China BAK Battery, Inc. (CBAK)

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TRANSCRIPT SPONSOR
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China BAK Battery, Inc. (CBAK)
Roth Capital Conference
February 20, 2007 11:30 am ET

Executives

Jim Groh - U.S. Representative

Presentation

Jim Groh

Good morning everybody, thank you for joining us. We'll be talking about our company, China BAK Battery this morning. I probably can't get through every slide in detail, so what I will do is try and hit the high points with you this morning.

This is our Safe Harbor statement and an advertisement from our Attorney Lou, who is in the front row. If you have any questions on that, I will be happy to answer them, which is pretty standard (inaudible).

To tell you a little bit about our company, we are one of the world’s largest and fastest growing battery cell manufacturers. What we make are lithium-ion cells and they are the power part of a lithium-ion battery. This happens to be for a mobile phone, a cell phone and this comprises about 96% of what ultimately will be a battery. This power cell will be put into a plastic case, it will have a wrap, it will have a connector mechanism which will marry it to the specific type of mobile phone that it's designed and used for.

In a very large and growing market and our cell prices and I would like to confirm that, our cell prices the market is estimated to be about $2.5 billion and growing depending on the research you look out at 15% to 20% per year. There are a number of lithium-ion product opportunities. The technology of lithium-ion has become the de facto technology in mobile and portable applications as far as beating the different technologies.

It's in laptops, Bluetooth headsets, cell phones and a number of emerging applications for high power, where lithium technology is being employed. And basically it’s the advantages of the energy density of our technology, the weight and just the core ability of the chemistry to deliver power in mobile and portable applications.

Our business has a recurring revenue stream, these were up especially in high-duty applications. So we don’t view our business just as a one off sales for potential device rather than it's a consumable business. You will see what I talk later about that goes on in China in cell phones. A lot of our business comes from replacing batteries, replacing so many cells in the batteries, which are replacing used batteries in cell phone.

We believe we have very low cost manufacturing by structure well beyond the China labor store. But it’s a combination of technology in a low cost structure. We have state-of-the-art technical capability. And as far as looking forward I mentioned product applications, we also have a number of emerging channels we are concentrating on and we feel we have multiple growth opportunities.

A little bit about the market in China and the lithium-ion cell battery producers in China. All our works are growing more rapidly than those in the rest of the world. Basically, it's been driven by a production shift of OEM factories to Asia in general and China in particular. Folks like Motorola and Lenovo have moved their U.S. based production of cell phones or PC's, respectively to China which imparts some very significant advantages for the China manufacturers against the Japanese and Korean manufacturers in terms of manufacturing costs, logistics and elimination of potential import duty.

TRANSCRIPT SPONSOR

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China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy.

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I mentioned before, there is something unique about the China market, the replacement cell phone business. There are 416 million cell phone subscribers estimated to be in China today, growing by another 250 million over the next five years. In China, cell phones are sold and resold through an existing distribution network. When you have your two-year old phone you will go to a kiosk that you will see at a retail establishment you will sell that phone and you will get cash if you have decided to upgrade to another phone. And that phone will be passed on towards or say less economically advantaged element of society. So, it's very common to see a cell phone in China that is five or seven-years old that is still in use.

Lastly, our initial business was basically how we started the company was through cell replacement batteries, to the installed base of cell phones. So, that installed base is our available market rather than just the one-off that are being made each year.

A little bit about our technology versus competing technologies. As I said before, I am not going to believe where it is lithium-ion is basically one. We are seeing lithium power technology is migrating now into a number of new high power application and basically it comes down to fundamental core chemistry as Dr. Mao will relate to you. Lithium, if you look at the periodic table is the lightest metal, a pretty good place to start.

As far as application, there were a number of them that the company is currently involved with or we are targeting, may be you can see there is a wide array of applications in use from notebook computers, PDAs, digital cameras, Bluetooth headsets. There's an emerging interest for our technology in the vehicle space Hybrid Electric Vehicles, Light Electric Vehicles, as well as Uninterruptible Power Supply. And product initiative, we became involved with last year we announced was this area of high power, cordless power tools that's a product made by DeWalt, which is a full-format circular saw. The DeWalt's positioning on its product is that it offers the power of a corded device without the cord.

