UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended June 30, 2009
 
OR
   
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from            to            
 
Commission File No.:  001-34098
 
HONG KONG HIGHPOWER TECHNOLOGY, INC.
(Exact name of Registrant as specified in its charter)
 
Delaware
 
20-4062622
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)

Building A1, Luoshan Industrial Zone, Shanxia, Pinghu, Longgang, Shenzhen, Guangdong, 518111,
People’s Republic of China
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)(ZIP CODE)

(86) 755-89686238
 (COMPANY’S TELEPHONE NUMBER, INCLUDING AREA CODE)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x    No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes o    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” as defined in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  o                                  Accelerated filer  ¨                             
 
 Non-accelerated filer  o                                   Smaller reporting company   x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No x
 
The registrant had 13,562,596 shares of common stock, par value $0.0001 per share, outstanding as of August 11, 2009.
 


 

 

HONG KONG HIGHPOWER TECHNOLOGY, INC.
FORM 10-Q
For the Quarterly Period Ended June 30, 2009
INDEX
 
 
Page
Part I
 
Financial Information
 
           
   
Item 1.
 
 Financial Statements
 
             
       
(a)
Balance Sheets as of June 30, 2009 (Unaudited) and December 31, 2008
2
             
       
(b)
Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2009 and 2008 (Unaudited)
4
             
       
(c)
Statements of Cash Flows for the Six Months Ended June 30, 2009 and 2008 (Unaudited)
5
             
       
(d)
Notes to Financial Statements (Unaudited)
7
             
   
Item 2.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
29
           
   
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
36
           
   
Item 4.
 
Controls and Procedures
37
           
Part II
 
Other Information
 
           
   
Item 1.
 
Legal Proceedings
37
           
   
Item 1A.
 
Risk Factors
37
           
   
Item 2.
 
Unregistered Sale of Equity Securities and Use of Proceeds
37
           
   
Item 3.
 
Default Upon Senior Securities
38
           
   
Item 4.
 
Submission of Matters to a Vote of Security Holders
38
           
   
Item 5.
 
Other Information
38
           
   
Item 6.
 
 Exhibits
38
           
Signatures
39

 
1

 

Part I. Financial Information
 
Item 1. Financial Statements
 
HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(Stated in US Dollars)

   
As of
 
   
June 30,
   
December 31,
 
   
2009
   
2008
 
   
(Unaudited)
   
(Audited)
 
   
$
   
$
 
ASSETS
           
Current Assets :
           
Cash and cash equivalents
    1,321,072       4,175,780  
Restricted cash
    4,119,107       4,845,478  
Accounts receivable
    9,723,528       8,765,593  
Notes receivable
    577,699       429,815  
Prepaid expenses and other receivables – Note 8
    3,513,894       1,732,709  
 Deferred charges – Stock-based compensation – Note 9
    -       216,667  
Inventories – Note 10
    7,870,800       11,208,697  
                 
Total Current Assets
    27,126,100       31,374,739  
Deferred tax assets – Note 6
    124,365       104,556  
Plant and equipment, net – Note 11
    9,014,536       7,778,477  
   Leasehold land, net – Note 12
    3,018,289       3,050,510  
   Intangible asset, net – Note 13
    875,000       900,000  
Currency forward – Note 7
    7,333       116,157  
                 
TOTAL ASSETS
    40,165,623       43,324,439  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
LIABILITIES
               
Current Liabilities :
               
  Non-trading foreign currency derivatives liabilities
    65,487       293,830  
Accounts payable
    9,243,613       8,306,123  
Other payables and accrued liabilities – Note 14
    6,735,102       3,139,275  
Income taxes payable
    333,799       476,330  
Bank borrowings – Note 15
    5,644,282       14,829,228  
                 
Total Current Liabilities
    22,022,283       27,044,786  
                 
COMMITMENTS AND CONTINGENCIES – Note 17
               

(continued)

 
2

 

HONG KONG HIGHPOWER TECHNOLOGY, INC AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(Stated in US Dollars)

   
As of
 
   
June 30,
   
December 31,
 
   
2009
   
2008
 
   
(Unaudited)
   
(Audited)
 
   
$
   
$
 
STOCKHOLDERS’ EQUITY
           
Preferred Stock
           
Par value: $0.0001
           
   Authorized: 10,000,000 shares
           
   Issued and outstanding: none
    -       -  
                 
Common stock
               
Par value : $0.0001
               
Authorized: 100,000,000 shares
               
Issued and outstanding: 2009 –13,562,596 shares (2008 –13,562,596 shares)
    1,356       1,356  
Additional paid-in capital
    5,048,194       5,048,194  
Accumulated other comprehensive income
    2,087,155       1,595,091  
Retained earnings
    11,006,635       9,635,012  
                 
TOTAL STOCKHOLDERS’ EQUITY
    18,143,340       16,279,653  
                 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
    40,165,623       43,324,439  

See accompanying notes to condensed consolidated financial statements.

 
3

 

HONG KONG HIGHPOWER TECHNOLOGY, INC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPENHENSIVE INCOME
(Stated in US Dollars)

   
Three months ended
 June 30,
   
Six months ended 
June 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
   
$
   
$
   
$
   
$
 
                         
Net sales
    15,445,484       19,021,476       26,755,289       36,853,038  
Cost of sales
    (12,371,676 )     (15,646,609 )     (21,285,385 )     (30,769,873 )
                                 
Gross profit
    3,073,808       3,374,867       5,469,904       6,083,165  
DepreciationNotes 2 and 11
    (68,075 )     (31,285 )     (119,189 )     (80,656 )
Selling and distribution costs
    (580,458 )     (547,697 )     (1,111,807 )     (961,720 )
General and administrative costs, including stock-based compensation
    (1,046,340 )     (1,571,405 )     (2,149,262 )     (2,341,101 )
Loss on exchange rate difference
    (22,865 )     (330,788 )     (55,589 )     (835,675 )
                                 
Income from operations
    1,356,070       893,692       2,034,057       1,864,013  
Change in fair value of currency forwards – Note7
    (21,510 )     -       (109,623 )     29,102  
Change in fair value of warrants – Note 5
    -       (71,250 )     -       (71,250 )
Other income – Note 3
    21,774       120,120       88,589       224,654  
Interest expenses – Note 4
    (39,377 )     (194,017 )     (80,497 )     (400,767 )
Other expenses - Note 5
    (119,549 )     -       (171,085 )     -  
                                 
Income before taxes
    1,197,408       748,545       1,761,441       1,645,752  
Income taxes – Note 6
    (228,752 )     (64,298 )     (389,819 )     (231,178 )
                                 
Net income for the period
    968,656       684,247       1,371,622       1,414,574  
                                 
Other comprehensive income
                               
- Foreign currency translation gain
    456,215       516,654       492,064       748,739  
                                 
Comprehensive income
    1,424,871       1,200,901       1,863,686       2,163,313  
                                 
Earnings per share of common stock
                               
  - Basic and diluted
    0.07       0.05       0.10       0.11  
- Diluted
    0.07       0.05       0.10       0.11  
                                 
Weighted average number of shares of common stock outstanding
                               
  - Basic
    13,762,217       12,899,560       13,651,389       12,849,203  
  - Diluted
    13,812,547       12,906,483       13,703,889       12,852,665  

See accompanying notes to condensed consolidated financial statements.

