CBAK Energy Technology (CBAT) 10-Q 2006 Q4 Quarterly report

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

FORM 10-Q

(Mark One)
x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the quarterly period ended December 31, 2006
o	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the transition period from _________ to _________

Commission File Number: 001-32898

China BAK Battery, Inc.

(Exact name of registrant as specified in its charter)

Nevada	88-0442833
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

BAK Industrial Park
No. 1 BAK Street
Kuichong Town, Longgang District
Shenzhen, People’s Republic of China	518119
(Address of principal executive offices)	(Zip Code)

(86 755) 897-70093
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o

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

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS

As of February 8, 2007, 48,889,646 shares of China BAK Battery, Inc. common stock, par value $0.001 per share, were outstanding.

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION
	Item 1. Financial Statements	4
	Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
	Item 3.  Quantitative and Qualitative Disclosures About Market Risk	37
	Item 4. Controls and Procedures	38
PART II — OTHER INFORMATION
	Item 1.  Legal Proceedings	41
	Item 1A.  Risk Factors	41
	Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds	41
	Item 3.  Defaults Upon Senior Securities	42
	Item 4.  Submission of Matters to a Vote of Security Holders	42
	Item 5.  Other Information	42
	Item 6.  Exhibits	42

2

Introductory Comment—Terminology

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

Introductory Comment—Forward-Looking Statements

          Statements contained in this Report include “forward-looking statements” within the meaning of such term in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements involve known and unknown risks, uncertainties and other factors which could cause actual financial or operating results, performances or achievements expressed or implied by such forward-looking statements not to occur or be realized. Forward-looking statements made in this Report generally are based on our best estimates of future results, performances or achievements, predicated upon current conditions and the most recent results of the companies involved and their respective industries. Forward-looking statements may be identified by the use of forward-looking terminology such as “may,” “will,” “could,” “should,” “project,” “expect,” “believe,” “estimate,” “anticipate,” “intend,” “continue,” “potential,” “opportunity” or similar terms, variations of those terms or the negative of those terms or other variations of those terms or comparable words or expressions. Potential risks and uncertainties include, among other things, such factors as:

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

• our ability to keep up with rapidly changing technologies and evolving industry standards;

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

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

• our ability to manage the expansion of our business operations effectively;

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

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

• our ability to maintain cost leadership;

• our ability to acquire land use rights to our facilities; and

• other risks identified in this Report.

          Additional disclosures regarding factors that could cause our results and performance to differ from results or performance anticipated by this Report are discussed in other reports that we filed with the SEC, including without limitation our Annual Report on Form 10-K for the fiscal year ended September 30, 2006. Readers are urged to carefully review and consider the various disclosures made by us in this Report and our other filings with the SEC. These reports attempt to advise interested parties of the risks and factors that may affect our business, financial condition and results of operations and prospects. The forward-looking statements made in this Report speak only as of the date hereof and we disclaim any obligation to provide updates, revisions or amendments to any forward-looking statements to reflect changes in our expectations or future events. 

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

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

3

PART I — FINANCIAL INFORMATION

Item 1  Financial Statements.

China BAK Battery, Inc. and subsidiaries
Condensed interim consolidated balance sheets
As of September 30, 2006 and December 31, 2006
(In U.S. dollars)

	Note		September 30, 2006		December 31, 2006
						(Unaudited)
Assets
Current assets
Cash and cash equivalents			$	21,099,555	$	25,363,580
Pledged deposits		2		12,971,989		9,393,332
Trade accounts receivable, net		3		64,332,171		67,018,481
Inventories		4		47,388,936		43,634,837
Prepayments and other receivables				1,134,770		2,612,745
Total current assets				146,927,421		148,022,975
Property, plant and equipment, net		5		109,406,116		113,164,746
Lease prepayments, net				3,161,477		3,185,141
Intangible assets, net				74,682		73,995
Deferred tax assets				85,598		162,395
Total assets			$	259,655,294	$	264,609,252

See accompanying notes to the condensed interim consolidated financial statements.

4

China BAK Battery, Inc. and subsidiaries
Condensed interim consolidated balance sheets
As of September 30, 2006 and December 31, 2006 (continued)
(In U.S. dollars)

	Note		September 30, 2006		December 31, 2006
						(Unaudited)
Liabilities
Current liabilities
Short-term bank loans		6	$	67,899,908	$	71,074,571
Accounts and bills payable				48,316,250		35,227,498
Accrued expenses and other payables				25,880,985		22,544,113
Share-based payment liabilities				3,625,165		—
Total current liabilities				145,722,308		128,846,182
Long-term bank loan		7		—		12,806,229
Deferred tax liabilities				304,957		313,656
Total liabilities				146,027,265		141,966,067
Commitments and contingencies		10
Shareholders’ equity
Ordinary shares $0.001 par value; 100,000,000 authorized; 48,885,896 issued and outstanding as of September 30, 2006 and December 31, 2006				48,886		48,886
Additional paid-in-capital				68,126,689		72,014,309
Statutory reserves				5,791,718		6,244,897
Retained earnings				36,212,357		39,341,930
Accumulated other comprehensive income				3,448,379		4,993,163
Total shareholders’ equity				113,628,029		122,643,185
Total liabilities and shareholders’ equity			$	259,655,294	$	264,609,252

See accompanying notes to the condensed interim consolidated financial statements.

5

China BAK Battery, Inc. and subsidiaries
Condensed interim consolidated statements of income and comprehensive income
for the three months ended December 31, 2005 and 2006
(Unaudited)
(In U.S. dollars)

			Three months ended December 31,
	Note		2005			2006
Net revenues		12	$	26,103,750		$	43,082,153
Cost of revenues				(19,028,190	)		(34,885,599	)
Gross profit				7,075,560			8,196,554
Operating expenses:
Research and development costs				(495,205	)		(636,914	)
Sales and marketing expenses				(1,204,557	)		(1,042,417	)
General and administrative expenses				(2,162,769	)		(2,960,973	)
Total operating expenses				(3,862,531	)		(4,640,304	)
Operating income				3,213,029			3,556,250
Finance costs, net				(180,636	)		(900,832	)
Gain on trading securities				279,260			—
Other (expenses) / income				(4,199	)		932,074
Income before income taxes				3,307,454			3,587,492
Income taxes				(115,576	)		(4,740	)
Net income			$	3,191,878		$	3,582,752
Other comprehensive income
- Foreign currency translation adjustment				221,730			1,544,784
Comprehensive income			$	3,413,608		$	5,127,536
Net income per share:
-Basic		9	$	0.07		$	0.07
-Diluted		9	$	0.07		$	0.07
Weighted average number of ordinary shares:		9
-Basic				48,878,396			48,885,896
-Diluted		9		48,894,480			48,911,340

See accompanying notes to the condensed interim consolidated financial statements.

6

China BAK Battery, Inc. and subsidiaries
Condensed interim consolidated statements of shareholders’ equity
for the three months ended December 31, 2005 and 2006
(Unaudited)
(In U.S. dollars)

	Ordinary shares				Additional paid- in-capital		Statutory reserves		Retained earnings			Accumulated other comprehensive income/(loss)		Total share- holders’ equity
	Number of shares		amount
Balance as of October 1, 2005		48,878,396		48,878		67,415,501		3,034,141		18,805,368			1,005,255		90,309,143
Net income		—		—		—		—		3,191,878			—		3,191,878
Share-based compensation for employee stock awards		—		—		711,513		—		—			—		711,513
Appropriation to statutory reserves		—		—		—		392,508		(392,508	)		—		—
Foreign currency translation adjustment		—		—		—		—		—			221,730		221,730
Balance as of December 31, 2005		48,878,396	$	48,878	$	68,127,014	$	3,426,649	$	21,604,738		$	1,226,985	$	94,434,264
Balance as of October 1, 2006		48,885,896	$	48,886	$	68,126,689	$	5,791,718	$	36,212,357		$	3,448,379	$	113,628,029
Net income		—		—		—		—		3,582,752			—		3,582,752
Issuance of 914,994 shares of restricted stock and reclassification of liability-classified awards		—		—		3,679,934		—		—			—		3,679,934
Share-based compensation for employee stock option awards		—		—		147,300		—		—			—		147,300
Share-based compensation for common stock granted to employees and non-employee directors		—		—		60,386		—		—			—		60,386
Appropriation to statutory reserves		—		—		—		453,179		(453,179	)		—		—
Foreign currency translation adjustment		—		—		—		—		—			1,544,784		1,544,784
Balance as of December 31, 2006		48,885,896	$	48,886	$	72,014,309	$	6,244,897	$	39,341,930		$	4,993,163	$	122,643,185

See accompanying notes to the condensed interim consolidated financial statements.

