
      An
      Bank, and borrowed $11.0 million of long-term loans with Shenzhen Eastern
      Branch, Agricultural Bank of China. The five new short-term loans provide for
      monthly interest payments at fixed annual interest rates from 6.561% to 7.29%,
      with principal repayments at maturities during the fourth calendar quarter
      of
      2008. The new long-term bank loans provide for monthly interest payments at
      a
      current annual interest rate of 7.65%, with principal repayments in three
      installments of $2.7 million on January 25, 2008, $4.1 million on January 25,
      2009 and $4.1 million on January 25, 2010, respectively. These debt arrangements
      are generally guaranteed by Mr. Xiangqian Li, our chairman, president, and
      chief
      executive officer.





On
      November 11, 2007, we renewed our credit facility agreement with Shenzhen
      Branch, Bank of China, to provide a maximum loan amount of RMB 450 million
      (approximately $61.6 million) for a term of one year beginning November 11,
      2007. The credit facility agreement is guaranteed by Mr. Xiangqian Li, and
      is
      also secured by $14.1 million of machines and equipments. As of December 31,
      2007, we had borrowed approximately $20.5 million under this credit facility
      agreement.





We
      had
      working capital of $6.2 million as of December 31, 2007, as compared to negative
      working capital of $7.0 million as of September 30, 2007, an increase of $13.2
      million. This increase was primarily attributable to increased prepayments
      to
      certain raw materials suppliers to increase our purchases of the main raw
      material in our products, lithium cobalt dioxide, in anticipation of a future
      increase in its cost. We had short-term bank loans maturing in less than one
      year of $99.9 million and long-term bank loans maturing within one year of
      $6.8
      million as of December 31, 2007, or a total of $106.7 million of loans maturing
      within one year, as compared to a total of $89.9 million of such loans as of
      September 30, 2007, an increase of $16.8 million. We had long-term bank loans
      maturing in over one year of $34.2 million as of December 31, 2007, as compared
      to $29.3 million of such loans as of September 30, 2007, an increase of $4.9
      million.




8





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 amounts available
      under existing credit facilities is insufficient to meet our requirements,
      we
      may seek to sell equity or 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 our
      shareholders’ interests. 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.





**Capital
      Expenditures**





We
      made
      capital expenditures of $9.2 million and $13.2 million in the three months
      ended
      December 31, 2007 and 2006, respectively. Our capital expenditures were used
      primarily to purchase plant and equipment to expand our production capacity.
      The
      table below sets forth the breakdown of our capital expenditures by use for
      the
      periods indicated.





**Three
                months ended December 31,****2007**
            
            **2006****(in
                thousands)**Construction
                costs
            
            $
            2,740
            
            $
            4,098Purchase
                of equipment
            
            $
            6,471
            
            $
            9,100Total
                capital expenditures
            
            $
            9,211
            
            $
            13,198





We
      estimate that our total capital expenditures in fiscal 2008 will reach
      approximately $60.7 million, primarily to purchase manufacturing equipment
      for
      the expansion of our production lines and construction of new factories in
      Tianjin and new Research and Development Test Centre in Shenzhen.





We
      have
      completed the construction of 185,993 square meters of new facilities comprised
      of manufacturing facilities, warehousing and packaging facilities, dormitory
      space and administrative offices at the BAK Industrial Park. Of that space,
      approximately 111,000 square meters are new manufacturing facilities. We have
      completed construction and put into use an additional administrative area,
      production facility, four manufacturing facilities, a warehouse and packaging
      facility, three dormitories and two dining halls. At present, we have no
      significant payment obligations related to these facilities.





We
      do not
      hold the land use right to the tract of property on which we have constructed
      our manufacturing facilities and other related facilities. 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. On June 20, 2007, we obtained the approvals for project planning
      and
      construction from the government of Shenzhen.





