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 March 31, 2011
 
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
 
HIGHPOWER INTERNATIONAL, 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)

_______________________________________________
Former Name

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” as defined in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  ¨
Accelerated filer  ¨
   
Non-accelerated filer  ¨
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 ¨     No x
 
The registrant had 13,582,106 shares of common stock, par value $0.0001 per share, outstanding as of May 12, 2011.
 
 
 

 
 
HIGHPOWER INTERNATIONAL, INC.
 FORM 10-Q
 For the Quarterly Period Ended March 31, 2011
 INDEX
 
       
Page
Part I
 
Financial Information
 
           
   
Item 1.
 
 Financial Statements
 
             
       
(a)
Balance Sheets as of March 31, 2011 (Unaudited) and December 31, 2010
1
             
       
(b)
Statements of Operations for the Three Months Ended March 31, 2011 and 2010 (Unaudited)
3
             
       
(c)
Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010 (Unaudited)
4
             
       
(d)
Notes to Financial Statements (Unaudited)
5
             
   
Item 2.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
35
           
   
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
40
           
   
Item 4.
 
Controls and Procedures
40
           
Part II
 
Other Information
 
           
   
Item 1.
 
Legal Proceedings
41
           
   
Item 1A.
 
Risk Factors
41
           
   
Item 2.
 
Unregistered Sale of Equity Securities and Use of Proceeds
41
           
   
Item 3.
 
Default Upon Senior Securities
41
           
   
Item 4.
 
Removed and Reserved
41
           
   
Item 5.
 
Other Information
42
           
   
Item 6.
 
 Exhibits
43
           
Signatures
44

 
 

 
 
Part I. Financial Information
 
Item 1. Financial Statements
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(Stated in US Dollars)


   
As of
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Audited)
 
    $     $  
ASSETS
             
Current Assets :
             
Cash and cash equivalents
    9,161,233       8,490,629  
Restricted cash
    6,636,347       6,044,960  
Accounts receivable
    20,317,450       20,846,540  
Notes receivable
    1,197,821       256,574  
Prepaid expenses and other receivables – Note 7
    5,433,605       3,231,211  
Inventories – Note 10
    11,551,519       13,447,432  
                 
Total Current Assets
    54,297,975       52,317,346  
Plant and equipment, net – Note 11
    14,548,996       13,652,254  
      Leasehold land, net – Note 12
    3,065,895       3,022,293  
  Intangible asset, net – Note 13
    787,500       800,000  
  Investment in an associate – Note 14
    101,351       103,123  
      Investment securities – Note 15
    54,973       53,904  
                 
TOTAL ASSETS
    72,856,690       69,948,920  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
LIABILITIES
               
Current Liabilities :
               
             Non-trading foreign currency derivatives liabilities
    212,908       77,699  
Accounts payable
    14,679,034       13,407,204  
Other payables and accrued liabilities – Note 19
    5,429,605       4,983,269  
Income taxes payable
    1,147,818       1,164,007  
Bank borrowings – Note 20
    23,725,366       22,539,032  
                 
Total Current Liabilities
    45,194,731       42,171,211  
                 
COMMITMENTS AND CONTINGENCIES – Note 22
               
                 

 (continued)
 
 
1

 
 
HIGHPOWER INTERNATIONAL, INC AND SUBSIDIARIES

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


   
As of
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Audited)
 
   
March 31,
   
December 31,
 
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: 2011 –13,582,106 shares
(2010 –13,582,106 shares)
    1,358       1,358  
Additional paid-in capital
    5,408,939       5,180,318  
Accumulated other comprehensive income
    2,592,699       2,475,749  
Retained earnings
    19,658,963       20,120,284  
                 
TOTAL STOCKHOLDERS’ EQUITY
    27,661,959       27,777,709  
                 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
    72,856,690       69,948,920  


See accompanying notes to unaudited condensed consolidated financial statements
 
 
2

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Stated in US Dollars)
 

   
Three months ended March 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
    $     $  
               
Net sales
    26,950,666       20,223,372  
Cost of sales
    (22,950,308 )     (15,977,042 )
                 
Gross profit
    4,000,358       4,246,330  
Depreciation – Notes 2 and 11
    (113,570 )     (69,242 )
Selling and distribution costs
    (1,174,685 )     (752,054 )
General and administrative costs including stock-based compensation
    (2,598,312 )     (1,453,607 )
Loss on exchange rate difference
    (172,936 )     (22,354 )
Loss on future contract
    (450,591 )     -  
Share of loss of an associate
    (1,772 )     -  
                 
(Loss)/Income from operations
    (511,508 )     1,949,073  
Change in fair value of currency forwards
            -  
Other income – Note 3
    232,548       77,374  
Interest expenses – Note 4
    (152,636 )     (66,333 )
Other expenses – Note 5
    (23,964 )     -  
                 
(Loss)/Income before income taxes
    (455,560 )     1,960,114  
Income taxes – Note 6
    (5,761 )     (379,414 )
                 
Net (loss)/income
    (461,321 )     1,580,700  
                 
Other comprehensive income
               
  - Foreign currency translation gain
    (18,783 )     (15,597 )
  - Cash flow hedge
    3,567       2,517  
                 
Comprehensive income
    (476,537 )     1,567,620  
                 
Income per common share
               
  - Basic
    (0.03 )     0.12  
                 
  - Diluted
    (0.03 )     0.12  
                 
Weighted average common shares outstanding
               
  - Basic
    13,582,106       13,582,106  
                 
  - Diluted
    13,783,856       13,632,096  

See accompanying notes to unaudited condensed consolidated financial statements
 
 
3

 
 
HIGHPOWER INTERNATIONAL, INC AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Stated in US Dollars)
 
 
   
Three months ended March 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
    $     $  
Cash flows from operating activities
             
Net (loss)/income
    (461,321 )     1,580,700  
Adjustments to reconcile net income to net cash provided by operating activities :
               
Amortization of intangible asset
    12,500       12,747  
Amortization of leasehold land
    16,395       15,726  
Depreciation
    415,965       360,572  
Loss on disposal of plant and equipment
    1,201       43,885  
Loss on future contract
    450,591       -  
Share based payment
    228,621       73,177  
Bad debt written off
    1,017       41,675  
                 
Changes in operating assets and liabilities :
               
(Increase) decrease in -
               
Accounts receivable
    529,090       1,667,206  
Notes receivable
    (941,247 )     (90,857 )
Prepaid expenses and other receivables
    (2,202,395 )     (2,202,045 )
Inventories
    1,895,913       (651,133 )
     Increase (decrease) in -
               
Accounts payable
    1,271,830       2,608,364  
Other payables and accrued liabilities
    446,336       523,479  
Income taxes payable
    (16,189 )     363,726  
                 
Net cash flows provided by operating activities
    1,648,307       4,347,222  
                 
Cash flows from investing activities
               
   Acquisition of plant and equipment
    (1,045,693 )     (565,454 )
   Sale proceeds of plant and equipment
    -       (2,760 )
                 
Net cash flows used in investing activities
    (1,045,693 )     (568,214 )
                 
Cash flows from financing activities
               
Proceeds from new short-term bank loans
    6,758,980       -  
Repayment of short-term bank loans
    (4,340,759 )     (2,929,416 )
  Repayment of other secured loans
    -       (1,206,776 )
Net (repayment) advancement of other bank borrowings
    (1,764,322 )     5,095,185  
Increase in restricted cash
    (591,387 )     (575,878 )
                 
Net cash flows provided by financing activities
    62,513       383,115  
                 
Net increase in cash and cash equivalents
    665,127       4,162,123  
Effect of foreign currency translation on cash and
cash equivalents
    5,477       (6,743 )
Cash and cash equivalents - beginning of period
    8,490,629       2,967,586  
                 
Cash and cash equivalents - end of period
    9,161,233       7,122,966  
                 
Supplemental disclosures for cash flow information :
               
   Cash paid for :
               
      Interest
    152,636       66,333  

See accompanying notes to unaudited condensed consolidated financial statements
 
 
4

 
 
HIGHPOWER INTERNATIONAL, INC AND SUBSIDIARIES

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

1.
Organization and Basis of Presentation

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

The Company 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.