7

China BAK Battery, Inc. and subsidiaries
Condensed interim consolidated statements of cash flows
for the three months ended December 31, 2005 and 2006
(Unaudited)
 (In U.S. dollars)

	Three months ended December 31,
	2005			2006
Cash flow from operating activities
Net income	$	3,191,878		$	3,582,752
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,246,507			2,045,817
Bad debt expense		255,488			485,407
Share-based compensation		711,513			262,455
Deferred income taxes		6,074			(70,403	)
Changes in operating assets and liabilities:
Trade accounts receivable		(6,407,929	)		(3,197,709	)
Inventories		(15,189,642	)		3,754,099
Prepayments and other receivables		(244,152	)		252,772
Accounts and bills payable		11,664,331			(11,762,195	)
Accrued expenses and other payables		1,023,888			2,491,604
Net cash used in operating activities		(3,742,044	)		(2,155,401	)
Cash flow from investing activities
Purchases of property, plant and equipment		(12,166,360	)		(13,192,785	)
Purchases of intangible assets		—			(4,759	)
Net cash used in investing activities	$	(12,166,360	)	$	(13,197,544	)

See accompanying notes to the condensed interim consolidated financial statements.

8

China BAK Battery, Inc. and subsidiaries
Condensed interim consolidated statements of cash flows
for the three months ended December 31, 2005 and 2006 (continued)
(Unaudited)
(In U.S. dollars)

	Three months ended December 31,
	2005			2006
Cash flow from financing activities
Proceeds from borrowings	$	7,558,672		$	28,402,934
Repayment of borrowings		(8,071,412	)		(12,422,042	)
(Increase) / decrease in pledged deposits		(5,499,114	)		3,578,657
Amounts received from related parties		250,285			—
Net cash (used in) / provided by financing activities		(5,761,569	)		19,559,549
Effect of exchange rate changes on cash and cash equivalents		(16,813	)		57,421
Net (decrease) / increase in cash and cash equivalents		(21,686,786	)		4,264,025
Cash and cash equivalents at the beginning of period		33,055,784			21,099,555
Cash and cash equivalents at the end of period	$	11,368,998		$	25,363,580
Supplemental disclosure of cash flow information:
Cash received during the period for:
Bills receivable discounted to bank	$	1,379,898		$	—
Proceeds from disposal of trading securities	$	3,981,274		$	—
Cash paid during the period for:
Income taxes	$	146,580		$	—
Interest, net of amounts capitalized	$	228,060		$	879,918
Purchases of trading securities	$	3,702,014		$	—

See accompanying notes to the condensed interim consolidated financial statements.

9

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
for the three months ended December 31, 2005 and 2006
(Unaudited)

1.	Principal Activities, Basis of Presentation and Organization
	Principal Activities
	China BAK Battery, Inc. (the “Company” or “China BAK”) was incorporated in the State of Nevada on October 4, 1999 as a limited liability company, as Medina Copy, Inc. The Company changed its name to Medina Coffee, Inc. (“Medina Coffee”) on October 6, 1999 and subsequently changed its name to China BAK Battery, Inc. on February 14, 2005. The Company and its subsidiaries (hereinafter, collectively referred to as the “Group”) are principally engaged in the manufacture, commercialization and distribution of a wide variety of standard and customized lithium ion (known as “Li-ion” or “Li-ion cell”) rechargeable batteries for use in cellular telephones, as well as various other portable electronic applications, including high-power handset telephones, laptop computers, power tools, digital cameras, video camcorders, MP3 players, electric bicycles, hybrid/electric motors, and general industrial applications.
	The shares of the Company have been traded in the over-the-counter market through the Over-the-Counter Electronic Bulletin Board since 2005.  On May 31, 2006, the Company obtained approval to list its common stock on the National Association of Securities Dealers Automated Quotations stock market, and trading commenced that same date under the symbol “CBAK”.
	Basis of Presentation and Organization
	As of December 31, 2006, the Company’s subsidiaries consist of: i) BAK International Limited (“BAK International”), a wholly owned limited liability company incorporated in Hong Kong on December 29, 2003 as BATCO International Limited, which changed its name to BAK International Limited on November 3, 2004; ii) Shenzhen BAK Battery Co., Ltd. (“Shenzhen BAK”), a wholly owned limited liability company established on August 3, 2001 in the People’s Republic of China (“PRC”); iii) BAK Electronics (Shenzhen) Co., Ltd. (“BAK Electronics”), a wholly owned limited liability company established in August 2005 in the PRC; and iv) BAK International (Tianjin) Ltd. (“BAK Tianjin”), a wholly owned limited liability company established on December 12, 2006 in the PRC.
	BAK Tianjin was incorporated in Tianjin Technology Industrial District on December 12, 2006 as a wholly owned subsidiary of BAK International with registered capital of $99,990,000. Pursuant to BAK Tianjin’s articles of association, BAK International is required to contribute $20,000,000 to BAK Tianjin as capital (representing 20% of BAK Tianjin’s registered capital) before March 11, 2007. The remaining $79,990,000 shall be fully contributed no later than December 11, 2008. BAK Tianjin will be principally engaged in the manufacture of advanced lithium ion batteries for use in light electric vehicles and uninterruptible power supply.  As of December 31, 2006, BAK Tianjin is still dormant.
	BAK International, a non-operating holding company that had substantially the same shareholders as Shenzhen BAK, entered into a share swap transaction with Shenzhen BAK on November 6, 2004 for the purpose of the subsequent reverse acquisition of the interest of China BAK as described below.  Pursuant to the terms of the transaction, the parties exchanged all outstanding shares of their capital stock for $11.5 million in cash, and as a result, BAK International became the parent company of Shenzhen BAK.  Certain shareholders of Shenzhen BAK, representing ownership interests of approximately 1.85%, elected not to acquire shares in BAK International.  The non-participating shareholders of Shenzhen BAK sold their right to acquire their proportional ownership interests in BAK International for cash, and the proportionate interests in BAK International to which the non-participating shareholders were entitled were acquired by the transferees.  After the share swap transaction between BAK International and the shareholders of Shenzhen BAK was complete, there were 31,225,642 shares of BAK International stock outstanding, exactly the same as the number of shares of capital stock of Shenzhen BAK outstanding immediately prior to the share swap, and the shareholders of BAK International were substantially the same as the shareholders of Shenzhen BAK prior to the share purchases.  Consequently, the share purchases between BAK International and the shareholders of Shenzhen BAK have been accounted for as a reverse acquisition of Shenzhen BAK with no adjustment to the historical basis of the assets and liabilities of Shenzhen BAK, and the operations were consolidated as though the transactions occurred as of the beginning of the first accounting period presented in the accompanying consolidated financial statements.

10

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
for the three months ended December 31, 2005 and 2006
(Unaudited)

On January 20, 2005, BAK International completed a private placement of its common stock with unrelated investors whereby it issued an aggregate of 8,600,433 shares of common stock for gross proceeds of $17,000,000.  In conjunction with this financing, Mr. Li Xiangqian, the Chairman and Chief Executive Officer of the Company, agreed to place 2,179,550 shares of the Company’s common stock owned by him into an escrow account, of which 50% was to be released to the investors in the private placement if the audited net income of the Group for the fiscal year ended September 30, 2005 was not at least $12,000,000, and the remaining 50% was to be released to investors in the private placement if audited net income of the Group for the fiscal year ended September 30, 2006 was not at least $27,000,000.  If the audited net income of the Group for the fiscal years ended September 30, 2005 and 2006 reached the above-mentioned targets, the 2,179,550 shares would be released to Mr Li Xiangqian (the “Escrow Arrangement”).

The Escrow Arrangement regarding the shares placed by Mr Li Xiangqian in an escrow account and the subsequent potential release of those shares based on the fulfillment of certain performance thresholds constitutes a compensatory plan to Mr. Li Xiangqian. A compensation charge should be recorded in the financial statements of the Company should these performance thresholds be achieved and shares released to Mr Li Xiangqian. However, as the Company did not meet the performance thresholds for the years ended September 30, 2005 and 2006 after consideration of the related compensation charge, the Company has determined that the threshold has not been achieved and no compensation charge was recorded by the Company for the years ended September 30, 2005 and 2006.