A little bit about the replacement battery market. This is where the company started. It’s the toughest doggy dog part of the business. We've estimated 60% share of the replacement battery market and that is defined by replacement battery manufacturers, third-party independent battery manufacturers. The non-OEM manufactures of replacement battery. That provides a very strong recurring revenue stream to us.

As I mentioned before, it’s our historical core business. We sell steel-case and aluminum-case battery cells to these third-party replacement manufacturers. What I mean by a third-party replacement manufacturer is if you walk into Radio Shack today, you will see Motorola brand batteries and you won't see Nokia brand battery, so you'll see a Radio Shack brand battery. That product was supplied to them by a third-party independent battery manufacture.

We have relationships, we sell the cells and we have relationships with the key battery pack customers which we've listed here. We make relatively few SKU's. And what these battery pack manufacturers do is the assembly operation to take this cell and put it into a battery that would be used for specific cell phone. One thing that’s interesting is that the cell for the Motorola Razor was a cell that was manufactured in configuration five years ago. It just goes into a different battery pack configuration that’s sort of married to that cell phone.

A little bit about the consumable aspect of our business, which we feel is important for people to understand. They are consumable products, especially in high-duty cycle the batteries ultimately wear-off, you can't recharge them. They lose their powerability. So, more devices in use basically installed based of whatever we are selling to create a recurring revenue stream along the lines of the Razor and Razor blade model.

We sell consumables to the installed base, and so our potential market on any specific device installed increases with the installed base. Potential markets for us expanded at geometric rate and basically this small graph, it illustrates that these are yearly device sales. The installed base is these blue bars. So, what we see in that business as far as technology changes or demand changes is rather a good aspect of stability and predictability, because technology changes come in an evolutionary basis rather than a revolutionary basis. I'll give you an example, NiCad and nickel-metal hydride batteries are still being sold today and those technologies basically became somewhat obsolete in the 1980s, but they are still an installed base of devices in use that's what batteries are being manufactured for.

A very core development initiative of our company is to sell through mobile phone OEM. The competitive environment here is not just cost its product safety and those of you who read about what happened last year in the laptop computer space, observed that concerns with safety that can become a very important industry driver in this business. Product safety is the OEM's primary concern. When Dr. Mao was talking to his counterparts and attempting to secure an OEM contract. First and foremost, the OEMs are concerned are can you make a safe product? And a safe product in our case is one where you can demonstrate manufacturing repeatability and there is very little variation from product-to-product in the process.

Today, most OEM cells are manufactured in Japan and Korea, and we believe we have a significant cost manufacturing advantage over the Japanese and Korean suppliers. And basically you will hear a lot about the initiatives we've taken to bring out process repeatability up to a level of those manufacturers.

We've announced a number of new customers in the OEM space, basically every tier-1 OEM manufacturer of cell phones in China. We now sell-through at the close of last quarter. So, we think our next step is going to be targeting the multi-national OEM, for slight Motorola, for slight Nokia and we have qualification underway with several big international tier-1 OEMs and we believe that's a significant opportunity for us.

A little bit about the high-power cells. We are very pleased last year to be partnered with a company. We are a supplier to a company called A123. We are working with them. We manufacture a very high-power cell. It looks like this. In the first high-power cell application of any note was DeWalt 36-volt line of power tools, The Power of Corded without the Cord. That grew in the first year for us fairly substantially. That our sales to A123 Systems you will note in our filings represented 15% of our Q1 2007 revenues. The power tool application was the first application for use of this technology. The high-power product A123 has disclosed that they see application for this technology not only in power tools, but in medical devices as well as the vehicle space, hydroelectric vehicles.

Laptop computer products, was a new product for us last year. We began commercial production last year. There is a very significant increase in sophistication of the manufacturing of this product. You can see what happens when manufacturing goes away if you look at what happened to Sony last year in the laptop cell space.

Process repeatability in the case of this product is absolutely paramount. You don't have it, if there is any manufacturing variability and it causes potential safety issues. There is a lot of power that resides in a lithium-ion cell and it's absolutely critical that a company have control of their process. We have now two fairly significant customers that basically sell in the replacement market and we are in negotiations with several tier-1 OEMs in the laptop computer space. Our production is currently 40,000 pieces per day.

Lithium polymer, a lithium polymer as far as product configuration varies all over the map. You can see these are lithium polymer cells as well as these are. They are utilizing small format batteries that customize in size and shape for specific applications like a Bluetooth headset or like a disposable cell phone. Our current capacity is over 1 million pieces per month and these are the types of applications that we are manufacturing products now.