In January 2008, HKHTC invested $749,971 in Huizhou Highpower Technology Co., Ltd. (“HZ Highpower”). HZ Highpower is a wholly-owned subsidiary of HKHTC. Huizhou Highpower has not commenced business as at December 31, 2010.

On June 20, 2008, HKHTC invested $250,000 in Springpower Technology (Shenzhen) Co., Ltd. (“SZ Springpower”) which became a wholly-owned subsidiary of HKHTC. On July 9, 2008, HKHTC invested an additional $750,000 in SZ Springpower. SZ Springpower 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.

The Company’s common stock commenced trading on the Nasdaq Global Market on December 21, 2009.  Prior to December 21, 2009, shares of the Company’s common stock were listed for 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.

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 were for the period of one year pursuant to a contract dated June 19, 2008, which has expired.

On November 18, 2009, HKHTC invested an additional $1,227,487 in SZ Highpower.

 
5

 
 
HIGHPOWER INTERNATIONAL, INC AND SUBSIDIARIES

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

1.
Organization and Basis of Presentation (continued)

On May 25, 2010, the Company invested $142,514 in Springpower International, Inc. (“Springpower International”) which became an associate of HKHTC. Springpower International incorporates in Canada, it mainly researches and develops advanced, high performance battery materials and clean energy materials.

On September 21, 2010, the Company invested $293,574 in Ganzhou Highpower Technology Co., Ltd. (“GZ Highpower”). GZ Highpower is a wholly owned subsidiary of SZ Highpower. GZ Highpower is expected to engage in trading and research of battery materials.

On October 21, 2010, the Company invested an additional $2,000,000 in HZ Highpower.

On October 20, 2010, with stockholders’ approval, Hong Kong Highpower Technology, Inc. officially changed its name to Highpower International, Inc.

On February 23, 2011, the Company established Icon Energy System Co., Ltd.  to engage in the research, design and production of advanced battery packs and systems.

Description of business

The subsidiaries of the Company include the following:

Name of company
Place and date incorporation
Attributable equity interest held
 
Principal activities
Hong Kong Highpower Technology Co., Ltd
(“HKHTC”)
Hong Kong
Jul 4, 2003
100%
Investment holding
       
Shenzhen Highpower Technology Co., Ltd
(“SZ Highpower”)
PRC
Oct 8, 2002
100%
Manufacturing of batteries
       
Highpower Energy Technology (Huizhou) Co., Ltd
(“HZ Highpower”)
PRC
Jan 29, 2008
100%
Inactive
       
Springpower Technology (Shenzhen) Co., Ltd
 (“SZ Springpower”)
PRC
Jun 4, 2008
100%
Manufacturing of batteries
       
Ganzhou Highpower Technology Co., Ltd
(“GZ Highpower”)
PRC
Sep 21, 2010
100%
Processing, marketing and trading of battery materials

 
6

 
 
HIGHPOWER INTERNATIONAL, INC AND SUBSIDIARIES

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

1.
Organization and Basis of Presentation (continued)

Icon Energy System Co., Ltd.
PRC
Feb 23, 2011
100%
Research and production of advanced battery packs and systems

 
The associate of the Company include the following:

Name of company
Place and date incorporation
Attributable equity interest held
 
Principal activities
Springpower International, Inc.
(“Springpower International”)
Canada
Mar 22, 2010
40%
Research and development of advanced 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, 2010.

Consolidation

The consolidated financial statements include the accounts of the Company and its subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation

On June 29, 2009, the Financial Accounting Standards Board (FASB) established the FASB Accounting Standards Codification (Codification) as the single source of authoritative U.S. generally accepted accounting principles (GAAP) for all nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) are also sources of authoritative U.S. GAAP for SEC registrants. The Codification does not change U.S. GAAP but takes previously issued FASB standards and other U.S. GAAP authoritative pronouncements, changes the way the standards are referred to, and includes them in specific topic areas. The Codification is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption of the Codification did not have any impact on the Company’s financial statements.
 
 
7

 
 
HIGHPOWER INTERNATIONAL, INC AND SUBSIDIARIES

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

2.
Summary of significant accounting policies (continued)

Associate

Associate is entity over which the group has significant influence but not control, generally accompanying a shareholding of between 20% and 50% of the voting rights. Investment in associate is accounted for using the equity method of accounting and is initially recognized at cost. The group’s investment in associates includes goodwill identified on acquisition, net of any accumulated impairment loss.

The group’s share of its associates’ post-acquisition profits or losses is recognized in the income statement, and its share of post-acquisition movements in other comprehensive income is recognized in other comprehensive income.

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.

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.
 
 
8

 
 
HIGHPOWER INTERNATIONAL, INC AND SUBSIDIARIES

NOTES TO UNAUDITED 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 three months ended March 31, 2011 and 2010 are as follows:

   
2011
   
2010
 
             
Energizer
    20 %     19 %

Details of the accounts receivable from the customers with the largest receivable balances as of March 31, 2011 and 2010 are as follows:

   
Percentage of accounts receivable
 
   
March 31,
   
March 31,
 
   
2011
   
2010
 
             
Energizer
    16 %     25 %
Gigaset Communications
    10 %     18 %
Largest receivable balances
    26 %     43 %

Cash and cash equivalents

Cash and cash equivalents include all cash, deposits in banks and other liquid investments with initial maturities of three 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.
 
 
9

 
 
HIGHPOWER INTERNATIONAL, INC AND SUBSIDIARIES

NOTES TO UNAUDITED 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 experienced bad debts of $1,017 and $41,675 during the three months ended March 31, 2011 and 2010, respectively.
 
 
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 three months ended March 31, 2011 and 2010, 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 $35,479 and $17,362 for the three months ended March 31, 2011 and 2010, 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:

Buildings
5% - 10%
Furniture, fixtures and office equipment
20%
Leasehold improvement
50%
Machinery and equipment
10%
Motor vehicles
20%

 
10

 
 
HIGHPOWER INTERNATIONAL, INC AND SUBSIDIARIES

NOTES TO UNAUDITED 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.

Construction in progress represents the properties and plant and machinery in the course of development for production or buildings under development and are stated at cost, less any identified impairment losses.  When the construction is completed and the asset is ready for its intended use, the related cost is transferred to an appropriate category of property, plant and equipment and depreciated in accordance with the above policy.

Investment Securities

Investments in less than twenty percent owned entities are accounted for under the cost basis and are reviewed for impairment periodically.

Management have strategic investments in certain debt and equity securities that are included in noncurrent “Investment securities” on our Consolidated Balance Sheets accounted for using the cost methods of accounting.

The Company ability to realize value from our strategic investments in companies that are not publicly traded depends on the success of those companies’ businesses and their ability to obtain sufficient capital to execute their business plans.  Because private markets are not as liquid as public markets, there is also increased risk that we will not be able to sell these investments, or that when we desire to sell them we will not be able to obtain fair value for them.

Intangible Assets and Long-Lived Assets

FASB ASC 350 “Intangibles – Goodwill and Other”, 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.