 
4

 

HONG KONG HIGHPOWER TECHNOLOGY, INC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Stated in US Dollars)

   
Six months ended June 30,
 
   
2009
   
2008
 
   
(Unaudited)
   
(Unaudited)
 
   
$
   
$
 
Cash flows from operating activities
           
Net income
    1,371,622       1,414,574  
Adjustments to reconcile net income to net cash provided by operating activities :
               
Amortization of intangible asset
    25,000       25,000  
Amortization of leasehold land
    31,331       -  
Bad debts written off
    -       1,258  
Depreciation
    424,007       345,674  
Change in fair value of currency forwards
    109,623       (29,102 )
Loss on disposal of plant and equipment
    6,834       17,551  
Share based payment
    216,667       114,584  
                 
Changes in operating assets and liabilities :
               
(Increase) decrease in -
               
Accounts receivable
    (850,943 )     4,209,356  
Notes receivable
    (146,046 )     90,315  
Deposit, prepaid expenses and other receivables
    (1,743,845 )     (2,761,398 )
Inventories
    3,451,450       (4,701,466 )
Increase (decrease) in -
               
Accounts payable
    835,955       1,973,774  
Other payables and accrued liabilities
    3,532,852       1,127,082  
Income taxes payable
    (165,841 )     226,163  
                 
Net cash flows provided by operating activities
    7,098,666       2,053,365  
                 
Cash flows from investing activities
               
Acquisition of plant and equipment
    (1,569,989 )     (1,935,077 )
Deposit paid for acquisition of machinery
    -       -  
                 
Net cash flows used in investing activities
    (1,569,989 )     (1,935,077 )
                 
Cash flows from financing activities
               
Proceeds from issuance of common stock
    -       1,963,067  
Proceeds from new short-term bank loans
    2,626,113       -  
Repayment of short-term bank loans
    -       (1,423,993 )
Repayment from other loans
    (11,936,980 )     2,475,343  
Net (repayment) advancement of other bank borrowings
    -       (670,659 )
Increase (Decrease) in restricted cash
    779,112       (1,026,983 )
                 
Net cash flows (used in) provided by financing activities
    (8,531,755 )     1,316,775  
                 
Net (decrease) increase in cash and cash equivalents
    (3,003,078 )     1,435,063  
Effect of foreign currency translation on cash and  cash equivalents
    148,370       75,279  
Cash and cash equivalents - beginning of period
    4,175,780       1,489,262  
                 
Cash and cash equivalents - end of period
    1,321,072       2,999,604  
(continued)

 
5

 

HONG KONG HIGHPOWER TECHNOLOGY, INC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(Stated in US Dollars)

   
Six months ended June 30,
 
   
2009
   
2008
 
   
(Unaudited)
   
(Unaudited)
 
   
$
   
$
 
Supplemental disclosures for cash flow information :
           
Cash paid for :
           
Interest
    80,497       400,767  
 Income taxes
    -       5,015  

See accompanying notes to condensed consolidated financial statements.

 
6

 

HONG KONG HIGHPOWER TECHNOLOGY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

1.
Organization and Basis of Presentation

Hong Kong Highpower Technology, Inc. (“Highpower” or the “Company,” formerly known as SRKP 11, Inc.) was incorporated in the State of Delaware on January 3, 2006 to locate a suitable acquisition candidate to acquire.

On October 20, 2007, Highpower entered into a share exchange agreement (the “Exchange Agreement”) with Hong Kong Highpower Technology Company Limited (“HKHTC”), which was incorporated in Hong Kong on July 4, 2003 under the Hong Kong Companies Ordinance. HKHTC was organized principally to engage in the manufacturing and trading of nickel metal hydride rechargeable batteries.

As used herein, the “Company” refers to Highpower and its wholly-owned subsidiaries, unless the context indicates otherwise.

Pursuant to the Exchange Agreement, Highpower agreed to issue shares of its common stock in exchange for all of the issued and outstanding securities of HKHTC. On November 2, 2007, upon the closing of the Exchange Agreement, HKHTC had a total of 500,000 shares of common stock issued and outstanding, and Highpower issued an aggregate of 9,248,973 shares of its common stock to the shareholders of HKHTC in exchange for all of the issued and outstanding securities of HKHTC on the basis of 18.497946 shares of Highpower for each share of HKHTC. The 9,248,973 shares of common stock issued to the shareholders of HKHTC in conjunction with this transaction have been presented as outstanding for all periods presented. In addition, immediately prior to the closing of the Exchange Agreement, Highpower and certain of its stockholders agreed to cancel an aggregate of 1,597,872 shares of outstanding common stock, as a result of which there were 1,777,128 shares of common stock outstanding immediately prior to the share exchange transaction.

On November 2, 2007, concurrently with the close of the Exchange Agreement, the Company received gross proceeds of $3,120,000 in a private placement transaction (the “Private Placement”). Pursuant to subscription agreements entered into with the investors, the Company sold an aggregate of 1,772,745 shares of common stock at $1.76 per share. The investors in the Private Placement also entered into lock-up agreements pursuant to which they agreed not to sell their shares until 90 days after the Company’s common stock is listed or quoted on either the New York Stock Exchange, NYSE Amex (formerly known as the American Stock Exchange), NASDAQ Global Market, NASDAQ Capital Market or the OTC Bulletin Board, when one-tenth of their shares are released from the lock-up agreement, after which their shares will automatically be released from the lock-up agreement on a monthly basis pro rata over a nine-month period. After commissions and expenses, the Company received net proceeds of approximately $2,738,000 from the Private Placement.

 
7

 

HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

1.
Organization and Basis of Presentation (continued)

Immediately after the closing of the Exchange Agreement and Private Placement, the Company had 12,798,846 shares of common stock issued and outstanding. Upon the closing of the Exchange Agreement, the shareholders of HKHTC and their designees owned approximately 72.3% of the Company’s issued and outstanding common stock, the pre-existing shareholders of the Company owned approximately 13.9% of the Company’s issued and outstanding common stock, and the investors in the Private Placemen owned 13.8% of the Company’s issued and outstanding common stock. Therefore, although HKHTC became the Company’s wholly-owned subsidiary, the transaction was accounted for as a recapitalization in the form of a reverse merger of HKHTC, whereby HKHTC was deemed to be the accounting acquirer and was deemed to have retroactively adopted the capital structure of SRKP 11. Since the transaction was accounted for as a reverse merger, the accompanying consolidated financial statements reflect the historical consolidated financial statements of HKHTC for all periods presented, and do not include the historical financial statements of SRKP 11. All costs associated with the reverse merger transaction, consisting primarily of consideration paid to the previous control parties of SRKP 11 and legal and investment banking fees and costs, were expensed as incurred as a cost of the recapitalization, and have been presented as an operating cost line item entitled fees and costs related to reorganization in the statement of operations.