While the 1,089,775 escrow shares relating to the 2005 performance threshold were previously released to Mr. Li Xianqian, Mr. Li Xianqian had undertaken on August 21, 2006, to return those shares to the escrow agent for the distribution to the relevant investors. The remaining 1,089,775 shares of Mr. Li Xianqiang relating to the 2006 performance threshold had been transferred to the relevant investors as of December 31, 2006.

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

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

The Company’s condensed interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“US GAAP”).

11

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
for the three months ended December 31, 2005 and 2006
(Unaudited)

	Basis of Presentation and Organization (continued)
	The interim results of operations are not necessarily indicative of the results to be expected for the fiscal year ending September 30, 2007. The Company’s consolidated balance sheet at September 30, 2006 has been taken from the Company’s audited balance sheet as of the date. All other financial statements contained herein are unaudited and, in the opinion of management, contain all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of financial position, results of operations and cash flows for the period presented. The Company’s accounting policies and certain other disclosures are set forth in the notes to the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended September 30, 2006. These financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto. The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
	This basis of accounting differs in certain material respects from that used for the preparation of the books of account of the Company’s principal subsidiaries, which are prepared in accordance with the accounting principles and the relevant financial regulations applicable to enterprises with limited liabilities established in the PRC (“PRC GAAP”) or in Hong Kong, the accounting standards used in the places of their domicile.  The accompanying condensed interim consolidated financial statements reflect necessary adjustments not recorded in the books of account of the Company’s subsidiaries to present them in conformity with US GAAP.
2	Pledged Deposits
	Pledged deposits at September 30, 2006 and December 31, 2006 consist of the following:

	September 30, 2006		December 31, 2006
Pledged deposits with banks for bills payable	$	12,971,989		9,393,332

3	Trade Accounts Receivable, net
	Trade accounts receivable at September 30, 2006 and December 31, 2006 consist of the following:

	September 30, 2006			December 31, 2006
Trade accounts receivable	$	56,197,229		$	62,381,038
Less: Allowance for doubtful accounts		(1,063,285	)		(1,574,684	)
		55,133,944			60,806,354
Bills receivable		9,198,227			6,212,127
	$	64,332,171		$	67,018,481

12

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
for the three months ended December 31, 2005 and 2006
(Unaudited)

An analysis of the allowance for doubtful accounts for the three months ended December 31, 2005 and 2006 is as follows:

	Three months ended December 31,
	2005		2006
Balance at beginning of year	$	1,593,538	$	1,063,285
Addition of bad debt expense, net		216,329		494,238
Foreign exchange adjustment		4,639		17,161
Balance at end of year	$	1,814,506	$	1,574,684

4	Inventories
	Inventories at September 30, 2006 and December 31, 2006 consist of the following:

	September 30, 2006		December 31, 2006
Raw materials	$	20,693,915	$	16,839,641
Work-in-progress		5,686,328		8,256,139
Finished goods		21,008,693		18,539,057
		$47,388,936	$	43,634,837

	Part of the Company’s inventories with carrying value of $10,115,442 and $10,244,983 as of September 30, 2006 and December 31, 2006, respectively, was pledged as collateral under certain loan agreements (see Note 6).
5	Property, Plant and Equipment, net
	Property, plant and equipment at September 30, 2006 and December 31, 2006 consist of the following:

	September 30, 2006			December 31, 2006
Buildings	$	63,508,910		$	66,755,770
Machinery and equipment		30,658,968			45,943,926
Office equipment		750,115			864,745
Motor vehicles		1,018,042			1,031,079
		95,936,035			114,595,520
Accumulated depreciation and amortization		(9,925,557	)		(11,949,224	)
Construction in progress		23,395,638			10,518,450
	$	109,406,116		$	113,164,746

13

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
for the three months ended December 31, 2005 and 2006
(Unaudited)

(i) Depreciation and amortization expense for the three months ended December 31, 2005 and 2006 is included in the consolidated statements of income and comprehensive income as follows:

	Three months ended December 31,
	2005		2006
Cost of revenues	$	893,680	$	1,435,902
Research and development costs		76,669		72,308
Sales and marketing expenses		140,572		154,765
General and administrative expenses		101,960		360,692
	$	1,212,881	$	2,023,667

(ii)	Construction in Progress
	Construction in progress mainly comprises capital expenditures for construction of the Company’s new corporate campus, including offices, factories and staff dormitories, located in Kuichong Township of Longgang District of Shenzhen.
	For the three months ended December 31, 2005 and 2006, the Company capitalized interest of approximately $204,253 and $48,854, respectively, to the cost of construction in progress.
(iii)	Pledged Property, Plant and Equipment
	As of September 30, 2006 and December 31, 2006, machinery and equipment with net book value of $6,253,302 and $19,381,730 of the Company were pledged as collateral under certain loan arrangements (see Note 6).
6	Short-term Bank Loans
	The Company obtained several short-term loan facilities from financial institutions in the PRC.  These facilities were secured by certain of the Company’s assets with the following carrying values:

	September 30, 2006		December 31, 2006
Inventories	$	10,115,442	$	10,244,983
Machinery and equipment, net		6,253,302		19,381,730
	$	16,368,744	$	29,626,713

As of September 30, 2006 and December 31, 2006, the Company had several short-term bank loans with aggregate outstanding balances of $67,899,908 and $71,074,571 respectively.  The loans were primarily obtained for general working capital, carried interest rates ranging from 4.725% to 5.85% per annum, and had maturity dates ranging from 6 to 12 months. Each loan is guaranteed by Mr. Li Xiangqian, Chairman of the Company, who did not receive any compensation for acting as guarantor.

The Company is subject to certain covenants, which require the Company to comply with certain financial ratios for its loan facilities, which are tested on a monthly basis. If the Company fails to meet the requirements, the outstanding bank loans, including interest and penalties due thereunder, will accelerate and become immediately due and payable. As of December 31, 2006, the Company is in compliance with all of these requirements.

14

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
for the three months ended December 31, 2005 and 2006
(Unaudited)

7	Long-term Bank Loan
	As of December 31, 2006, the Company had a long-term bank loan of $12,806,229 which was borrowed under a four-year long-term loan credit facility from China Development Bank, bearing annual interest rate of 6.48%, which is the benchmark rate of the People’s Bank of China for three- to five-year long-term loans. The long-term bank loan is payable in three instalments of $3,841,868 on November 20, 2008, $3,841,868 on November 20, 2009 and $5,122,493 on December 26, 2010.
	The long-term bank loan is guaranteed by Mr. Li Xiangqian, Chairman of the Company, and is secured by the fixed assets and land use rights of the Company’s Research and Development Test Center, which will be constructed in Shenzhen, PRC after obtaining the required land use rights for the location of the facility. Mr. Li Xiangqiang did not receive any compensation for acting as guarantor.
	Certain shares of the Company were pledged by Mr. Li Xiangqian in order to secure the long-term loan as of December 31, 2006.
8	Share-based Compensation
	The Company grants share options to officers and employees to reward for services and restricted ordinary shares to its non-employee directors.
	Employee Stock Option Plan
	In May 2005, the Board of Directors adopted the China BAK Battery, Inc. 2005 Stock Option Plan (the “Plan”). The Plan authorizes the issuance of up to 4,000,000 shares of the Company’s common stock. The exercise price of the options granted pursuant to the Plan must be at least equal to the fair market value of the Company’s common stock at the date of the grant. The Plan will terminate on May 16, 2055.
	Pursuant to the Plan, the Company issued 2,000,000 options with an exercise price of $6.25 per share on May 16, 2005. In accordance with the vesting provisions of the grants, the options will become vested and exercisable under the following schedule:

Numbers of Share	Percentage of Options Issued	Initial Vesting Date
800,000	40%	July 1, 2007
600,000	30%	January 1, 2008
600,000	30%	July 1, 2008
2,000,000	100%

Subsequent to the grant date, options to purchase 200,000 shares of common stock were forfeited because the optionees terminated their employment with the Company.  In addition, on September 28, 2006, options to purchase a total of 1,400,000 shares of common stock were cancelled pursuant to the Termination and Release Agreements signed on that day.  Details of the cancellation of stock options and the relevant replacement awards are set out below under “Employee Restricted Stock Awards.”

15

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
for the three months ended December 31, 2005 and 2006
(Unaudited)

A summary of share option plan activity for the three months ended December 31, 2006 is presented below:

	Number of shares		Weighted average exercise price per share		Weighted average remaining contractual term
Outstanding as of October 1, 2006		400,000	$	6.25
Granted		—		—
Exercised		—		—
Forfeited		—		—
Cancelled		—		—
Outstanding as of December 31, 2006		400,000	$	6.25		5 years
Exercisable as of December 31, 2006		—		—		—

The weighted-average grant-date fair value of options granted during 2005 was $3.67 per share. The Company recorded non-cash share-based compensation expense of $147,300 for the period ended December 31, 2006 in respect of share options granted in 2005, which was allocated to general and administrative expenses and research and development costs, respectively.