 
11

 
 
HIGHPOWER INTERNATIONAL, INC AND SUBSIDIARIES

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

2.
Summary of significant accounting policies (continued)

Intangible Assets and Long-Lived Assets (continued)

The Company accounts for the impairment of long-lived assets, such as plant and equipment, leasehold land and intangible assets, under the provisions of FASB ASC 360 “Property, Plant and Equipment – Overall”. ASC 360 establishes the accounting for impairment of long-lived tangible and intangible assets other than goodwill and for the disposal of a business. Pursuant to ASC 360, 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 three months ended March 31, 2011 and 2010.

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 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.

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 three months ended March 31, 2011 and 2010.
 
 
12

 

HIGHPOWER INTERNATIONAL, INC AND SUBSIDIARIES

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

2.
Summary of significant accounting policies (continued)

Income taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in consolidated statements of income in the period that includes the enactment date or date of change in tax rate. A valuation allowance is provided to reduce the amount of deferred tax assets if it is considered more likely than not that some portion or all of the deferred tax assets will not be realized.

The Company adopted FASB ASC 740, “Accounting for Uncertainty in Income Taxes” clarifies the accounting for uncertain tax positions. This interpretation requires that an entity recognizes in the consolidated financial statements the impact of a tax position, if that position is more likely than not of being sustained upon examination, based on the technical merits of the position. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. The Company has elected to classify interest and penalties related to unrecognized tax benefits, if and when required, as a component of income tax expense in the consolidated statements of income. According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational errors made by the taxpayer or the withholding agent. The statute of limitations is extended to five years under special circumstances, which are not clearly defined. In the case of a related party transaction, the statute of limitation is ten years. There is no statute of limitation in the case of tax evasion. The adoption of ASC 740 did not have a significant effect on the consolidated financial statements.

Comprehensive income

The Company has adopted FASB ASC 220 “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.
 
 
13

 
 
HIGHPOWER INTERNATIONAL, INC AND SUBSIDIARIES

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

2.
Summary of significant accounting policies (continued)

Foreign currency translation (continued)

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.


   
March 31, 2011
   
March 31, 2010
 
             
Quarter end RMB : US$ exchange rate
    6.5486       6.8267  
Average quarterly RMB : US$ exchange rate
    6.5795       6.8273  

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.

 
14

 

HIGHPOWER INTERNATIONAL, INC AND SUBSIDIARIES

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

2. 
Summary of significant accounting policies (continued)

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.

Earnings per share

The Company reports earnings per share in accordance with FASB Accounting Standard Codification Topic 260 (“ASC 260”) “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. Diluted earnings per common share computations are based on the weighted average number of common shares outstanding during the period, plus the dilutive effect of stock options, warrants and restricted stock awards.

Stock-Based Compensation

The Company accounts for stock-based payment transactions in which the Company receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. Stock-based compensation cost for restricted stock units (“RSUs”) is measured based on the closing fair market value of the Company’s common stock on the date of grant. Stock-based compensation cost for stock options is estimated at the grant date based on each option’s fair-value as calculated by the Black-Scholes-Merton (“BSM”) option-pricing model. The Company recognizes stock-based compensation cost as expense ratably on a straight-line basis over the requisite service period. The Company will recognize a benefit from stock-based compensation in equity if an incremental tax benefit is realized by following the ordering provisions of the tax law. In addition, the Company accounts for the indirect effects of stock-based compensation on the research tax credit, the foreign tax credit and the domestic manufacturing deduction through the income statement. Further information regarding stock-based compensation can be found in Note 8, “Shareholders’ Equity and Stock-Based Compensation.”

Share-based compensation expense was $228,621 and $73,177 and for the three months ended March 31, 2011 and 2010, respectively.
 
 
15

 
 
HIGHPOWER INTERNATIONAL, INC AND SUBSIDIARIES

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

2. 
Summary of significant accounting policies (continued)

Recently issued accounting pronouncements

In March 2008, the FASB issued ASC 815 (formerly SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133”) to amend and expand the disclosures about derivatives and hedging activities. The standard requires enhanced qualitative disclosures about an entity’s objectives and strategies for using derivatives, and tabular quantitative disclosures about the fair value of derivative instruments and gains and losses on derivatives during the reporting period. This standard is effective for both fiscal years and interim periods that begin after November 15, 2008. The adoption of this standard on December 29, 2008, the beginning of the Company’s fiscal year, did not have a material impact on its consolidated financial statements.

In August 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-05, which amends ASC Topic 820, Measuring Liabilities at Fair Value, which provides additional guidance on the measurement of liabilities at fair value. These amended standards clarify that in circumstances in which a quoted price in an active market for the identical liability is not available, we are required to use the quoted price of the identical liability when traded as an asset, quoted prices for similar liabilities, or quoted prices for similar liabilities when traded as assets. If these quoted prices are not available, we are required to use another valuation technique, such as an income approach or a market approach. These amended standards are effective for us beginning in the fourth quarter of fiscal year 2009. There was no material impact upon the adoption of this standard on the Company’s consolidated financial statements.

In September 2009, the FASB issued ASU 2009-06, Income Taxes (Topic 740), ”Implementation Guidance on Accounting for Uncertainty in Income Taxes and Disclosure Amendments for Nonpublic Entities”, which provides implementation guidance on accounting for uncertainty in income taxes, as well as eliminates certain disclosure requirements for nonpublic entities.  For entities that are currently applying the standards for accounting for uncertainty in income taxes, this update shall be effective for interim and annual periods ending after September 15, 2009. For those entities that have deferred the application of accounting for uncertainty in income taxes in accordance with paragraph 740-10-65-1(e), this update shall be effective upon adoption of those standards. The adoption of this standard is not expected to have an impact on the Company’s consolidated financial position and results of operations since this accounting standard update provides only implementation and disclosure amendments.

In September 2009, the FASB has published ASU 2009-12, “Fair Value Measurements and Disclosures (Topic 820) - Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)”. This ASU amends Subtopic 820-10, “Fair Value Measurements and Disclosures – Overall”, 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). This ASU also requires new disclosures, by major category of investments including the attributes of investments within the scope of this amendment to the Codification. The guidance in this update is effective for interim and annual periods ending after December 15, 2009. Early application is permitted.   The Company is in the process of evaluating the impact of this standard on its consolidated financial position and results of operations.
 
 
16

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

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

2. 
Summary of significant accounting policies (continued)

Recently issued accounting pronouncements (Continued)

In October 2009, the FASB has published ASU 2009-13, “Revenue Recognition (Topic 605)-Multiple Deliverable Revenue Arrangements”, which addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. Specifically, this guidance amends the criteria in Subtopic 605-25, “Revenue Recognition-Multiple-Element Arrangements”, for separating consideration in multiple-deliverable arrangements. This guidance establishes a selling price hierarchy for determining the selling price of a deliverable, which is based on: (a) vendor-specific objective evidence; (b) third-party evidence; or (c) estimates. This guidance also eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method and also requires expanded disclosures. The guidance in this update is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position and results of operations.

ASC 105, Generally Accepted Accounting Principles (“ASC 105”) (formerly SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles a replacement of FASB Statement No. 162), reorganized by topic existing accounting and reporting guidance issued by the Financial Accounting Standards Board (“FASB”) into a single source of authoritative generally accepted accounting principles (“GAAP”) to be applied by nongovernmental entities. All guidance contained in the Accounting Standards Codification (“ASC”) carries an equal level of authority. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. Accordingly, all other accounting literature will be deemed “non-authoritative”. ASC 105 is effective on a prospective basis for financial statements issued for interim and annual periods ending after September 15, 2009. The Company has implemented the guidance included in ASC 105 as of July 1, 2009. The implementation of this guidance changed the Company’s references to GAAP authoritative guidance but did not impact the Company’s financial position or results of operations.