In January 2008, HKHTC invested $749,971 in HZ Highpower Technology Co., Ltd. (“HZ Highpower”). HZ Highpower is a wholly-owned subsidiary of HKHTC. HZ Highpower has not commenced business as of June 30, 2009.

In June 20, 2008, HKHTC invested $250,000 in Spring Power Technology (Shenzhen) Co., Ltd. (“SZ Spring Power”, formerly known as Sure Power Technology (Shenzhen) Co., Ltd.) which became a wholly-owned subsidiary of HKHTC. On July 9, 2008, HKHTC invested an additional $750,000 in SZ Spring Power. SZ Spring Power commenced business in June 2008 and specializes in researching and manufacturing Lithium-ion rechargeable batteries.

On June 19, 2008, the Company effected a 5-for-8 reverse stock split of the Company’s issued and outstanding shares of common stock (the Reverse Stock Split”). The par value and number of authorized shares of the common stock remained unchanged.  All references to number of shares and per share amounts included in these consolidated financial statements and the accompanying notes have been adjusted to reflect the Reverse Stock Split retroactively.

On June 19, 2008, the company’s common stock commenced trading on the NYSE Amex.

On June 19, 2008, the Company issued 603,750 shares of common stock upon the closing of a public offering. The Company’s sale of common stock, which was sold indirectly by the Company to the public at a price of $3.25 per share, resulted in net proceeds of $1,486,400. These proceeds were net of underwriting discounts and commissions, fees for legal and auditing services, and other offering costs.

 
8

 

HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

1.
Organization and Basis of Presentation (continued)

On June 19, 2008, the Company issued 160,000 shares of common stock upon the closing of the public offering. The shares are treated as compensation for investor relations services. The services provided are for the period of one year from the date of June 19, 2008.

Description of business

The subsidiaries of the Company include the following:

Name of company
 
Place and date of
incorporation
 
Attributable equity
interest held
 
Principal activities
Hong Kong Highpower Technology Co., Ltd. (“HKHTC”)
 
Hong Kong
July 4, 2003
 
100%
 
Investment holding
             
Shenzhen Highpower Technology Co., Ltd. (“SZ Highpower”)
 
PRC
October 8, 2002
 
100%
 
Manufacturing of batteries
             
HZ Highpower Technology Co., Ltd.
(“HZ Highpower”)
 
PRC
January 29, 2008
 
100%
 
Inactive
             
Spring Power Technology (Shenzhen) Co., Ltd. (“SZ Spring Power”)
  
PRC
June 4, 2008
  
100%
  
Manufacturing of batteries

2.
Summary of significant accounting policies

Basis of presentation

The accompanying consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States of America. The consolidated financial statements for the interim periods are unaudited. In the opinion of management, these consolidated financial statements, include all adjustments, including normal recurring adjustments, necessary for their fair presentation. Interim results are not necessarily indicative of results of operations to be expected for a full year, The accompanying consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission and do not include all information and footnotes necessary for a complete presentation of financial statements in conformity with accounting principles generally accepted in the United States. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008.

 
9

 

HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

2.
Summary of significant accounting policies (continued)
 
Consolidation
 
The consolidated financial statements include the accounts of the Company and its subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation
 
Use of estimates

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. These accounts and estimates include, but are not limited to, the valuation of accounts receivable, inventories, deferred income taxes and the estimation on useful lives of plant and equipment. Actual results could differ from those estimates.

 
(a)
Comparative amounts

Certain comparative amounts in prior periods have been reclassified to conform to the current period’s presentation. The principal reclassification related to the separate presentation of loss on exchange rate difference as an operating cost line item in the statement of operations, which was previously included in general and administrative costs. These reclassifications had no effect on reported total assets, liabilities, stockholders’ equity, or net income (loss).

Economic and political risks

The Company’s operations are conducted in the People’s Republic of China (the “PRC”).  Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC and by the general state of the PRC economy.

The Company’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The Company’s results may be adversely affected by changes in the political and social conditions in the PRC and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad and rates and methods of taxation, among other things.

 
10

 

HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

2.
Summary of significant accounting policies (continued)
 
Concentrations of credit risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of accounts receivable. The Company extends credit based on an evaluation of the customer’s financial condition, generally without requiring collateral or other security. In order to minimize the credit risk, the management of the Company has delegated a team responsible for determining credit limits, credit approvals and other monitoring procedures to ensure that follow-up action is taken to recover overdue debts. Further, the Company reviews the recoverable amount of each individual trade debt at each balance sheet date to ensure that adequate impairment losses are made for irrecoverable amounts. In this regard, the directors of the Company consider that the Company’s credit risk is significantly reduced. Other than set forth below, no customers represented 10% or more of the Company’s net sales and accounts receivable.

A substantial percentage of the Company's sales are made to the following customers.  Details of the customers accounting for 10% or more of total net revenue in any of the six months ended June 30, 2009 and 2008 are as follows:

   
2009
   
2008
 
             
Company A
    22 %     22 %
Company B
    13 %     *  
*  Less than 10%
               
                 
      35 %     22 %

Details of the accounts receivable from the customers with the largest receivable balances at June 30, 2009 and 2008 are as follows:

   
Percentage of accounts receivable
 
   
June 30,
   
June 30,
 
   
2009
   
2008
 
             
Company A
    24 %     40 %
Company B
    11 %     32 %
Largest receivable balances
    35 %     72 %

Cash and cash equivalents

Cash and cash equivalents include all cash, deposits in banks and other liquid investments with initial maturities of six months or less.

Restricted cash

Certain cash balances are held as security for short-term bank borrowings and are classified as restricted cash in the Company’s balance sheets.

 
11

 

HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

2
Summary of significant accounting policies (continued)

Accounts receivable

Accounts receivable are stated at the original amount less an allowance made for doubtful receivables, if any, based on a review of all outstanding amounts at period end.  An allowance is also made when there is objective evidence that the Company will not be able to collect all amounts due according to the original terms of receivables. Bad debts are written off when identified. The Company extends unsecured credit to customers in the normal course of business and believes all accounts receivable in excess of the allowances for doubtful receivables to be fully collectible. The Company does not accrue interest on trade accounts receivable.

The Company did not experience any bad debts during the six months ended June 30, 2009 and 2008.

Inventories

Inventories are stated at the lower of cost or market value. Cost is determined on a weighted average basis and includes purchase costs, direct labor and factory overheads. There are no significant freight charges, inspection costs and warehousing costs incurred for any of the periods presented. In assessing the ultimate realization of inventories, management makes judgments as to future demand requirements compared to current or committed inventory levels. The Company’s reserve requirements generally increase based on management’s projected demand requirements, and decrease due to market conditions and product life cycle changes.  During the six months ended June 30, 2009 and 2008, the Company did not make any allowance for slow-moving or defective inventories. The Company’s production process results in a minor amount of waste materials. The Company does not record a value for the waste in its cost accounting. The Company records proceeds on an as realized basis, when the waste is sold. The Company has offset the proceeds from the sales of waste materials as a reduction of production costs. Proceeds from the sales of waste materials were approximately $18,831 and $208,052 for the six months ended June 30, 2009 and 2008 respectively. Generally, waste materials on hand at the end of a year are nominal.

