CBAK Energy Technology, Inc. - Quarter Report: 2009 December (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the transition period from ____________ to _____________

Commission File No. 001-32898

CHINA BAK BATTERY, INC.
(Exact Name of Registrant as Specified in Its Charter)

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) 8977-0093
(Registrant’s telephone number, including area code)

TABLE OF CONTENTS

PART I
FINANCIAL INFORMATION

PART II
OTHER INFORMATION

Introductory Comments

Terminology

Throughout this Report, the terms “we,” “us” or “our” refers to China BAK Battery, Inc. and its subsidiaries on a consolidated basis; “BAK International” refers to our Hong Kong subsidiary, BAK International Limited; “BAK Tianjin” refers to our PRC subsidiary, BAK International (Tianjin) Ltd.; “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; “BAK India” refers to our Indian subsidiary, BAK Telecom India Private Limited; “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, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements involve known and unknown risks, uncertainties and other factors which could cause actual financial or operating results, performances or achievements expressed or implied by such forward-looking statements not to occur or be realized. Forward-looking statements made in this Report generally are based on our best estimates of future results, performances or achievements, predicated upon current conditions and the most recent results of the companies involved and their respective industries. Forward-looking statements may be identified by the use of forward-looking terminology such as “may,” “will,” “could,” “should,” “project,” “expect,” “believe,” “estimate,” “anticipate,” “intend,” “continue,” “potential,” “opportunity” or similar terms, variations of those terms or the negative of those terms or other variations of those terms or comparable words or expressions. Potential risks and uncertainties include, among other things, such factors as:

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

• our limited operating history in developing, manufacturing and selling of lithium-based rechargeable battery cells;

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

• our future business development, results of operations and financial condition;

• our ability to diversify our product offering and capture new market opportunities;

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

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

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

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

• our ability to maintain an efficient cost structure;

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

i

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

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

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

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

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

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

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

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.

ii

PART I
FINANCIAL INFORMATION

Item 1. Financial Statements.

China BAK Battery, Inc. and subsidiaries
Condensed interim consolidated balance sheets
As of September 30, 2009 and December 31, 2009

(In US$)

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, 2009 and December 31, 2009 (continued)
(In US$)

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 loss
For the three months ended December 31, 2008 and 2009
(Unaudited)
(In US$)

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, 2008 and 2009
(Unaudited)

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, 2008 and 2009
(Unaudited)
(In US$)

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, 2008 and 2009 (continued)
(Unaudited)
(In US$)

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, 2008 and 2009
(Unaudited)

Principal Activities

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

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

Basis of Presentation and Organization

As of December 31, 2009, the Company’s subsidiaries consisted of: i) BAK International Limited (“BAK International”), a wholly owned limited liability company incorporated in Hong Kong on December 29, 2003 as BATCO International Limited, which changed its name to BAK International Limited on November 3, 2004; ii) Shenzhen BAK Battery Co., Ltd. (“Shenzhen BAK”), a wholly owned limited liability company established on August 3, 2001 in the People’s Republic of China (“PRC”); iii) BAK Electronics (Shenzhen) Co., Ltd. (“BAK Electronics”), a wholly owned limited liability company established on August 15, 2005 in the PRC; iv) BAK International (Tianjin) Ltd. (“BAK Tianjin”), a wholly owned limited liability company established on December 12, 2006 in the PRC; v) BAK Battery Canada Ltd. (“BAK Canada”), a wholly owned limited liability company established on December 20, 2006 in Canada as BAK Canada Battery Ltd., which changed its name to BAK Battery Canada Ltd. on December 22, 2006; vi) BAK Europe GmbH (“BAK Europe”), a wholly owned limited liability company established in Germany on November 28, 2007; and vii) BAK Telecom India Private Limited (“BAK India”), a wholly owned limited liability company established in India on August 14, 2008. BAK International beneficially owns 100% of BAK India partly through a nominee agreement with one of its employees.

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

Pursuant to Shenzhen BAK’s articles of association and relevant PRC regulations, BAK International was required to contribute about US$5.72 million to Shenzhen BAK as capital (representing 7% of Shenzhen BAK’s registered capital) no later than October 2008. On May 5, 2009, an approval from Shenzhen Bureau of Trade and Industry was obtained to reduce the required registered capital to US$76,877,480, which had been fully paid up, and on June 22, 2009, an updated business license of Shenzhen BAK from the Business Administration Bureau of Shenzhen was obtained. On December 25, 2009, BAK International contributed approximately US$10,122,520 capital to Shenzhen BAK and as of December 31, 2009, the total contribution from BAK International and Shenzhen BAK’s registered capital was US$87,000,000.

F-7

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

Basis of Presentation and Organization (continued)

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

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

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

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

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

F-8

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

Basis of Presentation and Organization (continued)

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

At the time the escrow shares relating to the 2006 performance threshold were transferred to the investors in fiscal year 2007, the Company should have recognized a credit to donated shares and a debit to additional paid-in capital, both of which are elements of shareholders’ equity. This entry is not material because total shares of common stock issued and outstanding, total shareholders’ equity and total assets do not change; nor is there any impact on income or earnings per share. Therefore, previously filed consolidated financial statements for the fiscal year ended September 30, 2007 will not be restated. This share transfer has been reflected in these financial statements by reclassifying the balances of certain items as of October 1, 2007. The balances of donated shares and additional paid-in capital as of October 1, 2007 were credited and debited by US$7,955,358 respectively.

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

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

Pursuant to the 2008 Settlement Agreements, the Company and the settling investors have agreed, without any admission of liability, to a settlement and mutual release from all claims relating to the January 2005 private placement, including all claims relating to the escrow shares related to the 2005 performance threshold that had been placed into escrow by Mr. Xiangqian Li, as well as all claims, including claims for liquidated damages relating to registration rights granted in connection with the January 2005 private placement. Under the 2008 Settlement Agreement, the Company has made settlement payments to each of the settling investors of the number of shares of the Company’s common stock equivalent to 50% of the number of the escrow shares related to the 2005 performance threshold these investors had claimed; aggregate settlement payments as of December 31, 2009 amounted to 368,745 shares. Share payments to date have been made in reliance upon the exemptions from registration provided by Section 4(2) and/or other applicable provisions of the Securities Act of 1933, as amended. In accordance with the 2008 Settlement Agreements, the Company filed a registration statement covering the resale of such shares which was declared effective by the SEC on June 26, 2008.

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

F-9

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (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, 2010. The Company’s consolidated balance sheet as of September 30, 2009 has been taken from the Company’s audited consolidated balance sheet as of that date. All other financial statements contained herein are unaudited and, in the opinion of management, contain all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of financial position, results of operations and cash flows for the periods presented. The Company’s accounting policies and certain other disclosure are set forth in the notes to the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended September 30, 2009. These financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto.

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

Recently Issued Accounting Standards

In December 2007, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Codification (“ASC”) Topic 810, “Consolidation,” which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The guidance applies to the Company’s financial statements starting in its fiscal year beginning on October 1, 2009. The adoption of ASC Topic 810 has no material impact on the Company’s financial statements.

In December 2007, the FASB issued ASC Topic 805, “Business Combinations,” which 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. ASC Topic 805 is required to be adopted by the Company for business acquisitions for which the acquisition date is on or after October 1, 2009. The adoption of ASC Topic 805 has no material impact on the Company’s financial statements.

In March 2008, the FASB issued ASC Topic 815, “Derivatives and Hedging,” which is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The adoption of ASC Topic 815 has no material impact on the Company’s financial statements.

In April 2008, the FASB issued ASC Topic 350, “Intangibles-Goodwill and Other,” which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). ASC Topic 350 is intended to improve the consistency between the useful life of an intangible asset determined under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141(Revised) and other U.S. GAAP. ASC Topic 350 is effective for fiscal years beginning after December 15, 2008 and is effective for the Company’s fiscal year beginning on October 1, 2009. Early adoption is prohibited. The adoption of ASC Topic 350 has no material impact on the Company’s financial statements.

F-10

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

Recently Issued Accounting Standards (continued)

In April 2009, the FASB issued ASC Topic 805, “Business Combinations,” which amends the provisions in SFAS No. 141 (Revised) for the initial recognition and measurement, subsequent measurement and accounting, and disclosures for assets and liabilities arising from contingencies in business combinations. ASC Topic 805 eliminates the distinction between contractual and non-contractual contingencies, including the initial recognition and measurement criteria in SFAS No. 141 (Revised) and instead carries forward most of the provisions in SFAS No. 141 for acquired contingencies. ASC Topic 805 is effective for contingent assets and contingent liabilities arising from business combinations whose acquisition dates are on or after December 15, 2008. The adoption of ASC Topic 805 has no material impact on the Company’s financial statements.

In June 2009, the FASB issued ASC Topic 860, “Transfers and Servicing,” which improves the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. ASC Topic 860 is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. The adoption of ASC Topic 860 is not expected to have a material impact on the Company’s financial statements.