In January 2010, the FASB issued Accounting Standards Update No. 2010-06 (ASU 2010-06), Fair Value Measurements and Disclosures which amends ASC Topic 820, adding new requirements for disclosures for Levels 1 and 2, separate disclosures of purchases, sales, issuances, and settlements relating to Level 3 measurements and clarification of existing fair value disclosures.  ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for the requirement to provide Level 3 activity of purchases, sales, issuances, and settlements on a gross basis, which will be effective for fiscal years beginning after December 15, 2010 (the Company’s fiscal year 2012); early adoption is permitted.  The Company is currently evaluating the impact of adopting ASU 2009-14 on its financial statements.
 
 
17

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

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

2. 
Summary of significant accounting policies(continued)

Recently issued accounting pronouncements (Continued)

In February 2010, FASB issued ASU 2010-9 Subsequent Events (Topic 855) Amendments to Certain Recognition and Disclosure Requirements ("ASU 2010-9"). ASU 2010-9 amends disclosure requirements within Subtopic 855-10. An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. This change alleviates potential conflicts between Subtopic 855-10 and the SEC's requirements. ASU 2010-9 is effective for interim and annual periods ending after June 15, 2010. The Company does not expect the adoption of ASU 2010-09 to have a material impact on its results of operations or financial position.

Effective July 1, 2010, we adopted the update to the accounting standard regarding derivatives and hedging (Topic 815). This update clarifies how to determine whether embedded credit derivatives, including those interests held in collateralized debt obligations and synthetic collateralized debt obligations, should be bifurcated and accounted for separately. The adoption of this standard did not have a significant impact on our results of operations.

In December 2010, the FASB issued Accounting Standards Update ASU 2010-29, Disclosure of Supplementary Pro Forma Information for Business Combinations (Topic 805). The update requires public companies to disclose pro forma information for business combinations that occur in the current reporting period. The disclosures include pro forma revenue and earnings of the combined entity for the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. This guidance is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010, with early adoption permitted. The Company’s adoption of FASB ASU No. 2010-29 effective December 1, 2010 did not have an impact on the Company’s consolidated results of operations or financial position but did result in additional disclosures.

3. 
Other income

   
Three months ended March 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
    $     $  
               
Bank interest income
    31,555       29,248  
Government sponsor
    79,478       14,647  
Foreign exchange contract income
    56,448       1,582  
Sundry income
    65,067       31,897  
                 
      232,548       77,374  
 

 
 
18

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

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

4.
Interest expenses

   
Three months ended March 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
    $     $  
               
Interest on trade related bank loan
    82,402       60,073  
Interest on short-term bank loans
    70,234       6,260  
                 
      152,636       66,333  

5. 
Other expenses


   
Three months ended March 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
    $     $  
               
Sundry expenses
    23,964       -  
                 
      23,964       -  

6. 
Income taxes

The components of the provision for income taxes are:

   
Three months ended March 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
    $     $  
               
PRC income taxes
    5,761       379,414  
                 
      5,761       379,414  

       Accounting for Uncertainty in Income Taxes

The Company adopted the provisions of FASB Accounting Standard Codification Topic 740 (ASC 740) “Income Taxes”. ASC 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with ASC 740, and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The adoption of the provisions of ASC 740 did not have a material effect on the Company’s financial statements.

Based on the Company’s evaluation, the Company has concluded that there are no significant uncertain tax positions requiring recognition in its financial statements.
 
 
19

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

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

7. 
Prepaid expenses and other receivables

   
At of
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
    $     $  
               
Purchase deposits paid
    2,671,089       688,041  
Advance to staff
    317,820       72,047  
Other deposits and prepayments
    521,054       500,362  
Valued-added tax prepayment
    905,308       975,552  
Other receivables
    1,018,334       995,209  
                 
      5,433,605       3,231,211  
 
8.
Share – based compensation expenses

 
Equity awards are currently made only from the 2008 Omnibus Incentive Plan as described below.

 
2008 Omnibus Incentive Plan

 
The 2008 Omnibus Incentive Plan (the “2008 Plan”) was approved by the Company’s Board of Directors on October 30, 2008 and became effective upon the approval of the Company’s stockholders on December 11, 2008. The 2008 Plan has a ten year term. The 2008 Plan reserves two million shares of common stock for issuance, subject to increase from time to time by the number of shares: (i) subject to outstanding awards granted under the Company’s prior equity compensation plans that terminate without delivery of any stock (to the extent such shares would have been available for issuance under such prior plan), and (ii) subject to awards assumed or substituted in connection with the acquisition of another company.

 
The 2008 Plan authorizes the issuance of awards including stock options, restricted stock units (RSUs), restricted stock, unrestricted stock, stock appreciation rights (SARs) and other equity and/or cash performance incentive awards to employees, directors, and consultants of the Company. Subject to certain restrictions, the Compensation Committee of the Board of Directors has broad discretion to establish the terms and conditions for awards under the 2008 Plan, including the number of shares, vesting conditions and the required service or performance criteria. Options and SARs have a contractual term of ten years and generally vest over four to five years with an exercise price equal to the fair market value on the date of grant. Incentive stock options (ISOs) granted must have an exercise price equal to the fair market value on the date of grant. Repricing of stock options and SARs is prohibited without stockholder approval. Certain change in control transactions may cause awards granted under the 2008 Plan to vest, unless the awards are continued or substituted for in connection with the transaction. At March 31, 2011, approximately 1,108,000 shares of our common stock remained available for issuance pursuant to awards granted under the 2008 Plan.
 
 
20

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

8.
Share – based compensation expenses (continued)

 
Stock-Based Compensation Related to employees

   
Number
   
Exercise
 
Contractual Term
   
of Shares
   
Price
 
Years
               
Outstanding, January 1, 2011
    -       -    
                   
Granted
    870,000     $ 3.55    
Exercised
    -       -    
Forfeited
    (10,000 )   $ 3.55    
                   
Outstanding, March 31, 2011
    860,000     $ 3.55  
9.81
Exercisable, March 31, 2011
    90,000     $ 3.55  
9.81

 
During the three months ended March 31, 2011 the Company granted 870,000 options to ten employees at a per share exercise price of $3.55. At the date of report, one employee has resigned already in March 2011, the 10,000 options has been forfeited in accordance to the terms and conditions of the plan.

 
The weighted-average fair value of options granted to employees for the three month period ended March 31, 2011 was $1.52 per share as calculated using the Black Scholes pricing model, with the following weighted-average assumptions:

Weighted averages
 
March 31,2011
 
       
Expected volatility
    40.01 %
Risk-free interest rate
    2.47 %
Expected term from grant datein years
    6.16  
Dividend rate
    -  
         
Fair value
  $ 1.52  

 
Stock-Based Compensation Related to Nonemployees

   
Number
   
Exercise
 
Contractual Term
   
of Share
   
Price
 
Years
               
Outstanding, January 1, 2011
    -       -    
                   
Granted
    15,000     $ 3.41    
Exercised
    -       -    
Forfeited
    -       -    
                   
Outstanding, March 31, 2011
    15,000     $ 3.41  
9.81
Exercisable, March 31, 2011
    -       -  
-

 
There were no options exercised during the three month period ending March 31, 2011.
 
 
21

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

8.
Share – based compensation expenses (continued)

Stock-Based Compensation Related to Nonemployees (continued)

 
The stock-based compensation cost of options granted to nonemployees is initially measured on the grant date using the Black-Scholes model and is remeasured over the vesting period as earned. The resulting value is recognized as an expense over the period in which services are received.