The fair value of the above option awards was estimated on the date of grant using a Black-Scholes Option Valuation Model that uses the assumptions noted in the following table. The expected volatility was based on the historical volatilities of the Company’s listed common stock in the United States. The Company uses historical data to estimate employee termination within the valuation model. The expected life of options granted is the period between the option grant date and the expected exercise date which is the mid-point of the exercisable date and the expiry date, which represents the period of time that options granted are expected to be outstanding.  Since the share options once exercised will primarily trade in the U.S. capital market, the risk-free rate for periods within the contractual term of the share option is based on the U.S. Treasury yield curve in effect at the time of grant.

Expected volatility	59.85%
Expected dividends	Nil
Expected life	6 years
Risk-free interest rate	4.13%

As of December 31, 2006, there were unrecognized compensation costs of approximately $515,000 related to non-vested share options. These costs are expected to be recognized over the remaining vesting period.

16

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
for the three months ended December 31, 2005 and 2006
(Unaudited)

Employee Restricted Stock Awards

On September 22, 2006, the Compensation Committee approved the form of Termination and Release Agreement covering the cancellation of 1,400,000 shares of stock options granted to the optionees who are residents of the PRC. The Compensation Committee also consented to adopt the terms and provisions for Restricted Stock Grant Agreement covering the issuance of restricted shares, and committed to determine an appropriate number of shares of restricted stock that will be granted to these optionees under the Plan (the “Replacement Awards”) during the first quarter of fiscal year 2007. In addition, the Compensation Committee also approved the officer of the Company to authorize delivery of the restricted shares to the employees. On September 28, 2006, options to purchase a total of 1,400,000 shares of common stock were cancelled pursuant to the Termination and Release Agreements signed on that day. The Replacement Awards were classified as liability-classified awards as of September 30, 2006.

Subsequent to September 28, 2006, certain employees who are entitled to the Replacement Awards terminated their employment with the Company. The related potential restricted stock grant of these employees were forfeited with the previously recognized compensation cost of $181,290 credited to sales and marketing expenses and general and administrative expenses.

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

Expected volatility	89.51%
Expected dividends	Nil
Expected life	4.4 years
Risk-free interest rate	4.61%

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

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

Number of Shares	Percentage of Stock Vested	Initial Vesting Date
365,998	40%	July 1, 2007
274,498	30%	January 1, 2008
274,498	30%	July 1, 2008
914,994	100%

Upon the grant of restricted stock, the Company has reclassified share-based payment liabilities of $3,679,934 to shareholders’ equity. The restricted stock grant is treated as equity-classified awards and the unrecognized compensation costs will be recognized over the vesting period. The Company recognized share-based compensation expense of $236,059 for the period from October 1, 2006 to December 26, 2006 in respect of the liability-classified award, and $31,186 for the period from December 26, 2006 to December 31, 2006 in respect of the equity-classified award.

17

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
for the three months ended December 31, 2005 and 2006
(Unaudited)

A summary of the restricted stock grant activity for the three months ended December 31, 2006 is presented below:

	Number of shares		Weighted- Average fair value
Non-vested as of October 1, 2006		—	$	—
Granted		914,994		6.25
Vested		—		—
Forfeited		—		—
Non-vested as of December 31, 2006		914,994	$	6.25

As such stock-based compensation is not deductible for income tax purpose in the PRC, no income tax benefits were recognized in this respect for the three months ended December 31, 2006.
As of December 31, 2006, there were unrecognized compensation costs of approximately $2,008,000 related to the restricted stock granted. These costs are expected to be recognized over the vesting period.
Compensation Plan for Non-employee Directors
On May 12, 2006, the Board of Directors adopted the China BAK Battery, Inc. Compensation Plan for Non-employee Directors (the “Plan 2006”). The Plan 2006 authorizes the issuance of 5,000 restricted shares of the Company’s common stock to each of the three eligible directors in addition to their annual retainer fee. Such restricted shares entitle the relevant non-employee directors to all rights of ordinary share ownership except that the shares may not be sold, transferred, pledged, exchanged or otherwise disposed of during the vesting period.
On May 12, 2006, the Company granted 5,000 restricted shares to each of the three newly elected independent directors with a fair value of $11.5 per share pursuant to the Plan 2006. The eligible directors shall vest in their rights under the restricted shares according to the following schedule:
(i)	25% of the restricted shares granted will immediately vest on the grant date; and
(ii)	The remaining 75% of the restricted shares will vest in three equal quarterly instalments on the last day of each subsequent quarter or in three equal quarterly instalments on the last day of each calendar quarter beginning on the last day of the first full calendar quarter after the grant date.
As of December 31, 2006, the Company had unrecognized stock-based compensation of approximately $11,980 associated with these restricted shares granted to non-employee directors. The first and second 25% of the restricted shares were issued as fully paid ordinary shares to the three independent directors on July 19, 2006 and August 16, 2006 respectively. A third 25% of the restricted shares were issued as fully paid ordinary shares to the three independent directors on January 8, 2007.
As the Company itself is an investment holding company which is not expected to generate operating profits to realize the tax benefits arising from its net operating loss carried forward, no income tax benefits were recognized for such stock-based compensation cost for non-employee directors for the three months ended December 31, 2006.

18

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
for the three months ended December 31, 2005 and 2006
(Unaudited)

9	Net Income per Share
	The calculation of basic net income per share is based on the net income for the three months ended December 31, 2006 attributable to equity shareholders of US$3,582,752 (three months ended December 31, 2005: US$3,191,878) and the weighted average number of ordinary shares of 48,885,896 in issue during the three months ended December 31, 2006 (three months ended December 31, 2005: 48,878,396).
	The calculation of diluted net income per share is based on the net income for the three months ended December 31, 2006 attributable to equity shareholders of US$3,582,752 (three months ended December 31, 2005: US$3,191,878) and the weighted average number of ordinary shares of 48,911,340 in issue during the three months ended December 31, 2006 (three months ended December 31, 2005: 48,894,480) after adjusting for the number of 25,444 dilutive potential ordinary shares. Restricted stock granted to employees and to non-employee directors are included in the computation of diluted net income per share for the three months ended December 31, 2006. Share warrants granted to external financial advisors, stock options granted to employees are excluded from the computation of diluted net income per share as the warrant and stock options were both anti-dilutive.
10	Commitments and Contingencies
(i)	Capital Commitments
	As of September 30, 2006 and December 31, 2006, the Company had the following capital commitments:

	September 30, 2006		December 31, 2006
For construction of buildings	$	557,883	$	224,749
For purchases of equipment		12,184,346		8,232,795
	$	12,742,229	$	8,457,544

	(a)	A new subsidiary, BAK Tianjin, was incorporated in Tianjin city, the PRC on December 12, 2006. BAK Tianjin plans to develop a production plant (see Note 1). As of December 31, 2006, the Company is in the process of evaluating the development plan and the budgeted development costs have yet to be determined.
	(b)	The Company plans to construct a new Research and Development Test Center in Shenzhen. As of December 31, 2006, the Company is in the process of evaluating the development plan and the budgeted development costs have yet to be determined.
(ii)	Land Use Rights and Property Ownership Certificate
	According to relevant PRC laws and regulations, a land use right certificate, along with government approvals for land planning, project planning, and construction, needs to be obtained before construction of a building is commenced.  A property ownership certificate shall be granted by the government upon application under the condition that the aforementioned certificate and government approvals are obtained.
	The Company has not yet obtained the land use right certificate relating to the premises occupied by the Company, BAK Industrial Park.  However, the Company is in the process of applying to obtain the land use right certificate. The local government of Kuichong Township of Longgang District of Shenzhen has, however, granted permission for Shenzhen BAK to construct the new production plant.