We
      are
      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, which we understand does not have the authority
      to grant us the land use rights certificate. Under our agreement with the
      Kuichong Township government, we have to pay for a 50-year land use rights
      certificate at an agreed unit price, which in the aggregate amounted to $4.0
      million as of September 30, 2004 and $3.5 million as of September 30, 2007,
      following an adjustment of the site area after a land survey and foreign
      exchange adjustment. Out of the $3.5 million, $3.0 million has been paid to
      the
      Kuichong Township government. The Shenzhen municipal government has approved
      the
      grant of a land use rights certificate, which we are currently in the process
      of
      obtaining. In the meantime, we have recognized a net payable purchase price
      of
      $544,000 for the land use rights on the assumption that it will be on the same
      terms as those agreed with the Kuichong Township government.




9





The
      following table sets forth our contractual obligations and commercial
      commitments as of December 31, 2007:





**Payment
                Due by Period****Total**
            
            **Less than**
              **1 Year**
            
            **1-3
                Years**
            
            **3-5
                Years**
            
            **More than
                5 Years****(in
                thousands)**Short-term
                bank loans
            
            
            99,937
            
            
            99,937
            
            
            —
            
            
            —
            
            
            —Bills
                payable
            
            
            31,926
            
            
            31,926
            
            
            —
            
            
            —
            
            
            —Long-term
                bank loans
            
            
            41,070
            
            
            6,845
            
            
            20,535
            
            
            13,690
            
            
            —Land
                use rights payable
            
            
            544
            
            
            544
            
            
            —
            
            
            —
            
            
            —Capital
                commitments
            
            
            6,391
            
            
            6,391
            
            
            —
            
            
            —
            
            
            —Future
                interest payment on short-term bank loans
            
            
            4,453
            
            
            4,453
            
            
            —
            
            
            —
            
            
            —Future
                interest payment on long-term bank loans
            
            
            5,753
            
            
            2,256
            
            
            3,022
            
            
            475
            
            
            —Total
            
            
            190,074
            
            
            152,352
            
            
            23,557
            
            
            14,165
            
            
            —





Other
      than the contractual obligations and commercial commitments set forth above,
      we
      did not have any other long-term debt obligations, operating lease obligations,
      capital commitments, purchase obligations or other long-term liabilities as
      of
      December 31, 2007.





**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 would provide contractual assurance of
      the
      debt, or guarantee the timely re-payment of principal and interest of the
      guaranteed party.





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 FASB Interpretation 45,
      “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including
      Indirect Guarantees of Indebtedness of Others,” or FIN 45. 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
      December 31, 2007. As of December 31, 2007, 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 a guarantee for another non-related party, Hunan Reshine New
      Material Ltd. The maximum amount of our exposure for these guarantees was $6.8
      million and $6.7 million at December 31, 2007, and September 30, 2007,
      respectively.





**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 six 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 December 31, 2007.




10





We
      have a
      long-term bank loan of $13.7 million maturing on December 26, 2010 with Shenzhen
      Branch, China Development Bank with three installments payable under which
      we
      have outstanding borrowings; the interest rate we pay on this long term loan
      is
      benchmark rate of the People’s Bank of China for three- to five- year long-term
      loans. In addition, we have a RMB 200 million (approximately $27.4 million)
      long-term loan agreement with Shenzhen Eastern Branch, Agricultural Bank of
      China, which became effective on December 18, 2006. The long-term loan may
      be
      drawn at any time within five years from the effective date of the agreement
      and
      will mature five years after it is drawn. The term loan, when drawn, will carry
      a floating interest rate of 90% of The People’s Bank of China benchmark rate for
      three-year to five-year long-term loans. As of December 31, 2007, we had
      borrowed $27.4 million under this loan agreement. This loan comprises a borrowed
      amount of $5.5 million with a current interest rate of 5.832% and repayable
      on
      January 25, 2012; a borrowed amount of $11.0 million with a current interest
      rate of 6.237%, repayable in three installments of $2.7 million on January
      25,
      2010, $6.8 million on January 25, 2011, and $1.4 million on January 25, 2012,
      respectively; and a borrowed amount of $11.0 million with a current interest
      rate of 7.65%, repayable in three installments of $2.7 million on January 25,
      2008, $4.1 million on January 25, 2009 and $4.1 million on January 25, 2010,
      respectively.