 
During the three months ended March 31, 2011 the Company granted options to purchase 15,000 shares of common stock to a consultant at a per share exercise price of $3.41, in exchange for services from the consultant.

 
The grant date fair values of stock options granted to nonemployees were calculated using the Black-Scholes pricing model with the following weighted-average assumptions:

Weighted averages
 
March 31,2011
 
       
Expected volatility
    39.45 %
Risk-free interest rate
    2.53 %
Expected term from grant datein years
    6.50  
Dividend rate
    -  
         
Fair value
  $ 1.22  

 
Expected Term.
 
The expected term of stock options represents the weighted-average period that the stock options are expected to remain outstanding. There have been no stock option exercises to date upon which to base an estimate of the expected term.  The Company determined it appropriate to estimate the expected term using the “simplified” method as prescribed by the Securities and Exchange Commission, or SEC, in Staff Accounting Bulletin No. 107, or SAB 107, as amended by SAB 110. The simplified method determines an expected term based on the average of the weighted average vesting term and the contractual term of the option.

 
Expected Volatility.
 
The Company has limited stock trading history and it is not able to reasonably estimate the fair value of its equity share options because it is not practicable for it to estimate the expected volatility of its share price.  The expected volatilities used for the three month period ended March 31, 2011 are based upon the volatilities of a peer group of comparable publicly traded companies. This peer group was selected by the Company using criteria including similar industry, similar stage of development and comparable market capitalization.

 
Risk-Free Interest Rate.
 
The risk-free interest rate assumption is based on U.S. Treasury instruments with a term consistent with the expected term of the Company’s stock options.

 
22

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)

8.
Share – based compensation expenses (continued)

 
Dividend Yield.
 
The Company has never declared or paid any cash dividends and does not plan to pay cash dividends in the foreseeable future, and therefore, used an expected dividend yield of zero in the valuation model.

 
Forfeitures.
 
The Company estimates forfeitures at the time of grant and revises the estimates in subsequent periods if actual forfeitures differ from what was estimated. The Company uses historical data to estimate pre-vesting option forfeitures and records stock-based compensation expense only for those awards that are expected to vest. All stock-based payment awards are amortized on a ratable basis over the requisite service periods of the awards, which are generally the vesting periods. The Company records stock-based compensation expense only for those awards that are expected to vest.

 
Total Share-Based Compensation Expense

 
No share-based compensation expense was capitalized in the periods presented. At March 31, 2011 the gross amount of unrecognized share-based compensation expense relating to unvested share-based awards was approximately $1.096 million, which the Company anticipates recognizing as a charge against income over a weighted average period of 3.34 years.

 
In connection with the grant of stock options to employees and nonemployees, the Company recorded stock-based compensation charges of $227,712 and $909 respectively for the three month period ending March 31, 2011. At March 31, 2011, options held by nonemployees to purchase 15,000 shares were unvested and subject to remeasurement.

 
The estimated fair value of share-based awards is recognized as a charge against income on a ratable basis over the requisite service period, which is generally the vesting period of the award. Total share-based compensation expense recognized in our condensed consolidated statements of operations for the three months ended March 31, 2011 and 2010 was as follows:

Summary of Compensation Expense
 
   
Three months ended March 31,
 
   
2011
   
2010
 
             
Costs of revenue
  $ 67,942     $ -  
General and administrative
    31,710       73,177  
Sales and marketing
    128,969       -  
                 
Total share-based compensation expenses
  $ 228,621     $ 73,177  


9. 
Earning per share

Basic earning per common share is computed by dividing income available to common shareholders by the weighted-averages number of shares of common stock outstanding during the period. Diluted earning per common share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock outstanding that would have been outstanding if the potentially dilutuve securities had been issued. Potentially dilutive securities include outstanding stock options, restricted shares. The dilutive effect of potentially dilutive securities is reflected in diluted earning per common share by application of the treasury stock method. Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greater dilutive effect from potentially dilutive securities.
 
 
23

 

HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

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

9. 
Earning per share (continued)

The following tables set forth the computation of basic and diluted earnings per common share for the three months ended March 31, 2011 and 2010.

   
Three months ended
 
   
March 31,
   
March 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
    $     $  
Numerator:
             
Net (loss)/income
    (461,321 )     1,580,700  
                 
Denominator:
               
Weighted-average shares outstanding
    13,582,106       13,582,106  
Effect of dilative securities
    201,750       49,990  
Denominator:
               
                 
Weighted-average shares diluted
    13,783,856       13,632,096  
                 
Basic earning per common share
    (0.03 )    
0.12
 
                 
Diluted earning per common share
    (0.03 )    
0.12
 
 

10.
Inventories

   
At of
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
    $     $  
               
Raw materials
    3,491,048       3,743,307  
Work in progress
    1,303,819       1,847,390  
Finished goods
    6,738,012       7,841,283  
Packing materials
    18,640       15,452  
                 
      11,551,519       13,447,432  

 
24

 

HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

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

11.
Plant and equipment

   
At of
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Audited)
 
    $     $  
Cost                
  Construction in progress
    4,270,530       3,499,495  
Furniture, fixtures and office equipment
    2,469,234       2,310,868  
Leasehold improvement
    -       732,560  
Machinery and equipment
    11,291,930       10,783,907  
Motor vehicles
    1,086,845       1,045,843  
Building
    258,746       253,709  
                 
      19,377,285       18,626,382  
                 
Accumulated depreciation
               
Construction in progress
    -       -  
Furniture, fixtures and office equipment
    1,135,934       962,193  
Leasehold improvement
    -       691,393  
Machinery and equipment
    3,208,165       2,890,437  
Motor vehicles
    467,409       417,193  
Building
    16,781       12,912  
                 
      4,828,289       4,974,128  
                 
Net
               
Construction in progress
    4,270,530       3,499,495  
Furniture, fixtures and office equipment
    1,333,300       1,348,675  
Leasehold improvement
    -       41,167  
Machinery and equipment
    8,083,765       7,893,470  
Motor vehicles
    619,436       628,650  
Building
    241,965       240,797  
                 
      14,548,996       13,652,254  
 
The components of depreciation charged are:

   
Three months ended March 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
    $     $  
               
Included in cost of sales and selling and distribution costs
    302,394       291,330  
Included in operating expenses
    113,570       69,242  
                 
      415,964       360,572  

 
25

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

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

12. 
Leasehold land

   
At of
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Audited)
 
    $     $  
               
Cost
    3,279,032       3,215,205  
                 
Accumulated amortization
    (213,137 )     (192,912 )
                 
Net
    3,065,895       3,022,293  

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

13. 
Intangible asset – Consumer battery license

   
At of
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Audited)
 
    $     $  
Cost
             
Consumer battery license fee
    1,000,000       1,000,000  
                 
Accumulated amortization
    (212,500 )     (200,000 )
                 
Net
    787,500       800,000  

Amortization expenses included in selling and distribution costs for the three months ended March 31, 2011 and 2010 was $12,500.

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.

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.
 
 
26

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

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

13.
Intangible asset – Consumer battery license (continued)

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 three months ended March 31, 2011, the Company recorded a total of approximately $88,780 as royalty expense, which was included in selling and distribution costs in the statement of operations. At March 31, 2011, accrued royalty fees payable was $1,248,374 (see Note 19).