In June 2009, the FASB issued ASC Topic 810, “Consolidation,” which amends FASB Interpretation No. 46 (revised December 2003) to address the elimination of the concept of a qualifying special purpose entity. ASC Topic 810 also replaces the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity and the obligation to absorb losses of the entity or the right to receive benefits from the entity. Additionally, ASC Topic 810 provides more timely and useful information about an enterprise’s involvement with a variable interest entity. ASC Topic 810 shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. The adoption of ASC Topic 810 is not expected to have a material impact on the Company’s financial statements.

In August 2009, the FASB issued ASU 2009-05, “Fair Value Measurements and Disclosures (Topic 820) – Measuring Liabilities at Fair Value,” or ASU 2009-05. ASU 2009-05 provides additional guidance for measuring the fair value of liabilities and clarifies that the quoted price for the identical liability, when traded as an asset in an active market, is a Level 1 measurement, providing there are no adjustments to the quoted price. Alternatively, when no quoted price is available, ASU 2009-05 affirms the use of other valuation techniques outlined in SFAS No. 157. ASU 2009-05 is effective for the first interim or annual reporting period beginning after its issuance. The adoption of ASU 2009-05 has no material impact on the Company’s financial statements.

In September 2009, the FASB issued ASU 2009-12, “Fair Value Measurements and Disclosures (Topic 820) – Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent),” or ASU 2009-12. ASU 2009-12 amends SFAS No. 157 to permit a reporting entity to measure the fair value of certain investments on the basis of the net asset value per share of the investment (or its equivalent). ASU 2009-12 also requires new disclosures, by major category of investments, about the attributes of investments within the scope of this amendment to the Codification. ASU 2009-12 is effective for interim and annual periods ending after December 15, 2009. Early adoption is permitted. The adoption of ASU 2009-12 has no material impact on the Company’s financial statements.

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

F-11

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

Recently Issued Accounting Standards (continued)

In January 2010, the FASB issued ASU 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements”, or ASU 2010-06. This ASU requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in Codification Subtopic 820-10. The FASB’s objective is to improve these disclosures and, thus, increase the transparency in financial reporting. Specifically, ASU 2010-06 amends Codification Subtopic 820- 10 to now require:

• A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and

• In the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements.

In addition, ASU 2010-06 clarifies the requirements of the following existing disclosures:

• For purposes of reporting fair value measurement for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities; and

• A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements.

ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early application is permitted. The Company is currently evaluating the impact of the adoption of ASU 2010-06 on its financial statements.

Pledged deposits as of September 30, 2009 and December 31, 2009 consisted of the following:

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

Trade accounts receivable as of September 30, 2009 and December 31, 2009 consisted of the following:

F-12

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

An analysis of the allowance for doubtful accounts for the three months ended December 31, 2008 and 2009 is as follows:

Inventories as of September 30, 2009 and December 31, 2009 consisted of the following:

Part of the Company’s inventories with carrying value of US$21,973,836 and US$21,971,583 as of September 30, 2009 and December 31, 2009, respectively, was pledged as collateral under certain loan agreements (see Note 7).

Prepayments and other receivables as of September 30, 2009 and December 31, 2009 consisted of the following:

F-13

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

Property, plant and equipment as of September 30, 2009 and December 31, 2009 consisted of the following:

(i) Depreciation expense for the three months ended December 31, 2008 and 2009 is included in the condensed interim consolidated statements of operations and comprehensive loss as follows:

(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, 2008 and 2009, the Company capitalized interest of  US$175,298 and US$181,057 to the cost of construction in progress.

(iii) Pledged Property, Plant and Equipment

As of September 30, 2009 and December 31, 2009, machinery and equipment with net book value of US$67,873,955 and US$65,968,067 of the Company were pledged as collateral under certain loan arrangements (see Notes 7 and 8).

F-14

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

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

As of September 30, 2009 and December 31, 2009, the Company had several short-term bank loans with aggregate outstanding balances of US$139,159,380 and US$125,044,458, respectively. The loans were primarily obtained for general working capital, carried interest rates ranging from 0.30% to 5.31% per annum, and had maturity dates ranging from 6 to 12 months. Each loan is guaranteed by Mr. Xiangqian Li, who did not receive any compensation for acting as guarantor.

As of December 31, 2009, the Company had pledged the land use rights certificate in relation to the land on which Shenzhen BAK’s corporate campus had been constructed for short-term bank loans amounting to US$58,590,889 borrowed from Shenzhen Eastern Branch, Agricultural Bank of China. As of December 31, 2009, the aggregate net book value of the buildings and land use rights in relation to the land use rights certificate was US$105,289,483.

As of September 30, 2009 and December 31, 2009, the Company had long-term bank loans of US$55,667,052 and US$46,872,711, respectively. As of December 31, 2009, US$5,859,089 was borrowed under a four-year long-term loan credit facility from China Development Bank, bearing interest at the benchmark rate of the People’s Bank of China (“PBOC”) for three-year to five-year long-term loans, which is currently 5.76% per annum. This long-term bank loan is repayable on December 26, 2010.

Three other long-term loans totaled an aggregate borrowed amount of US$21,971,583 as of December 31, 2009. These loans were borrowed under a five-year long-term loan credit facility from Shenzhen Eastern Branch, Agricultural Bank of China, and carry interest at 90% of the benchmark rate of the PBOC for three-year to five-year long-term loans. The first loan of US$5,859,089 currently carries interest at 5.184% per annum and is repayable on January 25, 2012. The second loan of US$11,718,177 currently carries annual interest of 5.184% and is repayable in three installments of US$2,929,544 on January 25, 2010, US$7,323,861 on January 25, 2011 and US$1,464,772 on January 25, 2012, respectively. The third loan of US$4,394,317 currently carries annual interest of 5.76% and is repayable on January 25, 2010.

Another loan of US$19,042,039 as of December 31, 2009 was borrowed under a four-year long-term loan credit facility from Tianjin Branch, Agricultural Bank of China and carries interest at the benchmark rate of the PBOC for three-year to five-year long-term loans, which is currently 5.76% per annum. This loan is repayable in three installments of US$4,394,317 on December 26, 2010, US$7,323,861 on December 26, 2011, and US$7,323,861 on May 26, 2012.

The long-term bank loan with China Development Bank is: (i) guaranteed by Mr. Xiangqian Li; (ii) secured by certain shares of the Company owned by Mr. Xiangqian Li; and (iii) to be secured by the property ownership and land use rights certificate relating to the land on which the Company’s Research and Development Test Centre is to be constructed and the facilities to be constructed thereon. As of December 31, 2009, the Company had obtained the relevant land use rights certificate and was in the process of negotiating with the relevant government bureau for the requisite approval to pledge it as described.

F-15

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

The long-term bank loan with Shenzhen Eastern Branch, Agricultural Bank of China is: (i) guaranteed by Mr. Xiangqian Li; (ii) secured by the Company’s machinery and equipment with carrying values of US$33,795,706 as of December 31, 2009 (see Note 6); and (iii) secured by the property ownership certificate and land use rights certificate in relation to the land on which Shenzhen BAK’s corporate campus had been constructed and any machinery and equipment purchased and used in the campus subsequent to such construction.

The long-term bank loan with Tianjin Branch, Agricultural Bank of China is secured by the machinery and equipment purchased for the automated high-power lithium-phosphate cells production line in Tianjin. As of December 31, 2009, construction of the automated high-power lithium-phosphate cells production line was in progress.

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

The aggregate maturities of long-term bank loans as of December 31, 2009 are as follows:

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

Stock Option Plan

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

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

F-16

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

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

A summary of share option plan activity for these options during the three months ended December 31, 2009 is presented below:

(1) Aggregate intrinsic value represents the value of the Company’s closing stock price on December 31, 2009 (US$2.78) in excess of the exercise price multiplied by the number of options outstanding or exercisable.

The weighted-average grant-date fair value of options granted during 2005 was US$3.67 per share. No non-cash share-based compensation expense was recognized in respect of these share options for the three months ended December 31, 2008 and 2009.

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:

As of December 31, 2009, there were no unrecognized compensation costs related to non-vested share options.

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

F-17

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

A summary of share option plan activity for these options during the three months ended December 31, 2009 is presented below:

(1) Aggregate intrinsic value represents the value of the Company’s closing stock price on December 31, 2009 (US$2.78) in excess of the exercise price multiplied by the number of options outstanding or exercisable.

The weighted-average grant-date fair value of options granted during 2007 was US$2.15 per share. The Company recorded non-cash share-based compensation expense of US$183,829 and US$58,002 for the three months ended December 31, 2008 and 2009 respectively, in respect of share options granted in 2007, which was allocated to cost of revenues, sales and marketing expenses, general and administrative expenses and research and development expenses respectively.

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

As of December 31, 2009, there were unrecognized compensation costs of US$212,821 related to the above non-vested share options. These costs are expected to be recognized over a weighted average period of 1.3 years.