A
      hypothetical 1.0% increase in the annual interest rates for all of our credit
      facilities under which we had outstanding borrowings at December 31, 2007,
      would
      decrease net income before provision for income taxes by approximately $0.3
      million or 31.0% for the three months ended December 31, 2007. 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 86.2% of our revenues and 97.1% of our
      costs and expenses for the three months ended December 31, 2007 are denominated
      in RMB, with the balance denominated in U.S. dollars. Approximately 99.6% of
      our
      assets except for cash were denominated in RMB as of December 31, 2007. 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 rate 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 $7.7 million based on our outstanding revenues, costs and expenses, assets
      and liabilities denominated in RMB as of December 31, 2007. As of December
      31,
      2007, our accumulated other comprehensive income was $13.7 million. We have
      not
      entered into any hedging transactions in an effort to reduce our exposure to
      foreign exchange risk.





**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.




11





***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 December 31,
      2007, and September 30, 2007, the carrying amount of property, plant and
      equipment, net was $154.1 million and $145.1 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.





***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
      collectibility. 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 December 31, 2007, and September 30, 2007, we had
      not
      charged off any balances as we had yet to exhaust all means of
      collection.





***Stock-Based
      Compensation***





We
      adopted the provisions of SFAS 123R, 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. SFAS
      123R 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 remeasured 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 SFAS 123R, we have recognized compensation costs of $842,000 in relation
      to
      stock-based award to our employees and non-employee directors in the three
      months ended December 31, 2007, as an increase in both the operating costs
      and
      shareholder’s equity.





**Changes
      in Accounting Standards**





In
      July
      2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes—an
      Interpretation of FASB Statement No. 109,” which clarifies the accounting for
      uncertainty in tax positions. This Interpretation requires that we recognize
      in
      our consolidated financial statements the impact of a tax position if that
      position is more likely than not of being sustained on audit, based on the
      technical merits of the position. The provisions of FIN 48 became effective
      for
      us on October 1, 2007. The adoption of FIN 48 has no material impact on the
      Company’s financial statements.




12





In
      September 2006, the FASB issued SFAS 157, “Fair Value Measurements”, which
      defines fair value, establishes a framework for measuring fair value in
      generally accepted accounting principles and expands disclosures about fair
      value measurements. SFAS 157 applies under other accounting pronouncements
      that
      require or permit fair value measurements, where fair value is the relevant
      measurement attribute. The standard does not require any new fair value
      measurements. SFAS 157 is effective for financial statements issued for fiscal
      years beginning after November 15, 2007, and interim periods within those fiscal
      years. The management is in the process of evaluating the impact SFAS 157 will
      have on the Company’s financial statements upon adoption.





In
      February 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial
      Assets and Financial Liabilities - Including an Amendment of FASB Statement
      No.
      115,” SFAS No. 159 permits entities to choose to measure many financial
      instruments and certain other items at fair value. Entities that elect the
      fair
      value option will report unrealized gains and losses in earnings at each
      subsequent reporting date. The fair value option may be elected on an
      instrument-by-instrument basis, with a few exceptions. SFAS No. 159 also
      establishes presentation and disclosure requirements to facilitate comparisons
      between entities that choose different measurement attributes for similar assets
      and liabilities. The requirements of SFAS No. 159 are effective for our fiscal
      year beginning on October 1, 2008. The management is in the process of
      evaluating the impact SFAS 159 will have on the Company’s financial statements
      upon adoption.





In
      December 2007, the FASB issued SFAS No. 160 “Noncontrolling Interests in
      Consolidated Financial Statements-an amendment of ARB No. 51”. SFAS 160
      establishes accounting and reporting standards for the noncontrolling interest
      in a subsidiary and for the deconsolidation of a subsidiary. The guidance will
      become effective for the fiscal year beginning after December 15, 2008. The
      management is in the process of evaluating the impact SFAS 160 will have on
      the
      Company’s financial statements upon adoption.