Plant and equipment

Plant and equipment are stated at cost less accumulated depreciation. Cost represents the purchase price of the asset and other costs incurred to bring the asset into its existing use. Maintenance, repairs and betterments, including replacement of minor items, are charged to expense; major additions to physical properties are capitalized.

Depreciation of plant and equipment is provided using the straight-line method over their estimated useful lives at the following annual rates:

Furniture, fixtures and office equipment
    20 %
Leasehold improvement
    50 %
Machinery and equipment
    10 %
Motor vehicles
    20 %

 
12

 

HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

2.           Summary of significant accounting policies (continued)

Plant and equipment (continued)

Upon sale or disposition, the applicable amounts of asset cost and accumulated depreciation are removed from the accounts and the net amount less proceeds from disposal is charged or credited to income.

Intangible Assets and Long-Lived Assets

SFAS No. 142, goodwill and Other Intangible Assets (“SFAS 142”), requires purchased intangible assets other than goodwill to be amortized over their useful lives unless these lives are determined to be indefinite. Accordingly, the consumer battery license is being amortized over its useful life of 20 years. The Company does not have any goodwill.

The Company accounts for the impairment of long-lived assets, such as plant and equipment, leasehold land and intangible assets, under the provisions of SFAS No. 144, “Accounting for the Impairment of Long-Lived Assets (“SFAS 144”)”. SFAS 144 establishes the accounting for impairment of long-lived tangible and intangible assets other than goodwill and for the disposal of a business. Pursuant to SFAS No. 144, the Company periodically evaluates, at least annually, whether facts or circumstances indicate that the carrying value of its depreciable assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of undiscounted future cash flows produced by the long-lived asset, or the appropriate grouping of assets, is compared to the carrying value to determine whether impairment exists. In the event that the carrying amount of long-lived assets exceeds the undiscounted future cash flows, then the carrying amount of such assets is adjusted to their fair value. The Company reports an impairment cost as a charge to operations at the time it is recognized.

There was no impairment of long-lived assets for the six months ended June 30, 2009 and 2008.

Revenue recognition

The Company recognizes revenue when the goods are delivered and the customer takes ownership and assumes risk of loss, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the sales price is fixed or determinable. Sales of goods represent the invoiced value of goods, net of sales returns, trade discount and allowances.

The Company does not have arrangements for returns from customers and does not have any future obligations directly or indirectly related to product resales by customers.  The Company has no incentive programs.

 
13

 

HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

2.
Summary of significant accounting policies (continued)

Advertising and promotion expenses

Advertising and promotion expenses are charged to expense as incurred.

Advertising and promotion expenses, which are included in selling and distribution costs, were not material for the six months ended June 30, 2009 and 2008.

Income taxes

The Company uses the asset and liability method of accounting for income taxes pursuant to SFAS No. 109, “Accounting for Income Taxes”. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and loss carry forwards and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. The Company has also adopted FIN 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109”.

Comprehensive income

The Company has adopted SFAS No. 130, “Reporting Comprehensive Income”, which establishes standards for reporting and display of comprehensive income, its components and accumulated balances. Accumulated other comprehensive income represents the accumulated balance of foreign currency translation adjustments of the Company.

Foreign currency translation

The functional currency of the Company is the Renminbi (“RMB”). The Company maintains its financial statements in the functional currency.  Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency at rates of exchange prevailing at the balance sheet dates.  Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income for the respective year.

For financial reporting purposes, the financial statements of the Company, which are prepared using the functional currency, are then translated into United States dollars.  Assets and liabilities are translated at the exchange rates at the balance sheet dates and revenue and expenses are translated at the average exchange rates and stockholders’ equity is translated at historical exchange rates. Any translation adjustments resulting are not included in determining net income but are included in foreign exchange adjustment in other comprehensive income, a component of stockholders’ equity.

 
14

 

HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

2.
Summary of significant accounting policies (continued)

Foreign currency translation (continued)

   
June 30, 2009
   
June 30,2008
 
             
Quarter end RMB : US$ exchange rate
    6.8186       6.8670  
Average quarterly RMB : US$ exchange rate
    6.8535       7.0225  

The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions.  No representation is made that RMB amounts could have been, or could be, converted into US$ at rates used in translation.

Transactions and balances

Transactions in foreign currencies are translated into the functional currency at the approximate rates of exchange ruling on the transaction date. Exchange gains and losses resulting from this translation policy are recognized in the statements of operations.

Fair value of financial instruments

The carrying values of the Company’s financial instruments, including cash and cash equivalents, restricted cash, trade and other receivables, deposits, trade and other payables, approximate their fair values due to the short-term maturity of such instruments. The carrying amounts of borrowings approximate their fair values because the applicable interest rates approximate current market rates.

The Company is exposed to certain foreign currency risk from export sales transactions and the related accounts receivable as they will affect the future operating results of the Company.

Foreign currency derivative

From time to time the Company may utilize forward foreign currency exchange contracts to reduce the impact of foreign currency exchange rate risks. Forward contracts are cash flow hedges of the Company’s foreign currency exposures and are recorded at the contract’s fair value. The effective portion of the forward contract is initially reported in “Accumulated other comprehensive income,” a component of shareholders’ equity, with a corresponding asset or liability recorded based on the fair value of the forward contract. When the hedged transaction is recorded (generally when revenue on the associated sales contract is recognized), any unrecognized gains or losses are reclassified into results of operations in the same period. Any hedge ineffectiveness is recorded to operations in the current period. The Company measures hedge effectiveness by comparing changes in fair values of the forward contract and expected cash flows based on changes in the spot prices of the underlying currencies. Cash flows from forward contracts accounted for as cash flow hedges are classified in the same category as the cash flows from the items being hedged.

 
15

 

HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

2.           Summary of significant accounting policies (continued)

Earnings per share

The Company reports earnings per share in accordance with SFAS No. 128, “Earnings Per Share”. Basic earnings per share is computed using the weighted average number of common shares outstanding during the periods presented. The weighted average number of shares represents the common stock outstanding during the years, as adjusted retroactively to reflect the November 2007 recapitalization as described at Note 1. As the Company did not have any common stock equivalents during such periods, basic and diluted earnings per share were the same for all periods presented.

Stock-Based Compensation

Effective January 1, 2006, the Company adopted Statements of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment (“SFAS No. 123R”). Under SFAS No. 123R, the Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and recognizes the costs over the period the employee is required to provide service in exchange for the award, which generally is the vesting period.

Stock-based compensation expense was $216,667 and Nil and for the six months ended June 30, 2009 and 2008, respectively.

Recently issued accounting pronouncements

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” and SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment to ARB No. 51”. SFAS No. 141(R) and SFAS No. 160 require most identifiable assets, liabilities, noncontrolling interests and goodwill acquired in a business combination to be recorded at “full fair value” and require noncontrolling interests (previously referred to as minority interests) to be reported as a component of equity, which changes the accounting for transactions with noncontrolling interest holders. Both statements are effective for periods beginning on or after December 15, 2008, and earlier adoption is prohibited. SFAS No. 141(R) will be applied to business combinations occurring after the effective date. SFAS No. 160 will be applied prospectively to all noncontrolling interests, including any that arose before the effective date. We are currently evaluating the impact of adopting SFAS No. 160 on our unaudited condensed consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities,” which requires enhanced disclosures about an entity’s derivative and hedging activities. This Statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company does not expect the adoption of SFAS No.161 will have a material impact on the unaudited condensed consolidated financial statements.