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

F-18

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

A summary of share option plan activity for these options during the three months ended December 31, 2009 is presented below:

(1) Aggregate intrinsic value represents the value of the Company’s closing stock price on December 31, 2009 (US$2.78) in excess of the exercise price multiplied by the number of options outstanding or exercisable.

The weighted average grant-date fair value of options granted on January 28, 2008 was US$3.59 per share. The Company recorded non-cash share-based compensation expense of US$148,989 and US$60,183 for the three months ended December
31, 2008 and 2009, respectively, in respect of share options granted on January 28, 2008, which was allocated to general and administrative expenses and research and development expenses respectively.

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

As of December 31, 2009, there were unrecognized compensation costs of US$115,321 related to the above non-vested share options. These costs are expected to be recognized over a weighted average period of 0.6 years.

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

F-19

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

A summary of share option plan activity for these options during the three months ended December 31, 2009 is presented below:

(1) Aggregate intrinsic value represents the value of the Company’s closing stock price on December 31, 2009 (US$2.78) in excess of the exercise price multiplied by the number of options outstanding or exercisable.

The weighted average grant-date fair value of options granted on May 29, 2008 was US$2.36 per share. The Company recorded non-cash share-based compensation expense of US$462,688 and US$195,063 for the three months ended December 31, 2008 and 2009 respectively, in respect of share options granted on May 29, 2008, which was allocated to general and administrative expenses and research and development expenses respectively.

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

As of December 31, 2009, there were unrecognized compensation costs of US$551,508 related to the above non-vested share options. These costs are expected to be recognized over a weighted average period of 1.2 years.

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

F-20

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

A summary of share option plan activity for these options during the three months ended December 31, 2009 is presented below:

(1) Aggregate intrinsic value represents the value of the Company’s closing stock price on December 31, 2009 (US$2.78) in excess of the exercise price multiplied by the number of options outstanding or exercisable.

The weighted average grant-date fair value of options granted on June 22, 2009 was US$2.46 per share. The Company recorded non-cash share-based compensation expense of US$614,860 for the three months ended December 31, 2009, in respect of share options granted on June 22, 2009, which was allocated to general and administrative expenses and research and development expenses respectively.

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

As of December 31, 2009, there were unrecognized compensation costs of US$3,228,870 related to the above non-vested share options. These costs are expected to be recognized over a weighted average period of 2.6 years.

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

F-21

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

A summary of share option plan activity for these options during the three months ended December 31, 2009 is presented below:

(1) Aggregate intrinsic value represents the value of the Company’s closing stock price on December 31, 2009 (US$2.78) in excess of the exercise price multiplied by the number of options outstanding or exercisable.

The weighted average grant-date fair value of options granted on June 26, 2009 was US$2.86 per share. The Company recorded non-cash share-based compensation expense of US$27,374 for the three months ended December 31, 2009, in respect of share options granted on June 26, 2009, which was allocated to research and development expenses.

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

As of December 31, 2009, there were unrecognized compensation costs of US$147,826 related to the above non-vested share options. These costs are expected to be recognized over a weighted average period of 2.6 years.

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

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

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

F-22

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

The Company recorded non-cash share-based compensation expense of US$22,022 for the three months ended December 31, 2008, in respect of the restricted shares granted in August 2008, which was allocated to general and administrative expenses. No non-cash share-based compensation expense was recognized for the three months ended December 31, 2009.

As of December 31, 2009, there were no unrecognized stock-based compensation costs associated with these restricted shares granted to non-employee directors. All of the restricted shares were issued as fully paid shares of common stock to the Company’s three independent directors on August 6, 2008, October 20, 2008, March 2, 2009 and April 2, 2009, respectively.

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

The Company recorded non-cash share-based compensation expense of US$179,682 for the three months ended December 31, 2009, in respect of the restricted shares granted in June 22, 2009, which was allocated to general and administrative expenses.

As of December 31, 2009, there were unrecognized stock-based compensation costs of US$961,118 associated with these restricted shares granted to Mr. Xiangqian Li. These costs are expected to be recognized over a weighted-average period of 2.6 years.

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

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

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

The Company recorded non-cash share-based compensation expense of US$10,046 for the three months ended December 31, 2009, in respect of the restricted shares granted in June 2009, which was allocated to general and administrative expenses.

As of December 31, 2009, there were unrecognized stock-based compensation costs of US$3,794 associated with these restricted shares granted to non-employee directors. The first and second 25% of the restricted shares were already issued as fully paid shares of common stock to the Company’s three independent directors on July 24, 2009 and November 16, 2009, respectively.

As the Company itself is an investment holding company which is not expected to generate operating profits to realize the tax benefits arising from its net operating loss carried forward, no income tax benefits were recognized for such stock-based compensation cost under the Stock Option Plan for the three months ended December 31, 2008 and 2009.

F-23

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

The calculation of basic net loss per share is based on the net loss for the three months ended December 31, 2009 attributable to equity shareholders of $3,392,327 (Three months ended December 31, 2008: $1,738,748) and the weighted average number of shares of common stock of 61,107,713 issued and outstanding during the three months ended December 31, 2009 (Three months ended December 31, 2008: 56,958,386).

The effects of 3,100,000 shares of stock options and 7,500 shares of restricted stock outstanding during the three months ended or as of December 31, 2008 were all anti-dilutive and the effects of 4,460,655 shares of stock options, 507,500 shares of restricted stock and 1,447,500 warrants outstanding during the three months ended or as of December 31, 2009 were all anti-dilutive. As such, basic and diluted net loss per share for the three months ended December 31, 2008 and 2009 are the same.

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

As of September 30, 2009 and December 31, 2009, the Company had the following contracted capital commitments:

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

The Company did not obtain the land use right certificate and approvals for project-planning and construction relating to the premises occupied by the Company, BAK Industrial Park, before construction of the buildings was commenced. On July 3, 2009, the Company had obtained the approval for project-planning and construction from the local government of Shenzhen. As of December 31, 2009, the Company has obtained the aforementioned land use rights certificate and government approvals and was in the process of negotiating with the relevant government for the application and acquisition of the appropriate property ownership certificate.

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

F-24

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

Pursuant to the land use rights certificate relating to the Company’s Tianjin facility, the Tianjin government had requested that the Company complete the construction of the Tianjin facility before September 30, 2008. As of December 31, 2009, the Company was in the process of negotiating with the relevant government bureau for the extension of the completion date. If the Company fails to obtain the approval for the extension of the completion date from the relevant government bureau, there is a risk that the land use rights certificate relating to the Company’s Tianjin facility will become invalid. However, management believes that this possibility, while present, is remote.

Pursuant to the property ownership and land use rights certificate that the Company obtained relating to the Research and Development Test Centre to be constructed in Shenzhen, the Company must complete at least 25% of the construction of the Research and Development Test Centre by September 30, 2008. On November 11, 2008 and May 27, 2009, the Company has signed two supplement agreements with Shenzhen government to increase the dimensions of the Research and Development Test Centre. According to the supplement agreements, the Company is required to complete the construction by May 6, 2011. According to the property ownership and land use rights certificate, such rights may not be pledged without the approval of the relevant government office. The Company is required to pledge its property ownership and land use rights certificate in relation to the Research and Development Test Centre to China Development Bank according to the loan agreement entered into with it. As of December 31, 2009, the Company was in the process of negotiating with the relevant government for the requisite approval.

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

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

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

F-25

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

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

Management has assessed the fair value of the obligation arising from the above financial guarantees and considered it immaterial to the condensed interim consolidated financial statements. Therefore, no obligations in respect of the above guarantees were recognized as of December 31, 2009.

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

The Company's outstanding discounted and transferred bills as of September 30, 2009 and December 31, 2009 are summarized as follows:

F-26

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

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

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

If the court were to issue an adverse decision, the Company could face a substantial monetary damages award. While such an adverse decision could also prohibit the Company from future production of rechargeable lithium cells manufactured for A123Systems or may require the Company to pay royalties to engage in any such production, the Company has no plans to pursue production of batteries for A123. The court has not issued any substantive decisions in the litigation and there has been no substantive pretrial discovery. As a result, at this time, the Company is unable to express a view on the extent of any possible award of damages that might be rendered in the litigation.

No customer individually comprised 10% or more of net revenue for the three months ended December 31, 2008 and 2009.

Financial instruments that potentially subject the Company to a significant concentration of credit risk consist primarily of cash and cash equivalents and pledged deposits. As of September 30, 2009 and December 31, 2009, substantially all of the Company’s cash and cash equivalents and pledged deposits were held by major financial institutions located in the PRC, which management believes are of high credit quality.