In
      December 2007, the FASB issued SFAS No. 141 (Revised) “Business Combinations.”
SFAS 141 (Revised) establishes principles and requirements for how the acquirer
      of a business recognizes and measures in its financial statements the
      identifiable assets acquired, the liabilities assumed, and any noncontrolling
      interest in the acquiree. The statement also provides guidance for recognizing
      and measuring the goodwill acquired in the business combination and determines
      what information to disclose to enable users of the financial statements to
      evaluate the nature and financial effects of the business combination. The
      guidance will become effective for the fiscal year beginning after December
      15,
      2008. The management is in the process of evaluating the impact SFAS 141
      (Revised) will have on the Company’s financial statements upon
      adoption.





**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.




13





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. Dollar****2007**
            
            **2006**Balance
                sheet items as of December 31
            
            
            7.3046
            
            
            7.8087Amounts
                included in the statement of income and comprehensive income, statement
                of
                changes in stockholders’ equity and statement of cash flows for the three
                months ended December 31
            
            
            7.4318
            
            
            7.8647Balance
                sheet items as of September 30
            
            
            7.5108
            
            
            7.9087





RMB
      is
      not readily convertible into U.S. dollars in the foreign exchange markets.
      The
      foreign exchange rate between the RMB and the U.S. dollar had been stable at
      approximately RMB 8.28 to $1.00 for the last few years. On July 21, 2005, the
      Central Bank of China announced that it would allow the RMB to move to a
      flexible exchange rate with a maximum daily variance against the U.S. dollar
      of
      0.3%. No provision has been made in the accompanying financial statements for
      the change in currency policy, nor has any determination been made as to the
      potential impact this may have on our future operations. As a result, the stated
      exchange rates may not accurately reflect the amount in U.S. dollars into which
      RMB could be actually converted at the date or during the periods reflected
      in
      the foregoing table.





**Item
      3.  Quantitative and Qualitative Disclosures About Market
      Risk**





The
      information required by this item is discussed in Item 2. “Management’s
      Discussion and Analysis of Financial Condition and Results of Operations —
Interest Rate Risk” and “— Foreign Exchange Risk.”





**Item 4. 
      Controls and Procedures.**





***Disclosure
      Controls and Procedures***





As
      required by Rule 13a-15 under the Securities 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
      December 31, 2007. 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 Securities 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 our Annual Report on Form 10-K for the
      fiscal year ended September 30, 2007 (the “2007 Form 10-K”), which we are still
      in the process of remediating. Investors are directed to Item 9A of the 2007
      Form 10-K for the description of these weaknesses.





***Remediation
      Measures for Material Weaknesses***





We
      have
      begun to take steps to remediate the material weaknesses described in our 2007
      Form 10-K, and plan to implement the new measures described below in our ongoing
      efforts to address these internal control deficiencies:





—
            We
                plan to further develop 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 plan to utilize qualified
                accounting advisors and supervisors to ensure that our staff has
                adequate
                professional knowledge and to monitor the need for additional or
                better-qualified staff. In addition, we plan to utilize appropriate
                training programs on accounting principles and procedures to better
                ensure
                the adequacy of our accounting and finance
                personnel.




14






—
            We
                plan to continue 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 accepted in the United
                States
                of America.—
            We
                plan to provide additional training to the Company’s internal auditor on
                appropriate controls and procedures necessary to document and evaluate
                our
                internal control procedures. In addition, one of our employees has
                assumed
                the full-time position of Director of Internal Audit and will be
                responsible for compliance with internal controls.—
            We
                also plan to further enhance 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.





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 December 31, 2007 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.**





Except
      as
      described below, we are not a party to any legal proceedings, nor are we aware
      of any threatened or contemplated proceedings which are expected to result
      in a
      material adverse effect on our financial position, or results of
      operation.