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. 
Investment in an associate

   
At of
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Audited)
 
    $     $  
               
Acquisition of associate
    142,514       142,514  
Share of loss - accumulated
    (41,163 )     (39,391 )
                 
Net
    101,351       103,123  

On March 22, 2010, the group acquired 40% of the share capital of Springpower International, Inc, which is an intellectual properties development company operating in Canada. The group‘s share of the results of its associate and its aggregated assets and liabilities, are as follows:

Name
Country of Incorporation
Assets
Liabilities
Revenue
Loss
% Interest Held
At March 31, 2011
           
   
$
$
$
$
 
Springpower International, Inc.
Canada
368,918
85,048
3,153
106,061
40%
             
At December 31, 2010
           
   
$
$
$
$
 
Springpower International, Inc
Canada
369,052
78,612
3,045
101,523
40%

 
27

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

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

15. 
Investment Securities

   
As of
 
   
March 31,
2011
(Unaudited)
   
December 31,
2010
(Audited)
 
    $     $  
               
Investment securities - cost method
    54,973       53,904  
                 
      54,973       53,904  

The investments in less than twenty percent owned entities are accounted for under the cost basis.

16. 
Fair Value Measurements

The Company adopted FASB ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), related to the Company’s financial assets and liabilities. ASC 820 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. ASC 820 defines fair value as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also describes three levels of inputs that may be used to measure fair value:
 
Level 1 — quoted prices in active markets for identical assets and liabilities.
 
Level 2 — observable inputs other than quoted prices in active markets for identical assets and liabilities.
 
Level 3 — unobservable inputs in which there is little or no market data available, which require the reporting entity to develop its own assumptions.
 
ASC 820 also provides guidance for determining the fair value of a financial asset when the market for that asset is not active, and for determining fair value when the volume and level of activity for an asset or liability have significantly decreased and includes guidance on identifying circumstances that indicate when a transaction is not orderly. The adoption of ASC 820 did not have a material impact on the Company’s financial condition or results of operations.
 
The effective date for certain aspects of ASC 820 was deferred and are currently being evaluated by the Company. Areas impacted by the deferral relate to nonfinancial assets and liabilities that are measured at fair value, but are recognized or disclosed at fair value on a nonrecurring basis. The effects of these remaining aspects of ASC 820 are to be applied by the Company to fair value measurements prospectively beginning November 1, 2009. The adoption of the remaining aspects of ASC 820 is not expected to have a material impact on its financial condition or results of operations. See Note 6 to the consolidated financial statements in this Report on Form 10-K for additional investment information.
 
 
28

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

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

16. 
Fair Value Measurements(continued)

The following table details the fair value measurements of assets and liabilities within the three levels of the fair value hierarchy at March 31, 2011 and December 31, 2010:

         
Fair Value Measurements at reporting date using
 
   
 
 
 
March 31, 2011
   
Quoted Price in active Markets for identical assets
(level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Other Unobservable Inputs
(Level 3)
 
    $     $     $     $  
Assets
                       
Accounts receivable
    20,317,450       -       -       20,317,450  
Prepaid expenses and other receivables
    5,433,605       -       -       5,433,605  
Notes receivable
    1,197,821       -       -       1,197,821  
                                 
Liabilities
                               
Non-trading foreign currency derivatives liabilities
    212,908       -       212,908       -  
Accounts payable
    14,679,034       -       -       14,679,034  
Other payables and accrued liabilities
    5,429,605       -       -       5,429,605  

         
Fair Value Measurements at reporting date using
 
   
 
 
 
December 31, 2010
   
Quoted Price in active Markets for identical assets
(level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Other Unobservable Inputs
(Level 3)
 
    $     $     $     $  
Assets
                       
Accounts receivable
    20,846,540       -       -       20,846,540  
Prepaid expenses and other receivables
    3,231,210       -       -       3,231,210  
Notes receivable
    256,574       -       -       256,574  
                                 
Liabilities
                               
Non-trading foreign currency derivatives liabilities
    77,699       -       77,699       -  
Accounts payable
    13,407,204       -       -       13,407,204  
Other payables and accrued liabilities
    4,983,269       -       -       4,983,269  
 
Level 2 financial assets represent the fair value of our foreign currency exchange contracts that were valued using pricing models that take into account the contract terms as well as multiple inputs are applicable, such as currency rate. Level 3 financial assets represent the fair value of our accounts receivables.
 
 
29

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

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

17.
Risk Management Activities, Including Derivative

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

 
Three months ended March 31,
 
 
2011
   
2010
 
 
(Unaudited)
   
(Unaudited)
 
  $     $  
Foreign exchange contracts, net
           
Gain recognized in Other income, net
56,448
      1,582  

Hedging Activities

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 March 31, 2011, the Company had a series of currency forwards totaling a notional amount US$15,500,000 expiring from April 2011 to December 2011.

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.

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.
 
 
30

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

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

17.
Risk Management Activities, Including Derivative (continued)

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.

The cost of the effective portion of the cash flow hedges was $212,908 and $8,524 for the three months ended March 31, 2011 and 2010, respectively.

18. 
Change in fair value of share warrants

On June 19, 2008, the Company issued to WestPark Capital, Inc. warrants to purchase 52,500 shares of common stock at an exercise price of $3.90 per share in connection with the initial public offering. The warrants have a term of five years and are exercisable no sooner than one year and no later than five years.

The fair value of the warrants at June 19, 2008, the date of issue is $276,000. The fair value of the warrants is appraised by an independent qualified valuer.

On December 16, 2009, a warrant holder exercised 5,000 shares of the warrants via a cashless exercise. The Company issued 2,510 shares of common stock upon the exercise of the warrants at no consideration. At March 31, 2011, warrants to purchase 47,500 shares of common stock were still outstanding.

19. 
Other payables and accrued liabilities

   
At of
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
    $     $  
               
Accrued expenses
    2,286,150       2,469,391  
Royalty payable
    1,248,374       1,159,594  
Sales deposits received
    1,113,035       1,007,201  
Other payables
    782,046       347,083  
                 
      5,429,605       4,983,269  
 
 
31

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

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

20.
Bank borrowings

   
At of
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
    $     $  
Secured:
             
Repayable within one year
             
Short term bank loans
    8,708,176       8,306,299  
Other trade related bank loans
    15,017,190       14,232,733  
                 
      23,725,366       22,539,032  

As of March 31, 2011, the above bank borrowings were secured by the following:

(a) 
charge over bank deposits of $6,636,347 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 $3,065,895 (see Note 12); and

(d)
other financial covenant

The interest rates of trade related bank loans were at bank’s prime lending rate per annum with various maturity dates. The rates at March 31, 2011 ranged from 5.1% to 7.0%.

21. 
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 $175,305 and $145,193 for the three months ended March 31, 2011 and 2010, respectively.
 
 
32

 

HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

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

22. 
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 2010 to 2011, 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 March 31, 2010 are as follows:

Period ending March 31,
  $  
         
2011
    794,395  
2012
    440,068  
         
      1,234,463  

Rent expenses for the three months ended March 31, 2011 and 2010 were $254,139 and $235,616 respectively.

23. 
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 FASB Accounting Standard Codification Topic 280 (ASC 280) “Segment Reporting”.
 
 
33

 
 
HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

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

23. 
Segment Information (continued)

All long-lived assets of the Company are located in the PRC. Geographic information about the revenues and accounts based on the location of the Company’s customers is set out as follows:

   
Three months ended March 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
    $     $  
Net revenue
           
Hong Kong and China
    16,734,474       12,016,686  
Asia
    1,475,450       1,134,710  
Europe
    6,469,280       4,628,822  
North America
    2,194,726       2,401,611  
South America
    32,246       41,543  
Others
    44,490       -  
                 
      26,950,666       20,223,372  


   
At of
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
    $     $  
Accounts receivable
           
Hong Kong and China
    15,089,785       14,944,284  
Asia
    295,790       603,275  
Europe
    3,995,770       3,441,242  
North America
    924,200       1,847,730  
South America
    3,944       2,080  
Africa
    7,961       7,929  
                 
      20,317,450       20,846,540  
 
24. 
Subsequent Events

We have evaluated significant events and transactions that occurred from April 1, 2011 through the date of this report and have determined that there were no events or transactions other than those disclosed in this report, if any, that would require recognition or disclosure in our Condensed Consolidated Financial Statements for the quarterly period ended March 31, 2011.