F-27

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
For the three months ended December 31, 2008 and 2009 (continued)
(Unaudited)

The Company currently engages in the manufacture, commercialization and distribution of a wide variety of standard and customized lithium ion rechargeable batteries for use in a wide array of applications. During the three months ended December 31, 2009, the Company manufactured six types of Li-ion rechargeable batteries: aluminum-case cell, battery pack, steel-case cell, 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, 2008 and 2009 were as follows:

Net revenues by product:

Net revenues by geographic area:

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

The Company has evaluated all subsequent events through February 9, 2010, the date these financial statements were issued, and determined that there were no subsequent events or transactions that required recognition or disclosure in the financial statements.

F-28

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

Overview

Although the business climate in China is recovering, the global economic environment remains weak. During the first quarter of fiscal year 2010, we generated $50.2 million in net revenues, down 12.7% from $57.6 million in the last quarter of 2009 and down 26.2% from $68.1 million in the first quarter of 2009. The decrease in net revenues was due to slower sales of cylindrical battery cells caused by fierce market competition on price.

In the first quarter of fiscal year 2010, we continued to implement our aggressive cost management program to reduce costs and expenses and enhance our quality control. As a result, our gross margin rose to 19.0% . We also have been focusing on developing new revenue sources in our domestic market and abroad. We won a $27.0 million bid to supply cell phone batteries directly to ZTE Corporation in the first half of 2010, and BAK Tianjin won its first major contract for high power batteries for electric buses.

We anticipate operating challenges due to the difficult business environment. These challenges may cause our revenues and gross margin to stop increasing. In response, we plan to continue to improve yield rate and to seek cost-saving methods of reducing material costs with the goal of maintaining our manufacturing cost advantage.

We have access to $234.7 million in short-term credit facilities and $46.9 million in long-term credit facilities. As of December 31, 2009, the principal outstanding amounts on these facilities included short-term bank loans of $125.0 million, long-term bank loans of $17.6 million maturing within one year and long-term bank loans of $29.3 million maturing after one year. At the same time our bills payable totaled $48.9 million, leaving $79.7 million of short-term funds available for additional cash needs. In addition, on July 10, 2008, our $60.0 million shelf registration statement was declared effective by the SEC, pursuant to which we have raised $36.6 million in gross proceeds from sales of common stock and issued common stock warrants exercisable for up to $21.6 million in additional gross proceeds. As $16.0 million of these warrants were not exercised before their expiration, we may raise up to an additional $17.8 million in gross proceeds from future equity financings under this shelf registration statement.

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

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

1

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 17.0% 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.

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

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

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

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

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

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

Income Taxes. Under PRC income tax laws and regulations, before January 1, 2008, a foreign-invested enterprise, or FIE, was generally subject to an enterprise income tax rate of 33.0%, which included a 30% state income tax and a 3.0% local income tax. However, from at least calendar year 2002 through calendar year 2007, an enterprise recognized as a “Manufacturing Enterprise Located in Special Economic Zone” under PRC tax laws was entitled to a preferential income tax rate of 15%. Moreover, a foreign-invested manufacturing enterprise, starting from its first profitable calendar year after offset of accumulated tax losses, was entitled to a two-year exemption from enterprise income tax followed by a three-year 50% reduction in its enterprise income tax rate, also referred to herein as the “tax holiday.” An enterprise qualified for such treatment may receive a further tax rate reduction related to the size of qualified capital contributions received. In addition, from at least calendar year 2002 through calendar year 2007, an enterprise qualified as an “advanced technology enterprise” under PRC tax law was also entitled to a 50% reduction of income taxes.

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

2

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

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

For BAK Electronics, established in August 2005, the same tax holiday was in effect for calendar years 2006 and 2007, making BAK Electronics fully exempt from any enterprise income tax. Following the tax holiday, a three-year 50% reduction in BAK Electronics’ enterprise income tax rate commenced. Pursuant to the transition period of the New CIT Law, BAK Electronics’ income tax rates for calendar years 2009, 2010 and 2011 were expected to be 20%, 22% and 24%, respectively, and starting in calendar year 2012 it was expected to be subject to an income tax rate of 25%. Taking the 50% reduction into account, BAK Electronics’ income tax rates are now expected to be 10%, 11% and 24% for calendar years 2009, 2010 and 2011, respectively, with no change in its expected 2012 tax rate of 25%. BAK Electronics did not incur any enterprise income tax for the calendar year 2009 due to the current tax losses carried forward from calendar year 2008.

Shenzhen BAK and BAK Electronics received in aggregate a tax benefit of $9,000 pursuant to their tax holiday and preferential tax rate for the three months ended December 31, 2009, or $0.0001 per basic share.

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

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

Our effective tax benefit rate was 27.3% for the three months ended December 31, 2009 and our effective tax benefit rate was 9.2% for the three months ended December 31, 2008.

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

Results of Operations

Comparison of Three Months Ended December 31, 2009 and December 31, 2008

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

3

Net Revenues. Net revenues decreased to $50.2 million for the three months ended December 31, 2009 as compared to $68.1 million for the same period of the prior year, a decrease of $17.9 million or 26.2% . The following sets forth the breakdown of our net revenues by battery cell type for the periods indicated.

• Net revenues from sales of aluminum-case cells decreased to $27.9 million in the three months ended December 31, 2009, from $37.3 million in the same period in fiscal year 2008, a decrease of $9.5 million or 25.3%, resulting from a decrease in our average selling price of 12.6% and sales volume of 13.8% driven by decreased sales to the OEM market in the PRC.

4

• Net revenues from sales of battery packs increased to $10.9 million in the three months ended December 31, 2009, from $5.4 million in the same period in fiscal year 2008, an increase of $5.6 million or 101.9%. This resulted from an increase in sales volume of 129.3% due to increased export sales, offset by a 10.3% decrease in average selling price.

• We sold $3.1 million in steel-case cells for the three months ended December 31, 2008 as compared to no sales for the three months ended December 31, 2009. This change was primarily attributable to our long- term strategic reduction and suspension of steel-case cell production in January 2009 which was designed to increase our production capacity of aluminum-case cells for sale to the OEM market and to take advantage of the greater sales prospects and lower costs of aluminum-case cells.

• Net revenues from sales of cylindrical cells decreased to $8.1 million in the three months ended December 31, 2009, from $18.4 million in the same period in fiscal year 2008, a decrease of $10.3 million or 55.9%, due to a decrease in our average selling prices of 25.5% driven by fierce market competition on price and sales volume of 40.7% driven by decreased sales to laptop manufacturers.

• We sold $3.2 million in lithium polymer cells in the three months ended December 31, 2009, compared to $3.9 million in lithium polymer cells in the same period in fiscal year 2008, a decrease of $852,000 or 21.2%, resulting from decreases of 10.1% in our average selling price and 12.4% in sales volume.

• We also sold approximately $163,000 in high-power lithium-phosphate cells in the three months ended December 31, 2009, as compared to no sales of this battery cell type in the same period of fiscal year 2008, due to our sale of sample products used in electric bicycles, power tools, uninterruptible power supplies, and other applications from our Tianjin facility.

Cost of Revenues. Cost of revenues decreased to $40.7 million for the three months ended December 31, 2009, as compared to $57.5 million for the same period in fiscal year 2008, a decrease of $16.8 million or 29.3% . The decrease in cost of revenues correlates to a decrease in sales volume over the three months ended December 31, 2009.

As a result, gross profit for the three months ended December 31, 2009 was $9.6 million or 19.0% of net revenues as compared to gross profit of $10.6 million or 15.6% of net revenues for the same period in fiscal year 2008. Our increase in gross profit as a percentage of net revenues was primarily due to the greater proportion of sales of battery packs with higher gross margin during the three months ended December 31, 2009.

Research and Development Costs. Research and development costs increased to $1.8 million for the three months ended December 31, 2009, as compared to $1.4 million for the same period in fiscal year 2008, an increase of $350,000 or 24.7%, due to salaries related to R&D staff increased by $254,000 primarily due to hiring more research experts during the three months ended December 31, 2009.

Sales and Marketing Expenses. Sales and marketing expenses increased to $2.0 million for the three months ended December 31, 2009, as compared to $1.6 million for the same period in fiscal year 2008, an increase of $428,000 or 26.8% . Equity-based compensation included in sales and marketing expenses increased by $140,000 due to compensation charges applied to the grant of stock options to employees in our sales department on June 22, 2009. As a percentage of revenues, sales and marketing expenses have increased to 4.0% for the three months ended December 31, 2009 from 2.3% for the same period in 2008, due to the significant decrease in revenues from sales.

General and Administrative Expenses. General and administrative expenses increased to $8.6 million, or 17.2% of revenues, for the three months ended December 31, 2009, as compared to $6.8 million or 9.9% of revenues, for the same period in fiscal year 2008, an increase of $1.9 million or 27.8% . Bad debt expenses increased by $2.4 million due to the provision charged after we had assessed the collection of accounts receivables from customers during the three months ended December 31, 2009.