 
16

 

HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

2.           Summary of significant accounting policies (continued)

Recently issued accounting pronouncements (continued)

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events”, SFAS No. 165 sets forth; (1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in financial statements, (2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and (3) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date.  Management has evaluated the period beginning July 1, 2009 through August 13, 2009, and concluded there were no events or transactions occurring during this period that required recognition or disclosure in the unaudited condensed consolidated financial statements.

In April 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) FAS No. 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments.”  This FSP amends Statement of Financial Accounting Standard (“SFAS”) No. 107, “Disclosures about Fair Value of Financial Instruments,” and requires disclosures about fair value of financial instruments for interim reporting periods as well as in annual financial statements.  Additionally, this FSP amends Accounting Principles Board (“APB”) Opinion No. 28, “Interim Financial Reporting,” to require those disclosures in summarized financial information at interim reporting periods.  These disclosures are required for interim reporting periods ending after June 15, 2009.  The adoption of FSP No. FAS 107-1 and APB No. 28-1 did not have a material impact to the unaudited condensed consolidated financial statements.

In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets, an amendment of SFAS No.  140”.  SFAS No. 166 amends SFAS No. 140 to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports 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 in transferred financial assets.  This Statement 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.  Earlier application is prohibited.  The recognition and measurement provisions of this Statement shall be applied to transfers that occur on or after the effective date.  Management does not expect the adoption of SFAS No. 166 will have a material impact to the unaudited condensed consolidated financial statements,

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standard Codification™ (“Codification”) and the Hierarchy of Generally Accepted Accounting Principles”, effective for interim and annual reporting periods ending after September 15, 2009.  This statement replaces SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles”, and establishes the Codification as the source of authoritative accounting principles used in the preparation of financial statements in conformity with generally accepted accounting principles.  The Codification does not replace or affect guidance issued by the SEC or its staff.  After the effective date of this statement, all non-grandfathered non-SEC accounting literature not included in the Codification will be superseded and deemed non-authoritative.  Management is currently evaluating the impact of adopting SFAS No. 168 on the Company’s unaudited condensed consolidated financial statements.

 
17

 

 HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

3.           Other income

   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
   
$
   
$
   
$
   
$
 
                         
Bank interest income
    7,627       41,032       32,769       79,045  
Gain on forward contract
    -       11,092       -       11,092  
Other interest income
    -       6,501       -       17,218  
Sundry income
    14,147       61,495       55,820       117,299  
                                 
      21,774       120,120       88,589       224,654  

4.
Interest expenses

   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
   
$
   
$
   
$
   
$
 
                         
Interest on trade related bank loan
    35,203       164,479       63,403       348,460  
Interest on short-term bank loans
    4,174       29,538       17,094       52,307  
                                 
      39,377       194,017       80,497       400,767  

5.
Other expenses

   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
   
$
   
$
   
$
   
$
 
                         
Foreign exchange contract expenses
    119,549       -       171,085       -  
                                 
      119,549       -       171,085       -  

 
18

 

HONG KONG HIGHPOWER TECHNOLOGY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

6.
Income taxes

The components of the provision for income taxes are:

   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
   
$
   
$
   
$
   
$
 
                         
PRC income taxes
    238,382       17,937       408,380       288,118  
                                 
Deferred tax benefit
    (9,630 )     46,361       (18,489 )     (56,940 )
                                 
      228,752       64,298       389,819       231,178  

The major components of deferred tax recognized in the consolidated balance sheets as of June 30, 2009 and December 31, 2008 are as follows:

   
At of
 
   
June 30,
   
December 31,
 
   
2009
   
2008
 
   
$
   
$
 
   
(Unaudited)
   
(Audited)
 
             
Temporary difference on:
           
Reorganization of expenses
    (109,134 )     (93,300 )
Accelerated tax depreciation on intangible asset
    (15,231 )     (11,256 )
                 
Deferred tax assets, net
    (124,365 )     (104,556 )
                 
Presented in the balance sheet:
               
Net deferred tax assets
    (124,365 )     (104,556 )

Effective January 1, 2007, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes (FIN 48). FIN 48 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. FIN 48 also provides guidance on de-recognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. The adoption of the provisions of FIN 48 did not have a material effect on the Company’s financial statements. As of June 30, 2009, no liability for unrecognized tax benefits was required to be recorded.

 
19

 

HONG KONG HIGHPOWER TECHNOLOGY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

7.
Risk Management Activities, Including Derivative

The Company selectively uses foreign currency forward contracts to offset the effects of foreign currency exchange rate changes on reported earnings, cash flow and net asset positions. The terms of these derivative contracts are generally for 12 months or less. Changes in the fair value of these derivative contracts are recorded in earnings to offset the impact of foreign currency transaction gains and losses attributable to certain third party and intercompany financial assets and liabilities with similar terms. The net gains and losses attributable to these activities are included in the statements of comprehensive income.

   
At of
 
   
June 30,
   
December 31,
 
   
2009
   
2008
 
   
$
   
$
 
   
(Unaudited)
   
(Audited)
 
             
Currency forwards (notional amount $4 million), consisting of a put and a call
    7,333       116,157  

Due to the volatility of the US Dollar to the Company’s functional currency, the Company has put into place a hedging program to attempt to protect it from significant changes to the US Dollar, which would affect the value of the Company’s US dollar receivables and sales. At June 30, 2009, the Company had a series of currency forwards totaling a notional amount US$1,000,000 expiring from April 2009 to July 2009.

The Company recognized the following gains and losses attributable to its derivative financial instruments during the following periods:

   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
   
$
   
$
   
$
   
$
 
                                 
Foreign exchange contracts, net
                               
Loss recognized in Other expenses, net
    119,549       -       171,085       -  

Hedging Activities

SZ Highpower uses foreign currencies derivative instruments to manage foreign exchange resulting from fluctuations in US Dollar to the Company’s functional currency (RMB). The notional amounts of these financial instruments are based on expected cash flow from operations.

 
20

 

HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

7.           Risk Management Activities, Including Derivative (continued)

At the inception of a derivative contract, SZ Highpower historically designated the derivative as a cash flow hedge. For all derivatives designated as cash flow hedges, SZ Highpower formally documented the relationship between the derivative contract and the hedged items, as well as the risk management objective for entering into the derivative contract. To be designated as a cash flow hedge transaction, the relationship between the derivative and the hedged items must be highly effective in achieving the offset of changes in cash flows attributable to the risk both at the inception of the derivative and on an ongoing basis. SZ Highpower historically measured hedge effectiveness on a quarterly basis and hedge accounting would be discontinued prospectively if it was determined that the derivative was no longer effective in offsetting changes in the cash flows of the hedged item. Gains and losses deferred in accumulated other comprehensive income related to cash flow hedge derivatives that became ineffective remained unchanged until the related cashflow was received. If SZ Highpower determined that it was probable that a hedged forecasted transaction would not occur, deferred gains or losses on the derivative were recognized in earnings immediately.