19

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
for the three months ended December 31, 2005 and 2006
(Unaudited)

	Management believes that the Company will ultimately be granted a land use right certificate, and that there should be no legal barriers for the Company to obtain a property ownership certificate for the premises presently occupied by the Company in BAK Industrial Park.  However, in the event that the Company fails to obtain the land use right certificate relating to BAK Industrial Park, there is a risk that the buildings constructed will need to be vacated as illegitimate constructions and the Company might be subject to penalties and fines.  However, management believes that this possibility, while present, is remote.
	The Company is not able to insure its manufacturing facilities since it has not yet received its land use right certificate. The Company intends to procure such insurance once it has received the certificate.
(iii)	Guarantees
	In order to secure the supplies of certain raw materials and upon the request of suppliers, the Company has given guarantees to certain suppliers which are summarized as follows:

	September 30, 2006		December 31, 2006
Guaranteed for Shenzhen Tongli Hi-tech Co. Ltd. - a non-related party	$	2,528,861	$	2,561,245
Guaranteed for Shenzhen Kuichong Zhenda  Industrial Co. Ltd. - a non-related party		1,264,430		1,280,623
	$	3,793,291	$	3,841,868

	Management has assessed the fair value of the obligation arising from the above financial guarantees and considered it is immaterial to the consolidated financial statements. Therefore, no obligations in respect of the above guarantees were recognized as of December 31, 2006.
(iv)	Outstanding Discounted Bills
	From time to time, the Company factors bills receivable to banks.  At the time of the factoring, all rights and privileges of holding the receivables are transferred to the banks.  The Company removes the asset from its books and records a corresponding expense for the amount of the discount.  The Company remains contingently liable on the amount outstanding in the event the bill issuer defaults.
	The Company’s outstanding discounted bills at September 30, 2006 and December 31, 2006 are summarized as follows:

	September 30, 2006		December 31, 2006
Bank acceptance bills	$	1,972,303	$	824,789
Commercial acceptance bills		5,013,466		3,329,620
	$	6,985,769	$	4,154,409

20

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
for the three months ended December 31, 2005 and 2006
(Unaudited)

(v)	Litigation and claims
	On September 12, 2006, Hydro-Quebec, a Canadian company, and the Board of Regents of the University of Texas System brought a federal patent infringement suit in the United States District Court for the Northern District of Texas against the Company. The Company has an agreement with A123Systems, Inc., under which the Company agrees to manufacture products for A123Systems, Inc. according to the specifications furnished by, and using the finished electrodes and other materials consigned by, A123Systems, Inc. to the Company. The plaintiffs alleged that by manufacturing rechargeable lithium cells for one of the Company’s customers, A123Systems, Inc., for use in DeWalt 36-volt cordless power tools manufactured by Black & Decker Corporation, the Company has infringed two U.S. patents owned by and exclusively licensed to the plaintiffs. The plaintiffs seek injunctive relief and damages in an unspecified amount. If the court issues an adverse decision, the Company may be required to pay the plaintiffs substantial monetary damages, terminate the Company’s existing production of rechargeable lithium cells manufactured for A123Systems, Inc., or pay royalties to continue such production. The court has not yet issued a decision on this matter and the Company is unable to quantify the extent of any possible award of damages that might become payable by the Company.
	Furthermore, if A123Systems, Inc. is found liable for the infringement, it may not be able to continue its cooperation with the Company at all or on terms and conditions acceptable to the Company, which in turn would adversely affect the Company’s ability to execute its strategy to expand its production of cells for power tools and capture high-margin businesses. Accordingly, the Company’s revenues and business prospects would be materially adversely affected.
11	Significant Concentrations
(a)	Customers and Credit Concentrations
	The Company had two customers that individually comprised 10% or more of net revenue for the three months ended December 31, 2005 and 2006, as follows:

	Three months ended December 31,
	2005			2006
	%			%
A123Systems, Inc.	$	—	—	$	6,398,903	15
Shenzhen Chaolitong Electronics Co. Ltd.	$	2,911,544	11	$	4,291,576	10
	$	2,911,544	11	$	10,690,479	25

	Approximately 1% of gross trade accounts receivable was due from A123Systems, Inc. at both September 30, 2006 and December 31, 2006.  Approximately 11% and 15% of gross trade accounts receivables were due from Shenzhen Chaolitong Electronics Co. Ltd. at September 30, 2006 and December 31, 2006 respectively.  A termination in relationship in or a reduction in orders from these two customers could have a material impact on the Company’s results of operations and financial condition.
(b)	Credit Risk
	Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents and pledged deposits.  As of December 31, 2005 and 2006, substantially all of the Company’s cash and cash equivalents and pledged deposits were held by major financial institutions located in the PRC, which management believes are of high credit quality.

21

China BAK Battery, Inc. and subsidiaries
Notes to the condensed interim consolidated financial statements
for the three months ended December 31, 2005 and 2006
(Unaudited)

12	Segment Information
	The Company currently engages in the manufacture, commercialization and distribution of a wide variety of standard and customized lithium ion rechargeable batteries for use in a wide array of applications.  The Company manufactures six types of Li-ion rechargeable batteries: steel-case cell, aluminium-case cell, battery pack, cylindrical cell, polymer cell and industrial battery.  The Company’s products are sold to packing plants operated by third parties primarily for use in mobile phones and other electronic devices.  Net revenues for the three months ended December 31, 2005 and 2006 were as follows:
	Net revenues by product:

	Three months ended December 31,
	2005			2006
			%			%
Steel-case Cell	$	14,220,881	54.48	$	15,031,595	34.89
Aluminium-case cell		8,855,015	33.92		17,202,935	39.93
High-power lithium-phosphate cell		—	—		6,398,903	14.85
Battery pack		2,953,801	11.32		2,413,126	5.61
Cylindrical cell		13,572	0.05		854,744	1.98
Polymer cell		60,481	0.23		1,180,850	2.74
	$	26,103,750	100.00	$	43,082,153	100.00

Net revenues by geographic area:

	Three months ended December 31,
	2005				2006
			%				%
PRC Mainland	$	19,333,652		74.06	$	31,419,765		72.93
United States of America		47,127		0.18		6,404,559		14.87
Hong Kong, China		2,677,313		10.26		1,943,612		4.51
The Republic of Turkey		2,747,920		10.53		738,934		1.71
Others		1,297,738		4.97		2,575,283		5.98
	$	26,103,750		100.00	$	43,082,153		100.00

22

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

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

Overview

          We are one of the largest manufacturers of lithium-ion battery cells in China and the world, as measured by production output. Our battery cells are the principal component of rechargeable lithium-based batteries used to power the following applications:

• cellular phones — customer segments include OEM and replacement battery manufacturers;

• notebook computers;

• cordless power tools; and

• portable consumer electronics, such as digital media devices, portable media players, and personal digital assistants, or PDAs.

We conduct all of our operations in China, in close proximity to China’s electronics manufacturing base and its rapidly growing market.

          Historically, we have primarily manufactured prismatic lithium-ion cells for the cellular phone replacement battery market and original equipment manufacturer, or OEM, market. Our products are packed into batteries by third-party battery pack manufacturers in accordance with the specifications of manufacturers of portable electronic applications.

          At the request of our customers that order prismatic battery packs, we also engage pack battery manufacturers to assemble our prismatic cells into batteries for a fee and then sell battery packs to these customers both for the cellular phone battery replacement market and OEM markets. We expect that sales of prismatic battery packs in such a manner will represent a decreasing percentage of our revenues going forward.

          We have recently expanded our product offerings by adding three new product lines:

• High-power, lithium-phosphate cells for use in cordless power tools. We began commercial production of lithium-phosphate cells in October 2005 for use in cordless power tools of Black & Decker, a leading power tools manufacturer.

• Lithium polymer cells for use in ultra-portable electronic devices, such as high-end cellular phones, Bluetooth headsets, digital medial players and digital audio players. We began commercial production of lithium polymer cells in September 2005.

• Cylindrical lithium-ion cells for use in notebook computers. We began trial production of cylindrical cells in April 2006 and began commercial production in June 2006. Prior to this, we have been producing a limited number of cylindrical cells using primarily a manual manufacturing process. These cylindrical cells were primarily sold for use on portable DVD players.

Demand for Lithium-Based Batteries

          All of our products are lithium-based rechargeable battery cells. Rechargeable lithium-based battery cells, compared to other types of rechargeable battery cells based on nickel cadmium or nickel metal hydride chemistries, have a higher energy density, meaning a greater energy capacity relative to a given battery cell’s weight and size. As a result, use of lithium-based batteries has risen significantly in portable electronic products. As the cost/power ratio of lithium-based batteries continues to improve, it is expected that its usage will also extend into other applications. End-product applications that are driving the demand for rechargeable lithium-based batteries include cellular phones, notebook computers, cordless power tools and portable consumer electronics.