In addition, we became liable for liquidated damages to certain shareholders whose shares were included in a resale registration statement on Form S-3 that we filed pursuant to a registration rights agreement that we entered into with such shareholders in relation to a private placement that we closed in November 2007. The SEC did not declare this registration statement effective by a certain date, and under the November 2007 registration rights agreement, the included selling shareholders became eligible for liquidated damages of approximately $561,000 as of December 31, 2008. Please see Part I, Item 3. “Legal Proceedings — Liquidated Damages Pursuant to November 2007 Registration Rights Agreement” for a further description of these liquidated damages. We therefore recognized in general and administrative expenses an amount of approximately $561,000 for the liquidated damages for the three months ended December 31, 2008.

5

On August 26, 2008, we conducted a registered direct offering of 4,102,564 shares of common stock, at an offering price of $3.90 per share, in which the investors also received warrants to purchase up to 4,102,564 shares of common stock at an exercise price of $3.90 per share. With one exception, all of the investors that participated in our November 2007 private placement, or affiliates of them, participated in our August 2008 registered direct offering. We reduced each of these investors’ (or each such investor’s participating affiliate’s) purchase price by an amount that was at least equal to the amount that we determined that we were liable for as liquidated damages to such investor (or its participating affiliate). As of December 31, 2009, the remaining investor had waived any and all rights relating to liquidated damages pursuant to the November 2007 registration rights agreement. As of December 31, 2009, no liquidated damages were recognized as general and administrative expenses. Pursuant to the settlements described above, we do not believe that we were liable for any amounts under this agreement.

As described under Part I, Item 3. “Legal Proceedings — Make Good Settlements” we have entered into settlement agreements pursuant to which we have issued shares to certain shareholders that purchased shares in a January 20, 2005 private placement transaction in settlement of claims related to the private placement, including claims for liquidated damages. Pursuant to the settlement agreements, the claims of each shareholder are released as of the applicable “release date” which occurred on June 26, 2008, the date the resale registration statement we filed relating to resales by the settling shareholders of the shares issued pursuant to the settlement agreement was declared effective by the SEC. We expect such settlements may result in gains in one or more future periods in accordance with their waivers of claims to liquidated damages.

Operating Income / (Loss). As a result of the above, operating loss totaled $2.9 million for the three months ended December 31, 2009, as compared to operating income of $816,000 for the same period of the prior year, a decrease of $3.7 million or 452.1% .

Finance Costs, Net. Finance costs, net, decreased to $2.2 million for the three months ended December 31, 2009, as compared to $2.8 million for the same period of the prior fiscal year, a decrease of $686,000 or 24.2% . We have $125.0 million in short-term bank loans maturing in less than one year, $17.6 million in long-term bank loans maturing within one year, and $29.3 million in other long-term bank loans maturing in more than one year, outstanding as of December 31, 2009, as compared to $112.1 million in short-term bank loans maturing in less than one year, $13.2 million in long-term bank loans maturing within one year, and $46.9 million in other long-term bank loans maturing in more than one year, outstanding as of December 31, 2008. The decrease in net finance costs is mainly attributable to a significant decrease in the average bank loan interest rates on both our short-term and long-term bank loans.

Government Grant Income / Other Income / (Other Expenses). We had deferred revenue from government grant income of $355,000 and other income of $7,000 for the three-month period ended December 31, 2009, as compared to government grant income of $102,000 and other income of $6,000 for the same period of the prior fiscal year. The government grants income for the three months ended December 31, 2009 mainly consisted of subsidies to pay for the land use rights to our corporate campus at BAK Industrial Park and government grant funds to subsidize a new high-technology project in the calendar year 2009. Government grants income for the three months ended December 31, 2008 mainly consisted of receipt of grant funds to subsidize the interest expenses incurred by the Company in prior years for research and development activities, to reward Shenzhen BAK for its contributions to the Shenzhen economy, and to subsidize the payment for land use rights of BAK Industrial Park. No present or future obligation will arise from the receipt of such income.

Income Tax Benefits. Income tax benefits were $1.3 million for the three months ended December 31, 2009, as compared to income tax benefits of $176,000 for the same period of 2008. The change was the result of an increase in our deferred tax provision during the quarter ended December 31, 2009.

6

Net Loss. As a result of the foregoing, we had a net loss of $3.4 million for the three months ended December 31, 2009 compared to $1.7 million for the same period of 2008.

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, 2009, we had cash and cash equivalents of $18.3 million, as compared to $30.7 million as of September 30, 2009. In addition, we had pledged deposits amounting to $19.0 million and $31.1 million as of December 31, 2009 and September 30, 2009, respectively. Typically, our banks require their borrowers to maintain deposits of approximately 10% to 100% of the outstanding loan balances and bills payable. The individual bank loans have maturities ranging from six to twelve months which coincides with the periods the cash remains pledged to the banks.

We had access to $234.7 million in short-term credit facilities and $46.9 million in long-term credit facilities as of December 31, 2009. As of December 31, 2009, the principal outstanding amounts included short-term bank loans of $125.0 million, long-term bank loans of $17.6 million maturing within one year, and long-term bank loans of $29.3 million maturing in over one year, and bills payable of $48.9 million, leaving $79.7 million of short-term funds available for additional cash needs. In addition, on July 10, 2008, our $60.0 million shelf registration statement was declared effective by the SEC, pursuant to which we have raised $36.6 million in gross revenue from common stock purchases and issued common stock warrants exercisable for up to $21.6 million in additional gross proceeds. As $16.0 million of these warrants were not exercised before their expiration, we may raise up to an additional $17.8 million in gross proceeds from future equity financings under this shelf registration statement.

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

Operating Activities

Net cash used in operating activities was $17.4 million in the three months ended December 31, 2009, compared to $21.1 million of net cash provided by operating activities in the same period in fiscal year 2008. The decrease of $38.6 million in operating activities was mainly attributable to an increase in prepayments to our lithium cobalt dioxide suppliers. We purchased more lithium cobalt dioxide, the main raw material in our products, in anticipation of the higher future cost of lithium cobalt dioxide. We also increased our inventory of aluminum-case cells and cylindrical cells as of December 31, 2009 in the expectation of increased sales in the coming months.

Investing Activities

Net cash used in investing activities decreased from $20.1 million in the three months ended December 31, 2008, to $3.9 million in the same period in fiscal year 2009. The net cash used in investing activities during the period ended December 31, 2009 was mainly used for procurement of machinery and equipment for cylindrical cell line and prismatic cell production line.

Financing Activities

7

Net cash provided by financing activities was $8.9 million in the three months ended December 31, 2009, compared to net cash provided by financing activities of $530,000 in the same period in 2008. This was mainly attributable to (i) net proceeds of $19.4 million from a private placement of our common stock completed in October 2009, (ii) a $227,000 increase in net proceeds from our issuance of capital stock pursuant to exercises of certain stock options in the three months ended December 31, 2009, (iii) a $12.1 million decrease in cash deposits at banks as collateral in the three months ended December 31, 2009, and (iv) decreased borrowings, net of repayments, of $22.8 million in the three months ended December 31, 2009.

As of December 31, 2009, the principal amounts outstanding under our credit facilities and lines of credit were as follows:

The above principal outstanding amounts under credit facilities and lines of credit included short-term bank loans of $125.0 million, long-term bank loans of $17.6 million maturing within one year and long-term bank loans of $29.3 million maturing in over one year, and bills payable of $48.9 million.

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

During the three months ended December 31, 2009, we entered into four new comprehensive credit facility agreements for a maximum loan amount of $102.9 million, repaid two loans totaling $14.6 million, and entered into seven new short-term bank loan agreements totaling $40.9 million. The four new credit facilities are with Shenzhen

8

Hi-Tech District Branch, Industrial Bank (“Industrial Bank”), Shenzhen Development Bank, Longgang Branch (“Shenzhen Development Bank”), Agricultural Bank – Shenzhen Branch (“Agricultural Bank”) and Tianjin Branch, Bank of Dalian (“Bank of Dalian”). The seven new short-term loan agreements include one loan agreement with Shenzhen Development Bank, totaling $2.9 million, one loan agreement with Bank of Dalian, totaling $2.9 million, one loan agreement with Shanghai Pudong Development Bank, totaling $1.5 million, one loan agreement with Bank of China, totaling $0.6 million, and three loan agreements with Agricultural Bank of China, Shenzhen Eastern Branch (“Agricultural Bank – Shenzhen Branch”), totaling $33.0 million. The material financing terms of these loans are described below.

On April 26, 2009, we entered into a comprehensive credit facility agreement with Bank of Communications to provide a maximum loan amount of RMB 200 million (approximately $29.3 million). This credit facility agreement is guaranteed by BAK Tianjin and Mr. Xiangqian Li. Loans may be drawn at any time from March 25, 2009 to March 25, 2010. As of December 31, 2009, we had borrowed approximately $7.3 million under a loan agreement dated June 23, 2009, bearing fixed interest of 4.779%, and which is repayable on June 23, 2010.