*Patent
      Litigation* .
      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
      us.
      We had an agreement with A123Systems, which, as amended on August 18, 2005,
      terminated in accordance with its terms on August 30, 2007, under which we
      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 us. 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, we had infringed two
      U.S. patents owned by and exclusively licensed to the plaintiffs. The plaintiffs
      seek injunctive relief and damages in an unspecified amount. If the court issues
      an adverse decision, we may be required to pay the plaintiffs substantial
      monetary damages, and we may be prohibited from future production of
      rechargeable lithium cells manufactured for A123Systems or be required to pay
      royalties to engage in any such production. The court has not yet issued a
      decision on this matter and we are unable to quantify the extent of any possible
      award of damages that might become payable by us.





*Liquidated
      Damages* .
      We are
      liable for liquidated damages to certain shareholders whose shares were included
      in a resale registration statement on Form SB-2 that we filed pursuant to a
      registration rights agreement that we entered into with such shareholders in
      September 2005. Under the registration rights agreement, among other things,
      (a)
      if a registration statement filed pursuant thereto ceases to be effective after
      its effective date to cover the resale of the shares for more than 30 trading
      days or (b) if for any reason we are required to file an additional registration
      statement covering such shares, and we do not file such additional registration
      statement within 45 days after the time we first know, or reasonably should
      have
      known, that such registration statement would be required to be filed, then,
      while the relevant shares could not be put back to us, we would be liable to
      pay
      partial liquidated damages to those selling shareholders equal to 1.0% of the
      aggregate investment amount paid by those selling shareholders for the shares,
      and on each monthly anniversary thereafter, unless the event is cured by such
      date, an additional 1.5% on (except with respect to the first such event) a
      daily pro-rata basis.




15





On
      August
      15, 2006, the SEC declared effective a post-effective amendment we filed on
      August 4, 2006 to terminate the effectiveness of the resale registration
      statement on Form SB-2 that included the resale of the shares held by those
      selling shareholders. Accordingly, as we were no longer eligible to file on
      Form
      SB-2, we were required to file an additional registration statement within
      45
      days after the termination of the effectiveness of the Form SB-2. On October
      11,
      2006, we filed a registration statement on Form S-1 that covers resale of the
      shares held by those shareholders, which was declared to be effective on October
      19, 2006. Following the termination of the Form SB-2, our failure to file an
      additional registration statement within the period provided under the
      registration rights agreement triggered, for the first time, an obligation
      to
      pay liquidated damages to the selling shareholders of 1% of the aggregate
      investment amount paid by them for the shares, or $241,232, based on the formula
      specified in the registration rights agreement. Because the Form S-1 was filed
      by the one-month anniversary of the applicable filing date, the event was cured
      and no additional liquidated damages were incurred. We previously reported
      in
      our Annual Report on Form 10-K for the fiscal year ended September 30, 2006
      (the
“2006 Form 10-K”), and in our Quarterly Report on Form 10-Q for the quarter
      ended December 31, 2006 (the “12/31/06 Form 10-Q”), that liquidated damages
      totaling $487,946 were due from us in respect of such event based on an
      incorrect interpretation of the liquidated damages due under the registration
      rights agreement. Among other things, the amount was calculated on a pro rata
      daily basis although the event, the first under the registration rights
      agreement, was cured by its one-month anniversary date.





In
      addition, on December 8, 2006, we filed our 2006 Form 10-K. After the filing
      of
      the 2006 Form 10-K, our previously filed registration statement on Form S-1
      was
      no longer available for resale by the selling shareholders whose shares were
      included in such Form S-1. A post-effective amendment to the Form S-1 covering
      resale by the selling shareholders was declared effective by the SEC on March
      23, 2007. Our failure to have the post-effective amendment declared effective
      within the 30-trading-day time period provided under the registration rights
      agreement (i.e., by January 25, 2007), triggered, for the second time, an
      obligation to pay liquidated damages to the selling shareholders. We estimate
      that we are liable to those selling shareholders for liquidated damages related
      to this second event in the amount of approximately $810,000, such that the
      total current estimated liquidated damages relating to both events amounts
      to
      approximately $1 million.