          Cellular Phones.  Demand for batteries for cellular phones is driven by two factors. The first is the sales of new cellular phones. An OEM of cellular phones includes a battery with a new cellular phone. There is also a replacement market for cellular phone batteries. Demand in the replacement market is in turn driven by a number of factors. Often a consumer will purchase a second battery to carry as a spare. In addition, lithium-ion batteries have a finite life, so over time consumers will need to purchase a battery to replace the failed battery in their phone. As the number of active cellular phone subscribers increases, the number of replacement batteries sold increases. A market characteristic unique to the Chinese cellular phone market is that cell phones are often sold and resold during their useful life. Over time these cell phones require a replacement battery. Our customers for cellular phone battery cells fall into two segments:

23

          OEM.  The OEMs manufacture mobile phone handsets. They purchase batteries to support their production of new cellular phones. They also purchase batteries to serve the replacement market which they sell under their own brand name.

          Independent Battery Manufacturers.  These third party manufacturers compete against the OEMs for a share of the replacement market. They typically sell their products under their own brand name or a private label.

         ��Notebook Computers.  Sales of notebook computers are driven by the increasing demand for mobile computing and the improved power and functionality of notebook computers. Lithium-based batteries have almost completely replaced nickel metal hydride batteries for notebook computers due to the increasing power of lithium-based batteries and demand for smaller lighter notebook computers.

          Power Tools.  Power tools such as drills, saws and grinders are used for both commercial and personal use. Due to high power requirements, many power tools have historically used small combustion engines, used heavier nickel metal hydride batteries or relied on external power sources. However, since the beginning of 2005, most major tool manufacturers, including Milwaukee, DeWalt/Black & Decker, Metabo, Ridgid and Bosch, have begun to use lithium-based battery packs, in particular lithium phosphate batteries, in their product lines. These manufacturers have taken advantage of both the increased power produced by lithium based batteries and the light weight of lithium based batteries by: (1) introducing more powerful products; (2) extending the life cycle of current products; or (3) decreasing the size of current products. The market for portable high-powered power tools is rapidly growing and has prompted many users, both commercial and personal, to replace or upgrade their current power tools.

          Portable Consumer Electronics. This category includes digital audio players (such as MP3 players), digital still cameras, digital video cameras portable DVD players, PDAs, BlackBerry devices, portable gaming systems and Bluetooth devices. There is a rapid trend to use lithium based batteries in portable consumer electronics (both rechargeable and non-rechargeable) due to a desire for smaller, longer lasting devices.

Pricing Pressure

          Portable electronic devices such as cellular phones and notebook computers are subject to declines in average selling prices from time to time due to evolving technologies, industry standards and consumer preferences. As a result, manufacturers of these electronic devices expect us, as a supplier, to cut our costs and lower the price of our products, particularly when they place substantial orders with us. We have reduced the price of our products in the past in order to meet market demand and expect to continue to face market-driven downward pricing pressures in the future. Our ability to maintain our cost-effectiveness will be critical to our future success in an increasingly price-sensitive market. We seek to achieve this by ramping up our production capacity to give us greater economies of scale through a higher bargaining power to secure a supply of materials and equipment at a lower cost, and a larger base for spreading out our fixed cost allocation. We believe this will provide incremental long-term growth opportunities, but in the short-term, will also require us to incur substantial capital expenditures.

Seasonality of Operating Results

          During the first several years of our operation, manufacturing capacities fell short of customer demands. As such, seasonality was minimal. Over the past year, we significantly increased manufacturing capacities to meet or exceed customer demand. Since we increased our manufacturing capacities, our revenues are now affected by seasonal variations in customer demand. We expect to experience seasonal lows in the demand for our products during the months of April to July, reflecting our customers’ decreased purchases. On the other hand, we will generally experience seasonal peaks during the months of September to March, primarily as a result of increased purchases from our customers during the holiday season, except that the months of October and February tend to be seasonally low sales months due to plant closures for the Chinese New Year and national holidays in the PRC.

Financial Statement Presentation

          Net revenues.  Our net revenues represent the invoiced value of our products sold, net of value added taxes, or VAT, sales returns, trade discounts and allowances. We are subject to VAT, which is levied on most of our products at the rate of 17% on the invoiced value of our products. Provision for sales returns are recorded as a reduction of revenue in the same period that revenue is recognized. The provision for sales returns represents our best estimate of the amount of goods that will be returned from our customers based on historical sales returns data.

24

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

	Three Months Ended December 31,
	2005		2006
	(in thousands)
Prismatic cells
Steel-case cells	$	14,221	$	15,031
Aluminum-case cells		8,855		17,203
Battery packs		2,954		2,413
High-power lithium-phosphate cell		—		6,399
Cylindrical cells		14		855
Lithium polymer cells		60		1,181
	$	26,104	$	43,082

          Our net revenues have increased significantly during the three months ended December 31, 2006, because of increased shipments as we ramped up our production capacity to meet customer demands for our products.

          Cost of Revenues.  Cost of revenues consists primarily of material costs, employee remuneration for staff engaged in production activity, share-based compensation, depreciation and related expenses that are directly attributable to the production of products. Cost of revenues also includes write-downs of inventory to lower of cost or market.

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

          Because the selling prices of our products decreased significantly during the three months ended December 31, 2006 as our market strategy to maintain the market shares as well as due to the pricing pressure in increasingly competitive market, our gross profit, as percentage of net revenues, decreased from 27.1% for the three months ended December 31, 2005 to 19.0% for the same period of 2006.

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

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

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

          Gain on Trading Securities.  Gain on trading securities represents realized gain from purchases and sales of certain listed shares in open market of Hong Kong Stock Exchange. These transactions were concluded by BAK International Limited, our Hong Kong subsidiary.  As of December 31, 2006, we and our subsidiary do not hold any equity or debt securities on hand for trading purpose.  We do not anticipate investment in trading securities to form an ongoing part of our treasury function.

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          Other Income / (Expense).  Other income for the three months ended December 31, 2006 mainly consists of government subsidy given as recognition of our contribution to the economic development of the area.  No present of future obligation would arise from the receipt of such amount.

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

          Income Taxes.  Under applicable income tax laws and regulations, an enterprise located in Shenzhen, including the district where our operations are located, is subject to a 15% enterprise income tax. Further, according to PRC laws and regulations, foreign invested manufacturing enterprises are entitled to, starting from their first profitable year, a two-year exemption from enterprise income tax followed by a three-year 50% reduction in its enterprise income tax rate. Our PRC subsidiaries, Shenzhen BAK and BAK Electronics, are each entitled to a two-year exemption from enterprise income tax and a reduced enterprise income tax rate of 7.5% for the following three years from its first profitable year. As such, for the first two calendar years ended December 31, 2003, Shenzhen BAK was exempted from any enterprise income tax. Between January 1, 2004 and December 31, 2006, Shenzhen BAK is subject to the enterprise income tax rate of 7.5%. BAK Electronics, established in August 2005, is eligible for the same preferential tax treatment applicable to Shenzhen BAK and currently is in the tax holiday and fully exempt from any enterprise income tax.

          In addition, due to the additional capital invested in Shenzhen BAK in both 2005 and 2006, Shenzhen BAK was granted a lower income tax rate of 3.309% and 1.7% in calendar year 2005 and 2006 respectively.

          Furthermore, to encourage foreign investors to introduce advanced technologies to China, the PRC government has offered additional tax incentives to enterprises that are classified as a foreign invested enterprise with advanced technologies. According to an official notice issued by the Shenzhen Municipal Trade and Industry Bureau, Shenzhen BAK received such designation in August 2005. As a result, as long as Shenzhen BAK maintains this designation, it may apply to the tax authority to extend its current reduced tax rate of 7.5% for another three years, until December 31, 2009.

          The PRC legislature is planning to reform PRC income tax laws in fiscal year 2007 or 2008, in which case the applicable tax rates might be subject to change such reform might also impact the preferential policies, from which our subsidiaries in the PRC currently benefit. As the details of such reform have not yet been finalized, management is not in a position to estimate whether there would be any potential financial statement impact on us.

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

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

          Our effective tax rates were 3.5% and 0.1% for the three months ended December 31, 2005 and 2006, respectively.

Results of Operations

          The following sets forth certain of our income statement information for the three months ended December 31, 2005 and 2006.