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

On November 27, 2009, we entered into a comprehensive credit facility agreement with Bank of Dalian for a maximum loan amount of RMB 40 million (approximately $5.9 million). If we increase paid-up capital by $20 million, then an additional RMB 10 million of credit facilities would be available. If we pay up 50% of our total registered capital, an another additional RMB 10 million of credit facilities would be available. If we pay up all our registered capital, the total amount of available credit under this facility would be RMB 80 million (approximately $11.8 million). This credit facility agreement is guaranteed by Shenzhen BAK and Mr. Xiangqian Li. Loans may be drawn at any time from November 27, 2009 to November 26, 2010. As of December 31, 2009, we had borrowed approximately $2.9 million under a loan agreement dated November 27, 2009 bearing annual interest of 5.31%, adjusted monthly, and which is repayable on November 26, 2010 under this credit facility agreement.

On December 25, 2009, we entered into a comprehensive credit facility agreement with Industrial Bank for a maximum loan amount of RMB 62.5 million (approximately $9.2 million). This credit facility agreement is guaranteed by BAK International, BAK Tianjin and Mr. Xiangqian Li. Loans may be drawn at any time from December 31, 2009 to December 31, 2010. As of December 31, 2009, we had no borrowings under this credit facility agreement.

As of December 31, 2009, we had also borrowed $3.6 million of notes payable outside any credit facility.

On January 21, 2009, we entered into a comprehensive credit facility agreement with Shenzhen Nanshan Branch, China Everbright Bank (“China Everbright Bank”) to provide a maximum loan amount of RMB 100 million (approximately $14.6 million). Loans may be drawn at any time from March 30, 2009 to March 30, 2010. As of December 31, 2009, we had borrowed $4.4 million of notes payable under this facility.

On December 31, 2009, we renewed our comprehensive credit facility agreement with Shenzhen Development Bank to provide a maximum loan amount of RMB 200 million (approximately $29.3 million). Loans may be drawn at any time over the one-year period beginning December 31, 2009 and will be due based on each loan agreement. This credit facility agreement is guaranteed by BAK International, BAK Tianjin and Mr. Xiangqian Li, and is also secured by $22.0 million of inventory and $5.0 million of machinery and equipment. As of December 31, 2009, we had borrowed approximately $2.9 million under a loan agreement dated December 31, 2009 under this credit facility agreement, bearing a floating interest rate equal to 95% of the PBOC’s benchmark rate on the date of the loan agreement and adjusted quarterly, and which was repayable on December 31, 2010.

9

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

As of December 31, 2009, we had six outstanding short-term loans under the comprehensive credit facility with Agricultural Bank – Shenzhen Branch totaling approximately $58.6 million, carrying annual interest at 4.86%, 4.617% and 5.31%, adjusted quarterly. The first loan, of approximately $11.0 million, currently carries annual interest of 5.31% and is due on January 5, 2010. The second loan, of approximately $7.3 million, currently carries annual interest at 4.617% and is due on January 21, 2010. The third loan, of approximately $7.3 million, currently carries annual interest at 4.617% and is due on January 22, 2010. The fourth loan, of approximately $13.2 million, currently carries annual interest at 4.86% and is due on May 17, 2010. The fifth loan, of approximately $8.8 million, currently carries annual interest at 4.86% and is due on May 19, 2010. The sixth loan, of approximately $11.0 million, currently carries annual interest at 4.86% and is due on May 21, 2010. Each of the loan agreements specifically provides for acceleration of repayment of the loan under certain conditions, as well as other penalties and remedies. We also had borrowed three short-term loans separate from our credit agreement with Agricultural Bank – Shenzhen Bank totaling $4.0 million, carrying annual interest at 0.29643% and 0.34786% . The first loan, of approximately $0.32 million, carries annual interest of 0.29643% and is repayable on May 26, 2010. The second loan, of approximately $0.68 million, carries annual interest of 0.41286% and is repayable on June 21, 2010. The third loan, of approximately $3.0 million, carries annual interest of 0.34786% and is repayable on June 25, 2010.

As of December 31, 2009, we also had three five-year term loans totaling approximately $22.0 million under the Agricultural Bank – Shenzhen Branch comprehensive credit facility carrying interest at 90% of the benchmark rate of the PBOC for three-year to five-year long-term loans. The first loan, of approximately $5.9 million, currently carries annual interest of 5.184% and is due on January 25, 2012. The second loan, of approximately $11.7 million, currently carries annual interest of 5.184% and is due in three installments of approximately $2.9 million on January 25, 2010, approximately $7.3 million on January 25, 2011, and approximately $1.5 million on January 25, 2012, respectively. The third loan, originally totaling approximately $8.8 million, currently carries annual interest of 5.76% and was structured to be repaid in two installments. The first installment of approximately $4.4 million was due on January 25, 2009, and was repaid on January 20, 2009. The second installment of approximately $4.4 million is due on January 25, 2010. These five-year term loans are specifically: (i) guaranteed by Mr. Xiangqian Li; (ii) secured by Shenzhen BAK’s machinery and equipment with carrying values of approximately $34.8 million as of September 30, 2009; and (iii) secured by the property ownership and land use rights certificates with an aggregate net book value of $104.5 million as of September 30, 2009 in relation to the land on which Shenzhen BAK’s corporate campus had been constructed and any machinery and equipment purchased and used at the campus subsequent to such construction.

10

On May 26, 2008, we entered into a four-year, long-term loan agreement of RMB 160 million (approximately $23.4 million) with Agricultural Bank of China, Tianjin Branch (“Agricultural Bank – Tianjin Branch”). This loan agreement is secured by the machinery and equipment purchased for the automated high-power lithium-phosphate cells production line at our Tianjin facility. As of December 31, 2009, we had borrowed $19.0 million under this loan agreement, payable in four installments: (i) RMB 30 million (approximately $4.4 million) on December 26, 2009, which has been repaid; (ii) RMB 30 million (approximately $4.4 million) on December 26, 2010; (iii) RMB 50 million (approximately $7.3 million) on December 26, 2011; and (iv) RMB 50 million (approximately $7.3 million) on May 26, 2012. The first installment was repaid by the deadline.

On February 13, 2009, we renewed a credit facility with China CITIC Bank. This credit facility was guaranteed by BAK International and Mr. Xiangqian Li. We were permitted to borrow up to RMB 150 million ($22.0 million) under this credit facility, which matures on February 12, 2010. As of December 31, 2009, we had borrowed $14.6 million under two loans at the fixed annual interest rate of 5.31% and $3.9 million of notes payable under this credit facility totaling approximately $18.5 million. The first loan, of approximately $7.3 million is repayable on February 25, 2010. The second loan, of approximately $7.3 million, carried annual interest of 5.31% prior to May 21, 2009. As of May 21, 2009, pursuant to a supplement agreement modifying the interest rate, this loan carries an annual interest rate of 4.779% . It is repayable on March 6, 2010.

On March 4, 2009, we renewed our credit facility agreement with Bank of China to provide a maximum loan amount of RMB 450 million (approximately $65.9 million). This credit facility was guaranteed by BAK International and Mr. Xiangqian Li, and is also secured by machinery and equipment with carrying values of approximately $28.2 million as of December 31, 2009. As of December 31, 2009, we had borrowed $29.3 million under three loans carrying annual interest at 5.31% and 4.779%, and $31.1 million of notes payable under this credit facility agreement. The first loan, of approximately $14.6 million, carries annual interest of 5.31% and is repayable on March 13, 2010. The second loan, of approximately $7.3 million, carries annual interest of 5.31% and matures on March 30, 2010. The third loan, of approximately $7.3 million, carries annual interest of 4.779% and is repayable on June 2, 2010. We had also borrowed $3.8 million of short-term bank loans and $4.2 million of notes payable separate from the credit facility.

On December 26, 2006, we entered into a four-year long-term loan agreement of RMB 100 million (approximately $14.6 million) with Shenzhen Branch, China Development Bank, or China Development Bank. The long-term loan is or was repayable in three installments as follows: RMB 30 million (approximately $4.4 million) on November 20, 2008, which has been repaid; RMB 30 million (approximately $4.4 million) on November 20, 2009, which has been repaid; and RMB 40 million (approximately $5.8 million) on December 26, 2010. The long-term loan carries an annual interest rate of 5.76% . The long-term loan is secured by Shenzhen BAK’s pledge of its new Research and Development Test Centre, which is to be constructed in Shenzhen, China. We have committed to pledge the property ownership and land use rights certificates relating to this property as security after the requisite government approval is obtained, pursuant to the loan agreement. According to the property ownership and land use rights certificate that we obtained in relation to this facility, such land may not be pledged without the approval of the relevant government office. As of December 31, 2009, we had not obtained the requisite approval, and were in the process of negotiating with the relevant government bureau for such approval. For further discussion regarding the status of property ownership rights relating to this facility, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Expenditures.” The obligations of Shenzhen BAK under this loan agreement are guaranteed by Mr. Xiangqian Li. We had borrowed $5.9 million under this loan agreement as of December 31, 2009.