As
      reported in our 2006 Form 10-K and our 12/31/06 Form 10-Q, we previously
      recorded charges in our statement of income and comprehensive income of $290,575
      for the year ended September 30, 2006, and $197,371 for the quarter ended
      December 31, 2006, based on the original incorrect interpretation of the
      calculation of liquidated damages. Accordingly, the amounts recorded in excess
      of $241,232 (i.e., $246,714) have been applied to offset the charge related
      to
      the liquidated damages incurred related to the second event in the second fiscal
      quarter of 2007, and we have recorded an additional charge in the second fiscal
      quarter of 2007 relating to the additional liquidated damages incurred of
      $563,000. We have assessed the impact of the foregoing on the financial
      statements included in our 2006 Form 10-K and our 12/31/06 Form 10-Q, and have
      determined that the impact is not material. Accordingly, we do not intend to
      restate the financial information included in the 2006 Form 10-K or the 12/31/06
      Form 10-Q; however, future filings will reflect the foregoing information.
      No
      liquidated damages have been paid as of the filing date of this
      Report.





**Item 1A. 
      Risk Factors.**





See
      Item
      1A. “Risk Factors” included in our 2007 Form 10-K.





**Item 2. 
      Unregistered Sales of Equity Securities and Use of
      Proceeds.**





See
      Items
      1.01 and 3.02 of our Current Report on Form 8-K filed with the SEC on November
      6, 2007, and Item 8.01 of our Current Report on Form 8-K filed with the SEC
      on
      November 9, 2007.





**Item 3. Defaults
      Upon Senior Securities.**





None.


16





**Item 4. Submission
      of Matters to a Vote of Security Holders.**





None.





**Item 5. Other
      Information.**





On
      November 11, 2007, we renewed our credit facility agreement with Shenzhen
      Branch, Bank of China, to provide a maximum loan amount of RMB 450 million
      (approximately $61.6 million) for a term of one year beginning November 11,
      2007. The credit facility agreement is guaranteed by Mr. Xiangqian Li, and
      is
      also secured by $14.1 million of machines and equipments. As of December 31,
      2007, we had borrowed approximately $20.5 million under this credit facility
      agreement. A
      summary
      of the terms of this credit facility and related guaranties are included as
      Exhibits 10.3 through 10.5 to this Report and are hereby incorporated by
      reference herein.




During
        the three months ended December 31, 2007, we repaid two short-term bank loans
        totaling $27.4 million with Shenzhen Branch, Bank of China and Shenzhen Pingshan
        Branch, Shenzhen Development Bank, and borrowed five new short-term bank
        loans
        totaling $34.9 million with Shenzhen Branch, Bank of China, Shenzhen Pingshan
        Branch, Shenzhen Development Bank, and Shenzhen Shuibei Branch, Shenzhen
        Ping An
        Bank, and borrowed $11.0 million of long-term loans with Shenzhen Eastern
        Branch, Agricultural Bank of China. The five new short-term loans provide
        for
        monthly interest payments at fixed annual interest rates from 6.561% to 7.29%
        with principal repayments at maturities during the fourth calendar quarter
        of
        2008. The new long-term bank loans provide for monthly interest payments
        at a
        current annual interest rate of 7.65%, with principal repayments in three
        installments of $2.7 million on January 25, 2008, $4.1 million on January
        25,
        2009 and $4.1 million on January 25, 2010, respectively. These debt arrangements
        are generally guaranteed by Mr. Xiangqian Li, our chairman, president and
        chief
        executive officer. The loan certificates under which the five new short-term
        loan agreements were made are included as Exhibits 10.6 through 10.10 to
        this
        Report and are hereby incorporated by reference herein. The loan certificates
        under which the new long-term loan agreements were made are included as Exhibits
        10.11 through 10.13 to this Report and are hereby incorporated by reference
        herein.