Derivatives, historically, were recorded on the balance sheet at fair value and changes in the fair value of derivatives were recorded each period in net income or other comprehensive income, depending on whether a derivative was designated as part of a hedge transaction and, if it was, depending on the type of hedge transaction. SZ Highpower’s derivatives historically consisted primarily of cash flow hedge transactions in which SZ Highpower was hedging the variability of cash flows related to a forecasted transaction. Period to period changes in the fair value of derivative instruments designated as cash flow hedges were reported in other comprehensive income and reclassified to net income in the periods in which the contracts are settled. The ineffective portions of the cash flow hedges were reflected in net income as an increase or decrease to other income (expense). Gains and losses on derivative instruments that did not qualify for hedge accounting were also recorded as an increase or decrease to other income (expense), in the period in which they occurred. The resulting cash flows from derivatives were reported as cash flows from operating activities.

8.
Prepaid expenses and other receivables

   
At of
 
   
June 30,
   
December 31,
 
   
2009
   
2008
 
   
(Unaudited)
   
(Audited)
 
   
$
   
$
 
             
Purchase deposits paid
    1,534,596       88,459  
Advance to staff
    213,278       143,595  
Other deposits and prepayments
    39,094       495,325  
Other receivables
    1,726,926       1,005,330  
                 
      3,513,894       1,732,709  

 
21

 
HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

9.
Deferred charges – Stock-based compensation

   
At of
 
    
June 30
   
December 31,
 
    
2009
   
2008
 
    
(Unaudited)
   
(Audited)
 
      $       $  
                 
Cost
               
Stock-based compensation – consulting fee
    520,000       520,000  
                 
Accumulated amortization
    520,000       303,333  
                 
Net
    -       216,667  

Amortization expenses included in general and administrative costs for the six months ended June 30, 2009 and 2008 were $216,667 and $43,334 respectively.

The Company is amortizing the $520,000 cost of stock-based compensation over a period of one year on the straight line basis.

10.
Inventories

   
At of
 
    
June 30,
   
December 31,
 
    
2009
   
2008
 
    
(Unaudited)
   
(Audited)
 
      $       $  
                 
Raw materials
    2,104,424       1,708,431  
Work in progress
    1,734,580       1,434,517  
Finished goods
    4,015,399       8,049,138  
Packing materials
    16,397       16,611  
                 
      7,870,800       11,208,697  
 
22

 
HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

11.
Plant and equipment

   
At of
 
    
June 30,
   
December 31,
 
    
2009
   
2008
 
   
(Unaudited)
   
(Audited)
 
      $       $  
Cost
               
Furniture, fixtures and office equipment
    729,518       598,496  
Leasehold improvement
    1,299,012       712,120  
Machinery and equipment
    8,872,944       8,155,270  
Motor vehicles
    504,024       476,910  
                 
      11,405,498       9,942,796  
                 
Accumulated depreciation
               
Furniture, fixtures and office equipment
    294,102       235,613  
Leasehold improvement
    -       220,746  
Machinery and equipment
    1,830,415       1,486,624  
Motor vehicles
    266,445       221,336  
                 
      2,390,962       2,164,319  
                 
Net
               
Furniture, fixtures and office equipment
    435,416       362,883  
Leasehold improvement
    1,299,012       491,374  
Machinery and equipment
    7,042,529       6,668,646  
Motor vehicles
    237,579       255,574  
                 
      9,014,536       7,778,477  

 
The components of depreciation charged are:

   
Three months ended
June 30,
   
Six months ended
June 30,
 
    
2009
   
2008
   
2009
   
2008
 
    
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
      $       $      
$
      $  
                                 
Included in factory overheads
    118,715       159,594       304,818       265,018  
Included in operating expenses
    68,075       37,285       119,189       80,656  
                                 
      186,790       196,879       424,007       345,674  
 
23

 
HONG KONG HIGHPOWER TECHNOLOGY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

12.
Leasehold land

   
At of
 
    
June 30,
   
December 31,
 
    
2009
   
2008
 
   
(Unaudited)
   
(Audited)
 
      $      
$
 
                 
Cost
    3,112,765       3,112,765  
                 
Accumulated amortization
    (94,476 )     (62,255 )
                 
Net
    3,018,289       3,050,510  

The leasehold land is being amortized annually using the straight-line method over the lease terms of 50 years.

13.
Intangible asset

   
At of
 
    
June 30,
   
December 31,
 
   
2009
   
2008
 
   
(Unaudited)
   
(Audited)
 
      $       $  
Cost
               
Consumer battery license fee
    1,000,000       1,000,000  
                 
Accumulated amortization
    (125,000 )     (100,000 )
                 
Net
    875,000       900,000  

Amortization expenses included in selling and distribution costs for the six months ended June 30, 2009 and 2008 was $25,000.

Shenzhen Highpower Technology Co., Ltd. (SZ Highpower), a wholly-owned subsidiary of the Company, entered into a Consumer Battery License Agreement with Ovonic Battery Company, Inc. (Ovonic), an unrelated party, dated May 14, 2004, pursuant to which SZ Highpower acquired a royalty-bearing, non-exclusive license to use certain patents owned by Ovonic to manufacture rechargeable nickel metal hydride batteries for portable consumer applications (Consumer Batteries) in the PRC, and a royalty-bearing, non-exclusive worldwide license to use certain patents owned by Ovonic to use, sell and distribute Consumer Batteries.  SZ Highpower made an up-front royalty payment to Ovonic of $50,000 in 2004.
 
24

 
HONG KONG HIGHPOWER TECHNOLOGY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

13.
Intangible asset (continued)

On August 8, 2007, SZ Highpwer and Ovonic amended the Consumer Battery License Agreement pursuant to which SZ Highpower agreed to pay a total of $112,580, which was to be made in two equal payments of $56,290, one of which was to be made within 15 days of August 8, 2007, and the other within 45 days of August 8, 2007, as royalties for its use of the licensed technology in 2004, 2005 and 2006.  Both of these payments were made during 2007 and were recorded as royalty expense in prior years, which was included in selling and distribution costs in the statement of operations.
 
The Consumer Battery License Agreement also requires the Company to pay an additional up-front royalty payment of $1,000,000 by four annual installments and an annual royalty fee based on the gross sales of consumer batteries over the term of the Consumer Battery License Agreement. Accordingly, during the year ended December 31, 2007, the Company recorded a total up-front royalty payment obligation of $1,000,000, which was included in other payables and accrued liabilities, with the related debit recorded as an intangible asset entitled consumer battery license agreement. During the six months ended June 30, 2009, the Company recorded a total of approximately $98,946 as royalty expense, which was included in selling and distribution costs in the statement of operations. At June 30, 2009, accrued royalty fees payable was $922,238 (see Note 14).

The Company is amortizing the $1,000,000 cost of the Consumer Battery License Agreement over a period of 20 years on the straight line basis. The accounting for the Consumer Battery License Agreement is based on the Company’s estimate of the useful life of the underlying technology, which is based on the Company’s assessment of existing battery technology, current trends in the battery business, potential developments and improvements, and the Company’s current business plan.
 