	Three months ended December 31,
	2005				2006
	(in thousands, except percentages)
Statement of Operation data
Revenues	$	26,104	100.0	%	$	43,082		100.0	%
Cost of revenues		19,028	72.9	%		34,886		81.0	%
Gross profit		7,076	27.1	%		8,196		19.0	%
Operating expenses:
Research and development costs		495	1.9	%		637		1.5	%
Sales and marketing expenses		1,205	4.6	%		1,041		2.4	%
General and administrative expenses		2,162	8.3	%		2,961		6.9	%
Total operating expenses		3,862	14.8	%		4,639		10.8	%
Operating income		3,214	12.3	%		3,557		8.2	%
Finance costs, net		181	0.7	%		901		2.1	%
Other expenses / (income)		4	—			(932	)	-2.2	%
Gain on trading securities		279	1.0	%		—		—
Income taxes		116	0.4	%		5		—
Net income	$	3,192	12.2	%	$	3,583		8.3	%

(1) Less than 0.1%

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Results of operations for the three months ended December 31, 2006 as compared to the three months ended December 31, 2005.

          Net Revenues.  Net revenues increased to $43.1 million for the three months ended December 31, 2006 as compared to $26.1 million for same period of the prior year, an increase of $17.0 million or 65.1%.

• Net revenues from the sales of steel-case cells increased to $15.0 million in the three months ended December 31, 2006 from $14.2 million in the same period in 2005, an increase of $810,000 or 5.7%, due to an increase in sales volume by 15.3%, as a result of higher demand in the replacement battery market in the PRC, which is offset by a decrease in average selling price by 8.3% primarily attributable to the pricing pressure in an increasingly competitive market.

• Net revenues from the sales of aluminum-case cells increased to $17.2 million in the three months ended December 31, 2006 from $8.9 million in the same period in 2005, an increase of $8.3 million or 93.3%, due to an increase in sales volume by 104% driven by increased sales in the OEM market in the PRC as a result of dramatic growth of the PRC cellular phone market, and is offset by a decrease in the average selling price by 4.9% attributable to pricing pressure in a competitive market.

• Net revenues from sales of battery packs decreased to $2.4 million in the three months ended December 31, 2006 from $3.0 million in the same period in 2005, an decrease of $0.6 million or 20%, due to a significant decrease in average selling price by 54.3%. The decrease in average selling price is primarily attributable to the change of type of the battery packs.

• We also sold $6.4 million of high-power lithium-ion cells, $1.2 million of lithium polymer cells and $0.9 million of cylindrical cells in the three months ended December 31, 2006, compared to only $60,000 of lithium polymer cells in the same period of 2005, when we began production.

          Cost of Revenues.  Cost of revenues increased to $34.9 million for the three months ended December 31, 2006 as compared to $19.0 million for the same period in 2005, an increase of $15.9 million or 83.7%. The increase in cost of revenues was attributable to an increase in units of products sold by 53.1%, but the unit costs of the products only increased slightly. 

           As a result, gross profit for the three months ended December 31, 2006 was $8.2 million or 19.0% of net revenues as compared to gross profit of $7.1 million or 27.1% of net revenues for the same period in 2005. The decrease in gross profit as a percentage of net revenues was primarily due to (1) the decreased average selling price by 7% due to the pricing pressure in increasingly competitive market and price cuts implemented in order to maintain our market share; (2) at the same time, the unit cost only increased slightly for the three months ended December 31, 2006 compared to the same period of 2005.

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          Research and Development Costs.  Research and development costs increased to $637,000 for the three months ended December 31, 2006 as compared to $495,000 for the same period in 2005. Share-based compensation included in research and development expenses was $159,000 for the three months ended December 31, 2006 as compared to $254,000 of the same period of the prior year, a decrease of $95,000 or 37.4%. On December 26, 2006, we made grants of a total of 914,994 shares of restricted stock to the employees whose options had been terminated and who continued to be employed by us on December 26, 2006, in order to replace the cancellation on September 22, 2006, of options to purchase 1,400,000 shares of stock that had been granted to those employees in May 2005. See Note 8 of the Notes to condensed interim consolidated financial statements for further information. Salaries related to research increased to $227,000 from $87,000 for the same period of the prior year, an increase of $140,000, primarily due to increased headcount.

          Sales and Marketing Expenses.  Sales and marketing expenses decreased to $1.0 million for the three months ended December 31, 2006 as compared to $1.2 million for the same period in 2005, a decrease of $164,000 or 5.1%. As a percentage of net revenues, sales and marketing expenses have decreased to 2.4% for the three months ended December 31, 2006, from 4.6% for the same period in 2005, primarily attributable to an increase in net revenue.

          General and Administrative Expenses.  General and administrative expenses increased to $3.0 million, or 6.9% of revenues, for the three months ended December 31, 2006 as compared to $2.2 million, or 8.3% of revenues, for the same period in 2005, an increase of $799,000 or 36.9%. Salaries increased by $322,000 as a result of increased headcount of administrative staff due to the restructuring of certain departments. Depreciation charges also increased by $253,000 due to the expansion of certain of our facilities in the three months ended December 31, 2006.

          On August 15, 2006, the SEC declared effective a post-effective amendment that we had filed on August 4, 2006, terminating the effectiveness of a resale registration statement on Form SB-2 that had been filed pursuant to a registration rights agreement with certain shareholders to register the resale of shares held by those shareholders. On October 11, 2006, we filed a registration statement on Form S-1 that covered resales of the shares held by those shareholders, which was declared effective on October 19, 2006.  Because the interval from August 15, 2006 to October 19, 2006 exceeded 30 trading days, those selling shareholders became eligible for liquidated damages totaling $487,946 from us. We therefore recognized in general and administrative expenses an amount of $197,000 for the liquidated damage for the three months ended December 31, 2006 (the remainder of the liquidated damanges was recognized in the fourth quarter of fiscal 2006). There was no comparable expense in the first fiscal quarter of 2006.

          Operating Income.  As a result of the above, operating income totaled $3.6 million for the three months ended December 31, 2006, as compared to operating income of $3.2 million for the same period of the prior year, an increase of $343,000 or 10.7%. As a percentage of net revenues, operating income was 8.2% for the three months ended December 31, 2006 as compared to 12.3% for the same period of the prior year.

          Finance Costs, Net.  Finance costs, net, increased to $901,000 for the three months ended December 31, 2006 as compared to $181,000 for the same period of the prior year, an increase of $720,000 or 397.8%. We had $71.1 million in short term loans and $12.8 million in long term loans outstanding as of December 31, 2006, as compared to $39.0 million in short term loans outstanding as of December 31, 2005. The increase in net finance costs is also attributable to the increase in the exacted bank loan interest rates.

          Other Expenses/(Income).  Other income was $932,000 for the three months ended December 31, 2006, as compared to other expenses of $4,000 for the same period of 2005. Other income for the three months ended December 31, 2006 mainly consists of government subsidy given as recognition of our contribution to the economic development of the area.  No present or future obligation will arise from the receipt of such amount. There was no comparable income in the same period of the prior year. 

          Gain on Trading Securities.  We recognized income of $279,000 from BAK International’s short-term investment in trading securities during the three months ended December 31, 2005.  There was no such trading gain during the three months ended December 31, 2006.

          Income tax expenses.  Income tax expenses decreased to $5,000 for the three months ended December 31, 2006, as compared to $116,000 for the same period of 2005. The decrease was the result of a decrease in income tax rate in calendar year 2006 due to the additional capital invested in Shenzhen BAK.

          Net Income.  As a result of the foregoing, we increased our net income to $3.6 million for the three months ended December 31, 2006 from $3.2 million for the same period of the prior year.

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Liquidity and Capital Resources

          We have historically financed our liquidity requirements from a variety of sources, including short-term bank loans and bills payable under bank credit agreements, long term bank loans, sale of bills receivable and issuance of capital stock. As of December 31, 2006, we had cash and cash equivalents of $25.4 million, as compared to $21.1 million as of September 30, 2006. In addition, we had pledged deposits amounting to $9.4 million and $13.0 million at December 31, 2006 and September 30, 2006, respectively. Typically, banks will require borrowers to maintain deposits of approximately 20% to 100% of the outstanding loan balances and bills payable. The individual short term bank loans have maturities ranging from five to twelve months which coincides with the periods the cash remains pledged to the banks.

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

	Three Months Ended December 31,
	2005			2006
	(in thousands)
Net cash used in operating activities		(3,742	)		(2,155	)
Net cash used in investing activities		(12,166	)		(13,198	)
Net cash (used in) / provided by financing activities		(5,762	)		19,560
Effect of exchange rate changes on cash and cash equivalents		(17	)		57
Net (decrease)/ increase in cash and cash equivalent		(21,687	)		4,264
Cash and cash equivalents at the beginning of period		33,056			21,100
Cash and cash equivalents at the end of period		11,369			25,364

Operating Activities

          Net cash used in operating activities was $2.2 million in the three months ended December 31, 2006 compared to $3.7 million in the same period in 2005. The improvement by $1.5 million in operating activities was mainly attributable to the better control in collection of trade accounts receivable and inventory management. While our sales volume has increased significantly compared to the period ended December 31, 2005, there is no significant increase in our operating assets. The negative cash flow was mainly result of a decrease in bills payable as part of bills payable had been settled as maturity in the three months ended December 31, 2006. However, we expect that our negative operating cash flow will improve through our increased effort to collect accounts receivables.