As far as our ability to compete our competitive positioning, we are relying on two things. The low cost manufacturing structure combined with state-of-the-art technology. Our market restructure, combines automated and manual processes that utilize low cost Chinese labor where it wanted or used automation where it optimizes the cost. We have sourced a lot of automated equipment from PRC in Taiwan and that our new equipment includes products like slitters, electrode processing equipment and winders. They not only decrease cost, but it decreases process variability which in turns improves reliability and safety.

When we sit down with an OEM they don't want to hear about price, they don't want to hear about sample, they want to have discussions with us about our manufacturing processes to assure that there is no human variability that could cause a potential safety issue with the product. You want to be in the tier-1 OEM business and this lithium-ion cell space is having an automated and repeatable process if they felt human variations.

Our world class technical capability, BAK facilities meet or exceed all international standards, and you can see the types of certifications and attestations that we have put into place. We have the most advanced, we believe the most advanced lithium-ion research lab in China and it is on a par we believe with anything you could find with a Korean or a Japanese manufacturer.

Our R&D organization focus is not to invent new technology. It is the take our strength which is the ability to reduce at lab technology to practice and scale it in a manner that we do so, in a very, very low cost manufacturing environment.

Our facilities, we have a 90-acre industrial campus in Shenzhen, which includes an R&D center. We have over 2 million square feet of manufacturing space and at last count over 10,500 employees. We are planning our next expansion will be in Tianjin. We have committed to purchase some land there for some development of new products.

We have built out fully our land campus in the Shenzhen area and also cooperating with a government agency which has been highly supportive of the company. We are planning on establishing a new R&D office in Central Shenzhen, which from a quality of life standpoint, ability to attract very high level technical people, a very desirable location, and we will be completing that facility over the next year.

So I want to summarize a little bit about our growth plans here and we've got about seven minutes. If you look schematically what is the company looking for with regards to expansion? Our core business was this intersection here of the mobile phone products to replacement battery manufacturers. We have very strong relationships in that market. We have commanding mass market share in that market. And basically our growth catalyst in that market is going to be the organic growth of our customers. We don't see increasing share gains being the growth catalyst rather just growing in line with our customers.

The OEM channel distribution or customer base has been the area we've been very much focused on. We have established as automated process control production. That capacity has been established. Our growth catalyst will be new OEM customers. [Blending] the ones who signed on with us recently, as well as, we've disclosed several times that we are targeting some multinational tier-1 OEMs. We've had very good success with the China tier-1 OEMs.

Really about 18 months ago, we were basically replacement battery manufacturer and we have now been fortunate enough to have won business from virtually every, what we consider, major Chinese manufacturer of cell phones in the China space. We're hoping to see their purchases from us grow and develop over the next couple of quarters. And so next step is to target the international tier-1 OEMs.

Laptop computers, is basically we're going to sell both replacement business as well as the OEM business. We established this production about a year and a half ago. I'll tell you when you'll see the factory from a sophistication standpoint, it's a quantum leap over making mobile phone batteries. And this production has now been fully reduced, the fact is we are making production quantity and doing all the things the process manufacturer would have to do in that space, like minimizing waste and scaling the production in a very efficient manner and that involves optimizing and [grading] your quality.

Lithium polymer is an exciting area for us. Well again we established production capability last year. Our growth channel there is new customer development and we continue to add manufacturing capacity. For example, applications. You can see I've got a product here for Bluetooth headsets, and a product here I'm holding in my hand for a disposable cell phone. So, it's an area where small format devices as they grow there are significant new opportunities for us to serve that market.

And there is a whole area of high-power. We've established production of this product in 2006. We supply A123 with a technology called nano-lithium phosphate based cells for their high power applications. The initial application I talked about was Black & Decker DeWalt division, and our goal there is supply A123.

We've also announced our plans to be in the high-power business. We are planning a facility in Tianjin. Our target applications are the uninterruptible power supplies in the light electric vehicle, potential applications for the technologies in the hybrid electric vehicle. We haven't fully disclosed our plans on that and as we get closer [in searching] but once it arrives on revenue opportunities and customer development, we will get back to you and tell you exactly when and what's going to be made in that facility.