14.
Other payables and accrued liabilities

   
At of
 
    
June 30,
   
December 31,
 
   
2009
   
2008
 
   
(Unaudited)
   
(Audited)
 
      $       $  
                 
Accrued expenses
    1,252,783       1,072,331  
Royalty payable
    922,238       1,540,900  
Sales deposits received
    4,533,234       388,261  
Value-added tax payables
    -       105,833  
Other payables
    26,847       31,950  
                 
      6,735,102       3,139,275  
 
25

 
HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

15.
Bank borrowings

   
At of
 
    
June 30,
   
December 31,
 
   
2009
   
2008
 
   
(Unaudited)
   
(Audited)
 
      $       $  
Secured:
               
Repayable within one year
               
Short term bank loans
    1,851,367       2,969,939  
Other trade related bank loans
    3,792,915       11,859,289  
                 
      5,644,282       14,829,228  

As of June 30, 2009, the above bank borrowings were secured by the following:

 
(a)
charge over bank deposits of $4,119,107 which is included in restricted cash on the Balance sheet;

 
(b)
personal guarantee executed by the directors of the Company;

 
(c)
the legal charge over leasehold land with carrying amount $3,018,289 (see Note 12); and

 
(d)
other financial covenant

The bank borrowings require one of the Company’s subsidiaries to maintain a minimum net worth of $11,732,692. The Company was in compliance with this requirement at June 30, 2009.

The interest rates of trade related bank loans were at bank’s prime lending rate per annum with various maturity dates. The rates at June 30, 2009 ranged from 6.5% to 8%.

The interest rates of short term bank loans were at 4.86% per annum at June 30, 2009.

16.
Pension plans

For employees in PRC, the Company contributes on a monthly basis to various defined contribution plans organized by the relevant municipal and provincial government in the PRC based on certain percentage of the relevant employees’ monthly salaries. The municipal and provincial governments undertake to assume the retirement benefit obligations payable to all existing and future retired employees under these plans and the Company has no further constructive obligation for post-retirement benefits beyond the contributions made. Contributions to these plans are expenses as incurred.

The assets of the schemes are controlled by trustees and held separately from those of the Company. Total pension cost was $258,228 and $48,840 for the six months ended June 30, 2009 and 2008, respectively.
 
26

 
HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

17.
Commitments and contingencies

Operating leases commitments

The Company leases factory and office premises under various non-cancelable operating lease agreements that expire at various dates through years 2009 to 2010, with an option to renew the lease. All leases are on a fixed repayment basis. None of the leases includes contingent rentals. Minimum future commitments under these agreements payable as of June 30, 2009 are as follows:

Period ending June 30,
    $  
         
2009
    276,097  
2010
    235,653  
         
      511,750  

Rent expenses for the six months ended June 30, 2009 and 2008 were $475,375 and $292,506 respectively.

Capital commitments

The Company has the following capital commitments as of June 30, 2009:

      $  
         
Purchase of plant and equipment
    187,526  
 
Contingencies

From time to time, the Company factors bills receivable to banks. At the time of the factoring, all rights and privileges of holding the receivables are transferred to the banks. The Company removes the asset from its books and records a corresponding expense for the amount of the discount. The Company remains contingently liable on the amount outstanding in the event the bill issuer defaults.

   
At of
 
    
June 30,
   
December 31,
 
   
2009
   
2008
 
   
(Unaudited)
   
(Audited)
 
      $       $  
                 
Bills discounted
    -       -  
 
27

 
HONG KONG HIGHPOWER TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

18.
Segment Information

The Company uses the “management approach” in determining reportable operating segments. The management approach considers the internal organization and reporting used by the Company’s chief operating decision maker for making operating decisions and assessing performance as the source for determining the Company’s reportable segments. Management, including the chief operating decision maker, reviews operating results solely by monthly revenue (but not by sub-product type or geographic area) and operating results of the Company and, as such, the Company has determined that the Company has one operating segment as defined by SFAS 131, “ Disclosures about Segments of an Enterprise and Related Information ”.

Long-lived assets of the Company are located in PRC.  Geographic information about the revenues and accounts receivable which are classified based on the location of the customers is set out as follows:

   
Six months ended June 30,
 
   
2009
   
2008
 
   
(Unaudited)
   
(Unaudited)
 
      $       $  
Net revenue
               
Hong Kong and China
    12,157,121       13,346,458  
Asia
    1,573,266       2,719,708  
Europe
    9,002,647       15,306,697  
North America
    3,818,465       5,187,455  
South America
    41,911       159,329  
Others
    161,879       133,391  
                 
      26,755,289       36,853,038  
 
   
At of
 
    
June 30,
   
December 31,
 
   
2009
   
2008
 
   
(Unaudited)
   
(Audited)
 
      $       $  
Accounts receivable
               
Hong Kong and China
    5,009,263       5,012,471  
Asia
    626,535       169,376  
Europe
    2,472,255       2,695,166  
North America
    85,628       875,022  
South America
    1,519,566       13,558  
Others
    10,281       -  
                 
      9,723,528       8,765,593  
 
28

 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion relates to a discussion of the financial condition and results of operations of Hong Kong Highpower Technology, Inc. (the “Company”) and its wholly-owned subsidiary Hong Kong Highpower Technology Co., Ltd. (referred to herein as “HKHT”), and HKHT’s wholly-owned subsidiaries Shenzhen Highpower Technology Co., Ltd. (“Shenzhen Highpower”) and Springpower Technology (Shenzhen) Co., Ltd. (“Springpower”). HKHT’s other subsidiary, HZ Highpower Technology Co. (“HZ Highpower”) has not yet commenced operations.

Forward-Looking Statements

This management’s discussion and analysis of financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and the related notes that are included in this Quarterly Report and the audited consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended December 31, 2008.

This Quarterly Report contains forward-looking statements that involve substantial risks and uncertainties. All statements other than historical facts contained in this report, including statements regarding our future financial position, capital expenditures, cash flows, business strategy and plans and objectives of management for future operations, are forward-looking statements. The words “anticipated,” “believe,” “expect, “plan,” “intend,” “seek,” “estimate,” “project,” “could,” “may,” and similar expressions are intended to identify forward-looking statements. Such statements reflect our management’s current views with respect to future events and financial performance and involve risks and uncertainties, including, without limitation, the current economic downturn adversely affecting demand for the our products; fluctuations in the cost of raw materials; our dependence on, or inability to attract additional, major customers for a significant portion of our net sales; our ability to increase manufacturing capabilities to satisfy orders from new customers; changes in the laws of the PRC that affect our operations; our ability to complete construction at our new manufacturing facility on time; our ability to control operating expenses and costs related to the construction of our new manufacturing facility; the devaluation of the U.S. Dollar relative to the Renminbi; our dependence on the growth in demand for portable electronic devices and the success of manufacturers of the end applications that use our battery products; our responsiveness to competitive market conditions; our ability to successfully manufacture Li-ion batteries in the time frame and amounts expected; the market acceptance of our Li-ion products; changes in foreign, political, social, business and economic conditions that affect our production capabilities or demand for our products; and various other matters, many of which are beyond our control. Actual results may vary materially and adversely from those anticipated, believed, estimated or otherwise indicated should one or more of these risks or uncertainties occur or if any of the risks or uncertainties described in elsewhere in this report or in the “Risk Factors” section of our 2008 Annual Report occur. Consequently, all of the forward-looking statements made in this filing are qualified by these cautionary statements and there can be no assurance of the actual results or developments.