**Item 6. 
      Exhibits.**





**Number**
            
            **Description**3.1
            
            Articles
                of Incorporation of the Registrant (incorporated by reference to
                Exhibit
                3.1 to the Registrant’s Annual Report on Form 10-K for the fiscal year
                ended September 30, 2006).3.2
            
            Bylaws
                of the Registrant (incorporated by reference to Exhibit 3.2 to the
                Registrant’s Annual Report on Form 10-K for the fiscal year ended
                September 30, 2007).4.1
            
            Form
                of Registration Rights Agreement, dated November 5, 2007 (incorporated
                by
                reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K
                filed with the Commission on November 6, 2007).10.1
            
            Form
                of Securities Purchase Agreement, dated November 5, 2007 (incorporated
                by
                reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K
                filed with the Commission on November 6, 2007).10.2
            
            Delivery
                of Make Good Shares, Settlement and Release Agreement, by and among
                the
                Registrant, Xiangqian Li, and BAK International, Ltd., dated October
                22,
                2007 (incorporated by reference to Exhibit 10.2 to the Registrant’s
                Current Report on Form 8-K filed with the Commission on November
                6,
                2007).10.3
            
            Credit
                Facility Agreement by and between Shenzhen BAK Battery Co., Ltd.
                and
                Shenzhen Branch, Bank of China, dated November 1, 2007.10.4
            
            Guaranty
                Contract of Maximum Amount by and between Shenzhen BAK Battery Co.,
                Ltd.
                and Shenzhen Branch, Bank of China, dated November 1,
                2007.10.5
            
            Pledge
                Contract of Maximum Amount by and between Shenzhen BAK Battery Co.,
                Ltd.
                and Shenzhen Branch, Bank of China, dated November 8,
                2007.10.6
            
            Loan
                Certificate between Shenzhen BAK Battery Co., Ltd. and Shenzhen Branch,
                Bank of China, dated November 27, 2007.10.7
            
            Loan
                Certificate between Shenzhen BAK Battery Co., Ltd. and Shenzhen Pingshan
                Branch, Shenzhen Development Bank, dated December 12,
                2007.10.8
            
            Loan
                Certificate between Shenzhen BAK Battery Co., Ltd. and Shenzhen Pingshan
                Branch, Shenzhen Development Bank, dated December 14,
                2007.10.9
            
            Loan
                Certificate between Shenzhen BAK Battery Co., Ltd. and Shenzhen Pingshan
                Branch, Shenzhen Development Bank, dated December 20,
                2007.10.10
            
            Loan
                Certificate between Shenzhen BAK Battery Co., Ltd. and Shenzhen Shuibei
                Branch, Shenzhen Ping An Bank, dated October 22, 2007.10.11
            
            Loan
                Certificate between Shenzhen BAK Battery Co., Ltd. and Shenzhen Eastern
                Branch, Agricultural Bank of China, dated October 11,
                2007.




17




10.12
            
            Loan
                Certificate between Shenzhen BAK Battery Co., Ltd. and Shenzhen Eastern
                Branch, Agricultural Bank of China, dated October 11,
                2007.10.13
            
            Loan
                Certificate between Shenzhen BAK Battery Co., Ltd. and Shenzhen Eastern
                Branch, Agricultural Bank of China, dated October 11,
                2007.31.1
            
            Chief
                Executive Officer Certification furnished pursuant to Section 302
                of the
                Sarbanes-Oxley Act of 2002.31.2
            
            Chief
                Financial Officer Certification furnished pursuant to Section 302
                of the
                Sarbanes-Oxley Act of 2002.32.1
            
            Chief
                Executive Officer and Chief Financial Officer Certifications furnished
                pursuant to Section 906 of the Sarbanes-Oxley Act of
                2002.





18


**SIGNATURES**





Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      has
      duly caused this report to be signed on its behalf by the undersigned thereunto
      duly authorized.


Date:
                February 6,
                2008
            CHINA
                BAK BATTERY, INC.By:
            /s/
                Xiangqian LiXiangqian
                Li, Chief Executive Officer(Principal
                Executive Officer)




By:
            /s/ Tony
                ShenTony
                Shen, Chief Financial Officer(Principal
                Financial Officer and Principal
              Accounting
                Officer)




19