A little bit about our management. Mr. Li is our full time CEO. He basically founded the company from nothing, and he's been the architect of its growth. Dr. Mao is with me today, he is our Chief Operating Officer and Chief Technical Officer. I am always amazed as I go through the business and talk to people, everyone who is in this business knows Henry. He's had a very successful tenure at other companies and was educated in Canada and basically provides much needed U.S. or English interface with potential customers. Mr. Han is our Chief Financial Officer and I serve the company as the U.S. based executive.

A bit about finances, last year this is what fiscal 2006 looked like. The first quarter, by the way, our fiscal year ends at the end of September. So the end of December was our first quarter of 2007. We had fairly significant revenue growth, year-over-year. As you can see, we have another pretty good track of developing our revenue. In terms of gross margins, if you've been following the company, it became an area of issue for us in the first quarter of 2007. And certainly it's a management challenge and area of management focus that's receiving a lot of attention.

Net income growth is driven by the gross margin as you can see historically we've shown some very successful development here. Someone made the point to me, that a lot of Chinese companies being listed in the U.S. business and they do around $2 million and $3 million net income. $20 million is a fairly significant amount of net income being generated by a company. As you can imagine there has been a lot of moving parts to customers, production, products, people, and alike to drive this kind of growth.

In our first quarter we were $3.583 million with just a year ago $3.192 million. The reason we didn't get the leverage, as we did have some issues with gross margin being compressed during this quarter.

Little bit about the capital structure, the consumer handouts I won't go through this in detail. A little bit of dollar income statement again, I won't review this in detail but you should probably see the gross margin compression became the area of concern to the business, because it's something that we are hopeful to improve upon.

Our balance sheet is fairly strong. We are a manufacturing business. There is a lot of bricks and mortars and equipment involved in the business.

To summarize here, we are right on track by two minutes. We remain one of the world's largest and fastest growing battery cell manufacturers. We have been growing much more rapidly than the market over the last few years attaining share, and what we've set out to do tactically, we feel, we have accomplished fairly well. We've entered in the new channels and distributions and new products and be able to do that to a fairly significant impact on the company.

We are in a very good market, it's a very large and growing market and it's growing in China. They are expanding number of product opportunities no one knows where lithium power technology is going to end up. But you read some of the exciting things in the Hybrid Electric Vehicle space, where some of the things that the technology could potentially impact in the uninterruptible power supply business. We really think when the first chapter of a technology that’s going to be around for a long time. We have a recurring revenue stream in our business, we sell the installed base. We think that’s a good place to be.

Basically, how we compete with a low cost manufacturing structure combined with the state-of-the-art technical capability. We don’t ask any customers to take a step back in terms of quality or in terms of process repeatability if they buy from us. We believe we offer everything that the Japanese and Korean competitors do. We just do it in low cost structure.

And lastly we have a number of growth opportunities, while those that are short-term catalysts and those that are longer-term upside opportunities for this business. We understand that the channel is executed by both. Executing those opportunities must be taken very seriously, but we remain optimistic about the prospects for the business going forward.

And with that I have with me Dr. Mao, the Chief Operating Officer of the company and myself, and we have Gerry Pascale here who helps with the financial analysis and we will be happy to take questions.

Question-and-Answer Session.

Moderator

We have time for one question and then management team will be available at the break-out room. It's right behind the [Cirius] Room. It's right at the door behind us, but we got time for one question.

Unidentified Audience Member

Question, in case of liability, you could share liability whoever you sell to when there is a product failure? And second question is how many in this kind of business in China is supplying the basic cell?

Jim Groh

The first question was on product liability. We manufacture product to the specification and we sell it to a battery pack manufacturer, where they put in safety circuit tree and they put in configuration. And so we believe our liability is to deliver product that’s right on arrival.

The second question has to do with competitive landscape in China. As far as our product positioning, we believe we are fairly unique that we are offering the automated process repeatable kind of tier-1 OEM quality. There are two companies one is BYD, they are also in this Shenzhen area. Their manufacturing strategy is somewhat different in our space, tend to use a lot of people. They are hand assembled products. There is company called Lishen, which is basically a state-owned enterprise that strategically, the people government decided that they needed this technology resident within the country, especially in the laptop computer space. Dr. Mao set that factory up and they are a niche player but reasonably they have pretty good technology because we know the guy who set it up.

Thank you for your questions.

TRANSCRIPT SPONSOR

China Direct Logo

China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy.

Read all investor conference presentation transcripts here.

To sponsor an investor conference presentation transcript please contact us.

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