We had negative working capital of $37.4 million as of December 31, 2009, as compared to negative working capital of $46.3 million as of September 30, 2009. This increase was primarily attributable to a decrease in short-term bank loans. We had short-term bank loans maturing in less than one year of $125.0 million and long-term bank loans maturing within one year of $17.6 million as of December 31, 2009, or a total of $142.6 million of loans maturing within one year, as compared to a total of $125.3 million of such loans as of December 31, 2008, an increase of $17.3 million. We had long-term bank loans maturing in over one year of $29.3 million as of December 31, 2009, as compared to $39.6 million of such loans as of September 30, 2009, a decrease of $10.3 million.

11

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

Capital Expenditures

We made capital expenditures of $3.9 million and 20.1 million in the three months ended December 31, 2009 and 2008, respectively. Our capital expenditures were used primarily to purchase plant and equipment to expand our production capacity.

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

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

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

12

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

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

As of September 30, 2007, we had fully paid the lease prepayment amount of $14.1 million for the acquisition of land use rights regarding our Tianjin facility. As of September 30, 2008, we had obtained the relevant land use rights certificate to this facility. As of December 31, 2009, we were in the process of obtaining the relevant property ownership rights certificate to this facility. Pursuant to our land use rights certificate relating to our Tianjin facility, the Tianjin government had originally requested that we complete construction of the Tianjin facility before September 30, 2008. As of September 30, 2008, we had not done so. Notwithstanding this requirement, we have obtained an extension from the Business Administration Bureau of Beichen District, Tianjin, to make the remaining contribution of the registered capital by December 11, 2009, which we have interpreted as an extension of the completion date of construction to this date. As of December 31, 2009, we are in discussions with the authorities regarding an extension of this deadline and no action has been taken by the authorities.

As of September 30, 2007, we had paid the lease prepayment amount of $717,000 for the acquisition of land use rights for a new Research and Development Test Centre to be constructed in Shenzhen, China. As of September 30, 2008, we had obtained the relevant property ownership and land use rights certificate. Pursuant to the property ownership and land use rights certificate, we are required to complete at least 25% of the construction of the new Research and Development Test Centre facility by September 30, 2008. As of September 30, 2008, we had not done so. Notwithstanding this requirement, the Shenzhen government has agreed to increase the dimensions of the Research and Development Test Centre and signed two supplemental agreements with us. According to the supplemental agreements, we are required to complete the construction by May 6, 2011. In addition, according to the property ownership and land use rights certificate, such land may not be pledged without the approval of the relevant government office. We are required to pledge our property ownership and land use rights certificate in relation to the new Research and Development Test Centre to China Development Bank pursuant to the loan agreement entered into with it. As of December 31, 2009, we were in the process of negotiating with the relevant government bureau for the requisite approval. In addition, the so-named “property ownership and land use rights certificate” relating to this facility that we were issued lacks certain terms relating to property ownership rights, which appears to indicate that the granting government has so far only granted us the relevant land use rights. As a result, this certificate may not be adequate evidence of our property ownership rights to this property. We anticipate that the government will re-grant this certificate with adequate property ownership indicia after we have satisfied the above construction requirement and followed certain procedures.

13

Contractual Obligations and Commercial Commitments

Please refer to Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Contractual Obligations and Commercial Commitments” in the 2009 Form 10-K for a discussion of our contractual obligations and commercial commitments as of September 30, 2009. There were no material changes outside the ordinary course of our business in our contractual obligations and commercial commitments for the quarter ended December 31, 2009.

Off-Balance Sheet Transactions

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

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

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

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

We have assessed the contingent liabilities arising from the above-described guarantees and have considered them immaterial to the consolidated financial statements. Therefore, no liabilities in respect of the guarantees were recognized as of December 31, 2009. As of December 31, 2009, we provided a guarantee for a non-related party, Nanjing Special Metal Equipment Co., Ltd., of one-year short-term bank loans with Evergrowing Bank with a maturity of August 6, 2010. We also provided the guarantees for four other non-related parties, Hunan Reshine New Material Ltd, Shenzhen Tongli Hi-tech Co. Ltd., Shenzhen B&G Technology Development Co. Ltd., and Siping Juyuan Hanyang Plate Heat Exchanger Co. Ltd. The maximum amount of our exposure for these guarantees was $27.8 million and $28.6 million at December 31, 2009 and September 30, 2009, respectively.

Critical Accounting Policies

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

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

14

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, 2009 and September 30, 2009, the carrying amount of property, plant and equipment, net was $218.6 million and $219.7 million, respectively. We assess the recoverability of property, plant and equipment to be held and used by a comparison of the carrying amount of an asset or group of assets to the future net undiscounted cash flows expected to be generated by the asset or group of assets. If such assets are considered impaired, the impairment recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets.

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

Inventory Obsolescence

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

Allowance for Doubtful Accounts

The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our accounts receivable. We determine the allowance based on historical write-off experience, customer specific facts and economic conditions. Bad debt expense is included in the general and administrative expenses. We review outstanding account balances individually for collectability. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. As of December 31, 2009 and September 30, 2009, we had not charged off any balances as we had yet to exhaust all means of collection.

Equity-Based Compensation

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

15

Pursuant to ASC Topic 718, we have recognized compensation costs of $1.1 million in relation to stock-based awards to our employees and non-employee directors for the three months ended December 31, 2009, as an increase in both the operating costs and shareholder’s equity.

Changes in Accounting Standards

In December 2007, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Codification (“ASC”) Topic 810, “Consolidation,” which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The guidance applies to the Company’s financial statements starting in its fiscal year beginning on October 1, 2009. The adoption of ASC Topic 810 has no material impact on our financial statements.

In December 2007, the FASB issued ASC Topic 805, “Business Combinations,” which 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. ASC Topic 805 is required to be adopted by the Company for business acquisitions for which the acquisition date is on or after October 1, 2009. The adoption of ASC Topic 805 has no material impact on our financial statements.

In March 2008, the FASB issued ASC Topic 815, “Derivatives and Hedging,” which is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The adoption of ASC Topic 815 has no material impact on our financial statements.

In April 2008, the FASB issued ASC Topic 350, “Intangibles-Goodwill and Other,” which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). ASC Topic 350 is intended to improve the consistency between the useful life of an intangible asset determined under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141(Revised) and other U.S. GAAP. ASC Topic 350 is effective for fiscal years beginning after December 15, 2008 and is effective for the Company’s fiscal year beginning on October 1, 2009. Early adoption is prohibited. The adoption of ASC Topic 350 has no material impact on our financial statements.

In April 2009, the FASB issued ASC Topic 805, “Business Combinations,” which amends the provisions in SFAS No. 141 (Revised) for the initial recognition and measurement, subsequent measurement and accounting, and disclosures for assets and liabilities arising from contingencies in business combinations. ASC Topic 805 eliminates the distinction between contractual and non-contractual contingencies, including the initial recognition and measurement criteria in SFAS No. 141 (Revised) and instead carries forward most of the provisions in SFAS No. 141 for acquired contingencies. ASC Topic 805 is effective for contingent assets and contingent liabilities arising from business combinations whose acquisition dates are on or after December 15, 2008. The adoption of ASC Topic 805 has no material impact on our financial statements.

In June 2009, the FASB issued ASC Topic 860, “Transfers and Servicing,” which improves the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. ASC Topic 860 is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. The adoption of ASC Topic 860 is not expected to have a material impact on our financial statements.

16

In June 2009, the FASB issued ASC Topic 810, “Consolidation,” which amends FASB Interpretation No. 46 (revised December 2003) to address the elimination of the concept of a qualifying special purpose entity. ASC Topic 810 also replaces the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity and the obligation to absorb losses of the entity or the right to receive benefits from the entity. Additionally, ASC Topic 810 provides more timely and useful information about an enterprise’s involvement with a variable interest entity. ASC Topic 810 shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. The adoption of ASC Topic 810 is not expected to have a material impact on our financial statements.

In August 2009, the FASB issued ASU 2009-05, “Fair Value Measurements and Disclosures (Topic 820) – Measuring Liabilities at Fair Value,” or ASU 2009-05. ASU 2009-05 provides additional guidance for measuring the fair value of liabilities and clarifies that the quoted price for the identical liability, when traded as an asset in an active market, is a Level 1 measurement, providing there are no adjustments to the quoted price. Alternatively, when no quoted price is available, ASU 2009-05 affirms the use of other valuation techniques outlined in SFAS No. 157. ASU 2009-05 is effective for the first interim or annual reporting period beginning after its issuance. The adoption of ASU 2009-05 has no material impact on our financial statements.

In September 2009, the FASB issued ASU 2009-12, “Fair Value Measurements and Disclosures (Topic 820) – Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent),” or ASU 2009-12. ASU 2009-12 amends SFAS No. 157 to permit a reporting entity to measure the fair value of certain investments on the basis of the net asset value per share of the investment (or its equivalent). ASU 2009-12 also requires new disclosures, by major category of investments, about the attributes of investments within the scope of this amendment to the Codification. ASU 2009-12 is effective for interim and annual periods ending after December 15, 2009. Early adoption is permitted. The adoption of ASU 2009-12 has no material impact on our financial statements.