 
34

 
 
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 Highpower International, 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. (“Spring power”). HKHT’s other subsidiary, HZ Highpower Technology Co. (“HZ Highpower”) has not yet commenced operations. Shenzhen Highpower’s wholly-owned subsidiary, Ganzhou Highpower Technology Co., Ltd. (“GZ Highpower”), commenced business operations in September 2010. HKHT formed another wholly-owned subsidiary, Icon Energy System Co., Ltd., a company organized under the laws of the PRC, in February 2011, which had not yet commenced operations as of March 31, 2011.

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, 2010.

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 2010 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 to Hong Kong Highpower Technology, Inc.  On October 20, 2010 we changed our name to Highpower International, Inc. On February 23, 2011, we created Icon Energy System Co., Ltd.

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.  Shenzhen Highpower formed GZ Highpower in September 2010.  GZ Highpower commenced business operations in September 2010. HZ Highpower has not yet commenced business operations. HKHT formed another wholly-owned subsidiary, Icon Energy System Co., Ltd., a company organized under the laws of the PRC, in February 2011, which has not yet commenced operations.

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.

 
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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.
 
We recently began a new materials business in which we buy and resell certain raw materials related to our battery manufacturing operations.  This new materials business generates revenue and income and helps us understand our raw material supply chain, control our raw material costs and ensure that we have a steady supply of raw materials for our battery manufacturing operations.

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.

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.”
 
 
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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
 
Three Months Ended March 31, 2011 and 2010

Net sales for the three months ended March 31, 2011 were $27.0 million compared to $20.2 million for the three months ended March 31, 2010 an increase of 34%.  The increase in net sales for the year ended March 31, 2011 over the year ended March 31, 2010 was due to a 5.8% increase in the average selling price of our Ni-MH battery units, a 3.6% increase in the number of Ni-MH battery units sold, a 22.7% increase in the average selling price of our Li-ion battery units, and a 22.8% increase in the number of Li-ion battery units sold.  In addition, revenue from our New Materials business increased to $6.9 million for the three months ended March 31, 2011 from $2.9 million for the three months ended March 31, 2010.

Cost of sales consists of the cost of nickel and other rare earth materials.  Costs of sales were $23.0 million for the three months ended March 31, 2011, as compared to $16.0 million for the comparable period in 2010.  As a percentage of net sales, cost of sales increased to 85.2% for the three months ended March 31, 2011 compared to 79.0% for the comparable period in 2010.  This increase was attributable to the increases of raw material prices including nickel and rare earth materials.
 
Gross profit for the three months ended March 31, 2011 was $4.0 million, or 14.8% of net sales, compared to $4.2 million, or 21.0% of net sales, for the comparable period in 2010.  Management considers gross profit to be a key performance indicator in managing our business. Gross profit margins are usually a factor of cost of sales, product mix and demand for product. The decrease in our gross profit margin for the three months ended March 31, 2011 is primarily due to a 16.7% increase in the average per unit cost of goods sold during three months ended March 31, 2011 as compared to the comparable period in 2010.

To cope with pressure on our gross margins we intend to control production costs by entering into long term contract to lock in the raw material prices at the appropriate timing. Additionally, we have reorganized the Company’s production structure and have focused more attention on employee training to enhance efficiency. We also intend to expand our market share by investing in greater promotion of our products in regions such as the U.S., and Europe, and by expanding our sales team with more experienced international sales personnel. We have also begun production capacity expansion for our Li-ion batteries business as to take advantage of the strong demand globally.

Selling and distribution costs were $1.2 million for the three months ended March 31, 2011 compared to $752,054 for the comparable period in 2010. The increase was primarily due to the expansion of our sales force and increased international marketing activities such as trade shows, customer visits, and advertising.
  
General and administrative costs were $2.6 million, or 9.6% of net sales, for the three months ended March 31, 2011, compared to $1.5 million, or 7.2% of net sales, for the comparable period in 2010. Management considers these expenses as a percentage of net sales to be a key performance indicator in managing our business.  The increase as a percentage of net sales was primarily due to increased labor costs and research and development expenses.  Research and development expenses increased $294,235 for the three months ended March 31, 2011 as compared to the comparable period in 2010 due to our increased commitment to advancing our research and development activities. Labor and personnel costs increased $590,234 for the three months ended March 31, 2011 as compared to the comparable period in 2010 due to the expansion of our workforce to expand our research and development and management functions.

 
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We experienced losses on the exchange rate difference between the U.S. Dollar and the RMB of $172,936 and $22,354 respectively, in the three months ended March 31, 2011 and 2010. The increase in the losses on exchange rate was due to the devaluation of the U.S. Dollar relative to the RMB over the respective periods.  Although our sales contracts do not automatically adjust to reflect changes in exchange rates, to cope with devaluation of the U.S. Dollar relative to the RMB, each time that we enter into new sales contracts with new or existing customers we adjust the selling price of batteries in anticipation of an increase, and to make up for any potential change, in the exchange rate between the two currencies.

Interest expense was $153,000 for the three months ended March 31, 2011, as compared to $66,000 for the comparable period in 2010. The decrease was primarily due to lower interest rates. We increased our borrowings by approximately $8.0 million in the three months ended March 31, 2011 as compared to the three months ended March 31, 2010.  Further increases in borrowing rates would further increase our interest expense, which would have a negative effect on our results of operations.

Other income from operations, which consists of bank interest income, exchange gains and losses and sundry income, was $233,000, for the three months ended March 31, 2011, as compared to $77,000 for the three months ended March 31, 2010, an increase of 33%. The increase was due to an increase in funds from a government sponsor of $65,000, an increase in bank interest income of $2,000, a $55,000 gain on a foreign exchange contract and a $33,000 increase in sundry income.

We had sundry expenses of $24,000 in the three months ended March 31, 2011.  We had no such expenses in the three months ended March 31, 2010.
 
During the three months ended March 31, 2011, we recorded a provision for income taxes of $6,000, as compared to $379,000 for the comparable period in 2010.  The decrease was a result of a decrease in our net taxable income.
 
Net loss for the three months ended March 31, 2011 was $461,000, compared to net income of $1.6 million for the comparable period in 2010.

Liquidity and Capital Resources

We had cash and cash equivalents of approximately $9.1 million as of March 31, 2011, as compared to $8.5 million as of December 31, 2010. Our funds are kept in financial institutions located in the PRC, which do not provide insurance for amounts on deposit.  Moreover, we are subject to the regulations of the PRC which restrict the transfer of cash from the PRC, except under certain specific circumstances. Accordingly, such funds may not be readily available to us to satisfy obligations which have been incurred outside the PRC. 
 
To provide liquidity and flexibility in funding our operations, we borrow amounts under bank facilities and other external sources of financing. As of March 31, 2011, we had in place general banking facilities with nine financial institutions aggregating $82.4 million. The maturity of these facilities is generally up to one year. The facilities are subject to annual review and approval. These banking facilities are guaranteed by us and our Chief Executive Officer, Dang Yu Pan, and contain customary affirmative and negative covenants for secured credit facilities of this type. However, these covenants do not have any impact on our ability to undertake additional debt or equity financing. Interest rates are generally based on the banks’ reference lending rates. No significant commitment fees are required to be paid for the banking facilities. As of March 31, 2011, we had utilized approximately $23.7 million under such general credit facilities and had available unused credit facilities of $58.7 million.
 