Overview

We were incorporated in the state of Delaware on January 3, 2006. We were originally organized as a “blank check” shell company to investigate and acquire a target company or business seeking the perceived advantages of being a publicly held corporation. On November 2, 2007, we closed a share exchange transaction, pursuant to which we (i) became the 100% parent of HKHT and its wholly-owned subsidiary, Shenzhen Highpower, (ii) assumed the operations of HKHT and its subsidiary and (iii) changed our name from SRKP 11, Inc. to Hong Kong Highpower Technology, Inc. HKHT was incorporated in Hong Kong in 2003, under the Companies Ordinance of Hong Kong. Shenzhen Highpower was founded in founded in 2001.  HKHT formed HZ Highpower and Springpower in 2008.  HZ Highpower has not yet commenced business operations.

In addition, on November 2, 2007, concurrently with the close of the Share Exchange, we conducted a private placement transaction (the “Private Placement”). Pursuant to Subscription Agreements entered into with the investors, we sold an aggregate of 1,772,745 shares of Common stock at $1.76 per share. As a result, we received gross proceeds in the amount of $3.12 million.

Through Shenzhen Highpower, we manufacture Nickel Metal Hydride (“Ni-MH”) batteries for both consumer and industrial applications. We have developed significant expertise in Ni-MH battery technology and large-scale manufacturing that enables us to improve the quality of our battery products, reduce costs, and keep pace with evolving industry standards. In 2008, we commenced manufacturing two lines of Lithium-Ion (“Li-ion”) and Lithium polymer rechargeable batteries through Spring Power for higher-end, high-performance applications, such as laptops, digital cameras and wireless communication products.  Our automated machinery allows us to process key aspects of the manufacturing process to ensure high uniformity and precision, while leaving the non-key aspects of the manufacturing process to manual labor.
 
29

 
We employ a broad network of salespersons in China and Hong Kong, which target key customers by arranging in-person sales presentations and providing post-sale services. The sales staff works with our customers to better address customers’ needs.

Critical Accounting Policies and Estimates

The SEC defines critical accounting policies as those that are, in management's view, most important to the portrayal of our financial condition and results of operations and those that require significant judgments and estimates.

The preparation of these condensed consolidated financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as well as the disclosure of contingent assets and liabilities at the date of our financial statements. We base our estimates on historical experience, actuarial valuations and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Some of those judgments can be subjective and complex and, consequently, actual results may differ from these estimates under different assumptions or conditions. While for any given estimate or assumption made by our management there may be other estimates or assumptions that are reasonable, we believe that, given the current facts and circumstances, it is unlikely that applying any such other reasonable estimate or assumption would materially impact the financial statements. The accounting principles we utilized in preparing our consolidated financial statements conform in all material respects to generally accepted accounting principles in the United States of America.

Use of Estimates. In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. These accounts and estimates include, but are not limited to, the valuation of accounts receivable, inventories, deferred income taxes and the estimation on useful lives of plant and equipment. Actual results could differ from those estimates.

Accounts Receivable. Accounts receivable are stated at original amount less allowance made for doubtful receivables, if any, based on a review of all outstanding amounts at the period end. An allowance is also made when there is objective evidence that we will not be able to collect all amounts due according to original terms of receivables. Bad debts are written off when identified. We extend unsecured credit to customers in the normal course of business and believe all accounts receivable in excess of the allowances for doubtful receivables to be fully collectible. We do not accrue interest on trade accounts receivable.

Revenue Recognition. We recognize revenue when the goods are delivered and the customer takes ownership and assumes risk of loss, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the sales price is fixed or determinable. Sales of goods represent the invoiced value of goods, net of sales returns, trade discount and allowances.
 
We do not have arrangements for returns from customers and do not have any future obligations directly or indirectly related to product resales by the customer. We have no incentive programs.

Inventories. Inventories are stated at the lower of cost or market value. Cost is determined on a weighted average basis and includes purchase costs, direct labor and factory overheads. In assessing the ultimate realization of inventories, management makes judgments as to future demand requirements compared to current or committed inventory levels. Our reserve requirements generally increase based on management’s projected demand requirements, and decrease due to market conditions and product life cycle changes. Our production process results in a minor amount of waste materials. We do not record a value for the waste in our cost accounting. We record proceeds on an as realized basis, when the waste is sold. We offset the proceeds from the sales of waste materials as a reduction of production costs.
 
30

 
Income Taxes. We use the asset and liability method of accounting for income taxes pursuant to SFAS No. 109, “Accounting for Income Taxes.” Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and loss carry forwards and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. We have also adopted FIN 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109.”

Foreign Currency Translation. Our functional currency is the Renminbi (“RMB”). We maintain our financial statements in the functional currency. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency at rates of exchange prevailing at the balance sheet dates. Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income for the respective periods.

For financial reporting purposes, our financial statements, which are prepared using the functional currency, are then translated into United States dollars. Assets and liabilities are translated at the exchange rates at the balance sheet dates and revenue and expenses are translated at the average exchange rates and stockholders’ equity is translated at historical exchange rates. Any translation adjustments resulting are not included in determining net income but are included in foreign exchange adjustment in other comprehensive income, a component of stockholders’ equity.

The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions.  No representation is made that RMB amounts could have been, or could be, converted into U.S. Dollars at rates used in translation.

Results of Operations

Non-GAAP Financial Results

In evaluating our business, we consider and use EBITDA, a financial measure not in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”), as a supplemental measure of our operating performance. We define EBITDA as net income (loss) before net interest expense, provision (benefit) for income taxes, and depreciation and amortization. We use EBITDA as a supplemental measure to review and assess our operating performance and to enhance comparability between periods. We also believe the use of EBITDA facilitates the use by investors of operating performance comparisons from period to period and company to company by backing out potential differences caused by variations in such items as the book amortization of intangible assets (affecting relative amortization expense), the age and book value of facilities and equipment (affecting relative depreciation expense), and capital structure (affecting relative interest expense). We also present EBITDA because we believe it is frequently used by securities analysts, investors and other interested parties as an alternate measure of financial performance. We reconcile EBITDA to net income (loss), the most comparable financial measure under U.S. GAAP.

We believe that EBITDA permits a comparative assessment of our operating performance, relative to our performance based on our U.S. GAAP results, while isolating the effects of interest, taxes, depreciation and amortization, which may vary from period to period without any correlation to underlying operating performance. We provide information relating to our EBITDA so that securities analysts, investors and other interested parties have the same data that we employ in assessing our overall operations. We believe that trends in our EBITDA are a valuable indicator of our operating performance and of our ability to produce operating cash flows to fund working capital needs, to service debt obligations and to fund capital expenditures.