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

In January 2010, the FASB issued ASU 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements”, or ASU 2010-06. This ASU requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in Codification Subtopic 820-10. The FASB’s objective is to improve these disclosures and, thus, increase the transparency in financial reporting. Specifically, ASU 2010-06 amends Codification Subtopic 820-10 to now require:

• A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and
• In the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements.

In addition, ASU 2010-06 clarifies the requirements of the following existing disclosures:

• For purposes of reporting fair value measurement for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities; and
• A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements.

ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early application is permitted. We are currently evaluating the impact of the adoption of ASU 2010-06 on our financial statements.

17

Exchange Rates

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

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

We are exposed to interest rate risk primarily with respect to our short-term bank loans and long-term bank loans. Although the interest rates, which are based on the banks’ prime rates with respect to our short-term loans are fixed for the terms of the loans, the terms are typically three to twelve months for short-term bank loans and interest rates are subject to change upon renewal. There were no material changes in interest rates for short-term bank loans renewed during the three months ended December 31, 2009.

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

A hypothetical 1.0% increase in the annual interest rates for all of our credit facilities under which we had outstanding borrowings at December 31, 2009, would increase net loss before provision for income taxes by approximately $1.7 million or 36.9% for the three months ended December 31, 2009. 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 71.0% of our revenues and 96.0% of our costs and expenses for the three months ended December 31, 2009 are denominated in RMB, with the balance denominated in U.S. dollars. Approximately 99.8% of our assets except for cash were denominated in RMB as of December 31, 2009. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between U.S. dollars and RMB. If the RMB depreciates against the U.S. dollar, the value of our RMB revenues, earnings and assets as expressed in our U.S. dollar financial statements will decline. Assets and liabilities of our operating subsidiaries are translated into U.S. dollars at the exchange rate at the balance sheet date, their equity accounts are translated at historical exchange rates, and their income and expenses items are translated using the average rate for the period. Any resulting exchange differences are recorded in accumulated other comprehensive income or loss. An average appreciation (depreciation) of the RMB against the U.S. dollar of 5% would increase (decrease) our comprehensive income by $11.0 million based on our outstanding revenues, costs and expenses, assets, and liabilities denominated in RMB as of December 31, 2009. As of December 31, 2009, our accumulated other comprehensive income was $24.7 million. We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.

18

Inflation Risk

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

Item 4. Controls and Procedures.

Disclosure Controls and Procedures

As required by Rule 13a-15 under the Exchange Act, our management has carried out an evaluation, with the participation and under the supervision of our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2009. Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating and implementing possible controls and procedures.

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

Remediation Measures for Material Weaknesses

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

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

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

19

We continued to provide additional training to the Company’s internal auditor on appropriate controls and procedures necessary to document and evaluate our internal control procedures. In addition, one of our employees has assumed the full-time position of Director of Internal Audit, and has been, and will continue to be, responsible for compliance with internal controls.

We further enhanced the self-assessment of our internal control over financial reporting by increasing our periodic independent testing, which would evaluate the adequacy of the design and effectiveness of our internal control procedures.

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

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

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

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, 2009 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

20

PART II

OTHER INFORMATION

Item 1. Legal Proceedings.

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. A123Systems, Black & Decker Corporation and Black & Decker (U.S.) Inc. have also been named as co-defendants in this lawsuit. The court has not ruled on this lawsuit. The Company understands that this lawsuit is a countersuit against A123Systems, which filed a claim against Hydro-Quebec in the United States District Court of Massachusetts in April 2006. In that suit, A123Systems sought declaratory relief that the two said U.S. patents are invalid and that A123Systems is not infringing either of these two patents.

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

If the court were to issue an adverse decision, the Company could face a substantial monetary damages award. While such an adverse decision could also prohibit the Company from future production of rechargeable lithium cells manufactured for A123Systems or may require the Company to pay royalties to engage in any such production, the Company has no plans to pursue production of batteries for A123. The court has not issued any substantive decisions in the litigation and there has been no substantive pretrial discovery. As a result, at this time, the Company is unable to express a view on the extent of any possible award of damages that might be rendered in the litigation.

Liquidated Damages Pursuant to September 2005 Registration Rights Agreement

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.

21

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 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 $1.0 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 pursuant to the registration rights agreement that we entered into in September 2005 as of the filing date of this Report.

22

Liquidated Damages Pursuant to November 2007 Registration Rights Agreement

Prior to the three months ended December 31, 2009, we were initially liable for liquidated damages to a shareholder whose shares were required to be included in a resale registration statement on Form S-3 that we filed pursuant to a registration rights agreement that we entered into with this shareholder and certain other investors in November 2007. Under the registration rights agreement, among other things, if a registration statement filed pursuant thereto has not been declared effective by the SEC by the 100th calendar day after the closing of our private placement on November 9, 2007, or the Effectiveness Deadline, then we would be liable to pay partial liquidated damages to each investor of (a) 1.5% of the aggregate purchase price paid by such investor for the shares it purchased in our November 2007 private placement on the one-month anniversary of the Effectiveness Deadline; (b) an additional 1.5% of the aggregate purchase price paid by such investor every thirtieth day thereafter (prorated for periods totaling less than thirty days) until the earliest of the effectiveness of the registration statement, the ten-month anniversary of the Effectiveness Deadline, and the time that we are no longer required to keep such resale registration statement effective because either the investors have sold all of their shares or the investors may sell their shares pursuant to Rule 144 without volume limitations; and (c) 0.5% of the aggregate purchase price paid by each investor for the shares it purchased in our November 2007 private placement on the ten-month anniversary of the Effectiveness Deadline and every thirtieth day thereafter (pro-rated for periods totaling less than thirty days), until the earlier of the effectiveness of the registration statement and the time that we are no longer required to keep such resale registration statement effective because either the investors have sold all of their shares or the investors may sell their shares pursuant to Rule 144 without volume limitations. Such liquidated damages would bear interest at the rate of 1% per month (prorated for partial months) until paid in full.

On December 21, 2007, pursuant to the registration rights agreement, we filed a registration statement on Form S-3, which was declared effective by the SEC on May 7, 2008. The lateness of this filing triggered liquidated damages consistent with the formula described above. On August 26, 2008, we conducted a registered direct offering of 4,102,564 shares of common stock, at an offering price of $3.90 per share, in which the investors also received warrants to purchase up to 4,102,564 shares of common stock at an exercise price of $3.90 per share. With one exception, all of the investors that participated in our November 2007 private placement, or affiliates of them, participated in our August 2008 registered direct offering. We reduced each of these investors’ (or each such investor’s participating affiliate’s) purchase price by an amount that was at least equal to the amount that we determined that we were liable for as liquidated damages to such investor (or its participating affiliate). As of June 30, 2009, the remaining investor had waived any and all rights relating to liquidated damages pursuant to the November 2007 registration rights agreement. As of December 31, 2009, approximately $159,000 of liquidated damages remained outstanding for accounting purposes. Pursuant to the settlements described above, however, we do not believe that we are actually liable for this amount.

Make-Good Settlements

Beginning on March 13, 2008, we have entered into settlement agreements with certain investors in the January 20, 2005, private placement completed by the Company. Pursuant to the settlement agreements, we and such investors have agreed, without any admission of liability, to a settlement and mutual releases from all claims relating to the January 20, 2005 private placement, including all claims relating to 1,089,775 “make good shares” of our common stock that had been placed into escrow by Xiangqian Li, our chairman and chief executive officer, in connection with the January 20, 2005, private placement, as well as all claims, including claims for liquidated damages, relating to registration rights granted in connection with the January 20, 2005, private placement. Pursuant to the settlement agreements, we have made settlement payments to each of the settling investors of a number of shares of common stock equal to 50% of the number of “make good shares” such investor had claimed. Aggregate settlement payments amounted to 368,745 shares as of December 31, 2009, all of which were issued in the fiscal year ended September 30, 2008. Share payments to date have been made in reliance upon the exemptions from registration provided by Section 4(2) and/or other applicable provisions of the Securities Act. In accordance with the settlement agreements, we filed a registration statement covering the resale of such shares, which was declared effective by the SEC on June 26, 2008.

In accordance with the Delivery of Make Good Shares, Settlement and Release Agreement entered into with Mr. Li on October 22, 2007 (the “Li Settlement Agreement”), we may continue to negotiate with the investors who participated in the January 20, 2005, private placement in order to achieve a complete settlement of our obligations under the applicable agreements with such investors.

23

Item 1A. Risk Factors.

See Part I, Item 1A. “Risk Factors” included in our 2009 Form 10-K.

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

None.

Item 3. Defaults Upon Senior Securities.

None.

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

None.

Item 5. Other Information.

None.

Item 6. Exhibits.

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

24

25

SIGNATURES

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