For the three months ended March 31, 2011, net cash provided by operating activities was approximately $1.6 million, as compared to $4.3 million for the comparable period in 2010. The decrease in net cash provided by operating activities is primarily attributable to the net loss and increased receivables during the three months ended March 31, 2011.

Net cash used in investing activities was $1.04 million for the three months ended March 31, 2011 compared to $568,000 million for the comparable period in 2010. The increase of cash used in investing activities was primarily attributable to an increase in the ongoing construction of our Huizhou production facilities and acquisition of new equipment over the respective periods.
 
Net cash provided by financing activities was $63,000 during the three months ended March 31, 2011, as compared to net cash used in financing activities of $383,000 for the three months ended March 31, 2010.  The decrease in net cash provided by financing activities was attributable to repaying our bank loans.
 
 
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For the three months ended March 31, 2011, our inventory turnover was 7 times, as compared to 5.7 times at March 31, 2010. The average days outstanding of our accounts receivable at March 31, 2011 were 69, as compared to 63 days at March 31, 2010. Inventory turnover and average days outstanding are key operating measures that management relies on to monitor our business. In the next 12 months, we expect to expand our research, development and manufacturing of lithium-based batteries and anticipate additional capital expenditures.
 
We are required to contribute a portion of our employees’ total salaries to the Chinese government’s social insurance funds, including medical insurance, unemployment insurance and job injuries insurance, and a housing assistance fund, in accordance with relevant regulations.  Total contributions to the funds were approximately $175,305 and $145,193 in the three months ended March 31, 2011 and 2010, respectively.  We expect the amount of our contribution to the government’s social insurance funds to increase in the future as we expand our workforce and operations.

Based upon our present plans, we believe that cash on hand, cash flow from operations and funds available under our bank facilities will be sufficient to fund our capital needs for the next 12 months.  However, our ability to maintain sufficient liquidity depends partially on our ability to achieve anticipated levels of revenue, while continuing to control costs. If we did not have sufficient available cash, we would have to seek additional debt or equity financing through other external sources, which may not be available on acceptable terms, or at all. Failure to maintain financing arrangements on acceptable terms would have a material adverse effect on our business, results of operations and financial condition.
 
The use of working capital is primarily for the maintenance of our accounts receivable and inventory. We provide our major customers with payment terms ranging from 30 to 75 days. Additionally, our production lead time is approximately 30 to 40 days, from the inspection of incoming materials, to production, testing and packaging. We need to keep a large supply of raw materials and work in process and finished goods inventory on hand to ensure timely delivery of our products to our customers. We use two methods to support our working capital needs: (1) paying our suppliers under payment terms ranging from 30 to 60 days; and (2) using short-term bank loans. We use our accounts receivable as collateral for our loans. Upon receiving payment for our accounts receivable, we pay our short-term loans. Our working capital management practices are designed to ensure that we maintain sufficient working capital.

Recent Accounting Pronouncements

In January 2010, the FASB issued Accounting Standards Update No. 2010-06 (ASU 2010-06), Fair Value Measurements and Disclosures which amends ASC Topic 820, adding new requirements for disclosures for Levels 1 and 2, separate disclosures of purchases, sales, issuances, and settlements relating to Level 3 measurements and clarification of existing fair value disclosures.  ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for the requirement to provide Level 3 activity of purchases, sales, issuances, and settlements on a gross basis, which will be effective for fiscal years beginning after December 15, 2010 (the Company’s fiscal year 2012); early adoption is permitted.  The Company is currently evaluating the impact of adopting ASU 2009-14 on its financial statements.
 
In February 2010, FASB issued ASU 2010-9 Subsequent Events (Topic 855) Amendments to Certain Recognition and Disclosure Requirements ("ASU 2010-9"). ASU 2010-9 amends disclosure requirements within Subtopic 855-10. An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. This change alleviates potential conflicts between Subtopic 855-10 and the SEC's requirements. ASU 2010-9 is effective for interim and annual periods ending after June 15, 2010. The Company does not expect the adoption of ASU 2010-09 to have a material impact on its results of operations or financial position.

Effective July 1, 2010, we adopted the update to the accounting standard regarding derivatives and hedging (Topic 815). This update clarifies how to determine whether embedded credit derivatives, including those interests held in collateralized debt obligations and synthetic collateralized debt obligations, should be bifurcated and accounted for separately. The adoption of this standard did not have a significant impact on our results of operations.

In December 2010, the FASB issued Accounting Standards Update ASU 2010-29, Disclosure of Supplementary Pro Forma Information for Business Combinations (Topic 805). The update requires public companies to disclose pro forma information for business combinations that occur in the current reporting period. The disclosures include pro forma revenue and earnings of the combined entity for the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. This guidance is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010, with early adoption permitted. The Company’s adoption of FASB ASU No. 2010-29 effective December 1, 2010 did not have an impact on the Company’s consolidated results of operations or financial position but did result in additional disclosures.

 
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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Credit Risk

We are exposed to credit risk from our cash at bank, fixed deposits and contract receivables. The credit risk on cash at bank and fixed deposits is limited because the counterparts are recognized financial institutions. Contract receivables are subject to credit evaluations. We periodically record a provision for doubtful collections based on an evaluation of the collectibility of contract receivables by assessing, among other factors, the customer’s willingness or ability to pay, repayment history, general economic conditions and our ongoing relationship with the customers.

Foreign Currency and Exchange Risk

The Company maintains its financial statements in the functional currency of Renminbi (“RMB”). Substantially all of our operations are conducted in the PRC and we pay the majority of our expenses in RMB. Approximately 75% of our sales are made in U.S. Dollars. During the three months ended March 31, 2011, the exchange rate of the RMB to the U.S. Dollar has appreciated 1.2% from the level at the end of December 31, 2010.  A future appreciation of the RMB against the U.S. Dollar would increase our costs when translated into U.S. Dollars and could adversely affect our margins unless we make sufficient offsetting sales. Conversion of RMB into foreign currencies is regulated by the People’s Bank of China through a unified floating exchange rate system. Although the PRC government has stated its intention to support the value of the RMB, there can be no assurance that such exchange rate will not continue to appreciate significantly against the U.S. Dollar. Exchange rate fluctuations may also affect the value, in U.S. Dollar terms, of our net assets. In addition, the RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. Due to the volatility of the US Dollar to our functional currency the Company put into place in 2008 a hedging program to attempt to protect it from significant changes to the US Dollar which affect the value of its US dollar receivables and sales.  At March 31, 2011, the Company had a series of currency forwards totaling a notional amount US$15,500,000 expiring from April 2011 to December 2011.  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. We experienced a gain of $56,488 in the value of currency forwards in the three months ended March 31, 2011 as compared to a gain of $1,582 on currency forwards during the comparable period in 2010.
 
Country Risk

The substantial portion of our business, assets and operations are located and conducted in Hong Kong and China. While these economies have experienced significant growth in the past twenty years, growth has been uneven, both geographically and among various sectors of the economy. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall economy of Hong Kong and China, but may also have a negative effect on us. For example, our operating results and financial condition may be adversely affected by government control over capital investments or changes in tax regulations applicable to us. If there are any changes in any policies by the Chinese government and our business is negatively affected as a result, then our financial results, including our ability to generate revenues and profits, will also be negatively affected.
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