Investing Activities

          Net cash used in investing activities decreased from $13.2 million in the three months ended December 31, 2005 to $12.1 million in the same period in 2006.  The net cash used in investing activities during the period ended December 31, 2006 was mainly used for the construction of the facility to house a new cylindrical cell production line and a new automated aluminum cell line.

Financing Activities

          Net cash provided by financing activities was $19.6 million in the three months ended December 31, 2006 compared to net cash used in finance activities of $5.8 million in the same period in 2005. This was mainly attributable to (i) a $16.5 million increase in net proceeds from borrowing due to more loans being secured for working capital and construction of new production line in the three months ended December 31, 2006, and (ii) $9.1 million decrease in cash deposited to bank as collateral in the three months ended December 31, 2006.

          As of December 31, 2006, the principal outstanding under our credit facilities and lines of credit were as follows:

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	Maximum Amount Available		Amount Borrowed
	(in thousands)
Short-term credit facilities:
Agricultural Bank of China	$	51,225	$	28,925
Shenzhen Development Bank		19,209		12,806
Shenzhnen Commercial Bank		12,806		7,315
China CITIC Bank		16,403		597
Bank of China		64,031		28,478
CITIC Ka Wah Bank Limited		6,000		—
Subtotal—short-term credit facilities	$	169,674	$	78,121
Long-term credit facilities:
Agricultural Bank of China		25,612		—
China Development Bank		12,806		12,806
Subtotal—long-term credit facilities		38,418		12,806
Lines of Credit:
Agricultural Bank of China				1,987
Shenzhen Development Bank				104
China Construction Bank				6,110
China Merchants Bank				835
Subtotal—lines of credit				9,036
Total Principal Outstanding			$	99,963

          There are no restrictions for our above unused credit facilities.

          The above principal outstanding amounts under credit facilities included short-term bank loans of $71.1 million, bills payable of $16.1 million and long-term bank loans of $12.8 million.

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          For the purpose of presentation, the movement in bills payable balances is included in operating activities in the statements of cash flows due to their nature.

          We refinanced our short-term bank loans during the three months ended December 31, 2006 at annual interest rates of 4.725% to 5.85%, payable monthly, and for terms of six to twelve months. These debt arrangements are generally guaranteed by Mr. Li Xianqian, our chairman, president, and chief executive officer.

          Pursuant to the refinancing, we pledged $10.2 million of inventory and $5.8 million of equipment and machinery as security for our comprehensive credit facility with Shenzhen Development Bank as of December 31, 2006. In addition, as all of the bank loans were borrowed by Shenzhen BAK, in the event (i) Shenzhen BAK has a bad credit record at any other bank or we are involved in any material adverse litigation with any other bank, (ii) Shenzhen BAK’s liabilities exceed 70% of its assets, or Shenzhen BAK’s current ratio is less than 0.8, or (iii) Shenzhen BAK’s monthly sales revenue declines by 10% as compared with the same period of the prior year, Shenzhen Development Bank is entitled to accelerate the loan repayment (such ratios are based on the financial data of Shenzhen BAK prepared under PRC GAAP). We were in compliance with these requirements as of December 31, 2006.

          During the three months ended December 31, 2006, we repaid four short-term bank loans totaling $12.4 million, and entered into five new short-term bank loan agreements totaling $14.7 million. The five new facilities provide for monthly interest payments at fixed annual interest rates from 5.508% to 5.58%, with principal repayments at maturities during the second calendar quarter and the fourth calendar quarter of 2007.

          On November 23, 2006, Shenzhen BAK entered into a $26 million long-term loan agreement with Shenzhen Eastern Branch, Agricultural Bank of China, which became effective on December 18, 2006. The long-term loan may be drawn at any time within five years of the effective date of the loan agreement, and will mature in five years after it is drawn. The long-term loan when drawn will carry a floating interest rate of 90% of the People’s Bank of China benchmark rate. The long-term loan is secured by pledged machinery and equipment valued at $13.6 million as of December 31, 2006. Shenzhen BAK’s obligations under the loan agreement are guaranteed by BAK International and by Mr. Li. As of December 31, 2006, we had no borrowings under this loan agreement.

          On December 26, 2006, Shenzhen BAK entered into a four-year long-term loan agreement of $12.8 million with Shenzhen Branch, China Development Bank. The long-term loan is payable in three installments as follows:

          RMB 30 million on November 20, 2008;

          RMB 30 million on November 20, 2009; and

          RMB 40 million on December 26, 2010.

          The long-term loan carries an annual interest rate of 6.48%, which is the benchmark rate of the People’s Bank of China for three- to five-year long-term loans. The long-term loan will be secured by Shenzhen BAK’s pledge of its new Research and Development Test Center, which is to be constructed in Shenzhen, China, after Shenzhen BAK obtains the required land use rights for the location of the facility; such land use rights will also be pledged as security. The obligations of Shenzhen BAK under the loan agreement are guaranteed by Mr. Li. We borrowed the full $12.8 million under this loan agreement on December 27, 2006.

           We had a working capital (refer to current assets less current liabilities excluding share-based payment liabilities) surplus of $19.2 million as of December 31, 2006, as compared to $4.6 million as of September 30, 2006, an increase of $14.6 million. This increase was primarily attributable to a decrease in bills payable because parts of bills payable were settled as maturity. We had short-term bank loans maturing in less than one year of $71.1 million as of December 31, 2006, as compared to $67.9 million as of September 30, 2006, an increase of $3.2 million.

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

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Capital Expenditures

          We made capital expenditures of $12.2 million and $12.1 million in the three months ended December 31, 2005 and 2006, respectively. Our capital expenditures were used primarily to purchase plant and equipment to expand our production capacity. The table below sets forth the breakdown of our capital expenditures by use for the periods indicated.

	Three months Ended December 31,
	2005		2006
	(in thousands)
Construction costs	$	4,542	$	4,098
Purchase of equipment		7,624		9,100
Total capital expenditures	$	12,166	$	13,198

          We estimate that our total capital expenditures in fiscal 2007 will reach approximately $55.0 million, primarily to purchase manufacturing equipment for the expansion of our production lines.

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

          We do not hold the land use right to the tract of property on which we have constructed our manufacturing facilities and other related facilities. According to the relevant PRC laws and regulations, a land use right certificate, along with government approvals for land planning, project planning, and construction must be obtained before the construction of any building is commenced. An ownership certificate will be granted by the government upon application under the condition that the aforementioned certificate and government approvals are obtained.

          We are constructing and have completed part of the construction of our facilities with the approval of the local government of Kuichong Township of Longgang District of Shenzhen, which we understand does not have the authority to grant us the land use rights certificate. Under our agreement with the Kuichong Township government, we have to pay for a 50-year land use rights certificate at an agreed unit price, which in the aggregate amounted to $4.0 million as of September 30, 2004 and $3.3 million as of September 31, 2006, following an adjustment of the site area after a land survey. Out of the $3.3 million, $0.3 million has been paid to the Kuichong Township government. We have been actively negotiating with the Shenzhen municipal government with a view to resolving the lack of authority issue, but we can make no assurances that we will be able to acquire the land use right by purchasing it directly from the Shenzhen municipal government on the same terms, or if at all. In the meantime, we have recognized a net payable purchase price of $3.0 million for the land use rights on the assumption that it will be on the same terms as those agreed with the Kuichong Township government.

          We are also required to contribute $20 million in fiscal year 2007 as the first installment of capital to our new subsidiary BAK Tianjin. Such amount would be applied by BAK Tianjin in respect of the acquisition of land use right as well as the facility and is included in our estimate of capital expenditure for fiscal year 2007 described above.

          We plan to construct our new Research and Development Test Center in Shenzhen in the second half of 2007.

32

          The following table sets forth our contractual obligations and commercial commitments as of December 31, 2006:

	Payment Due by Period
	Total		Less than 1 Year		1-3 Years		3-5 Years		More than 5 Years
		(in thousands)
Short-term bank loans		71,075		71,075		—		—		— ��
Bills payable		16,082		16,082		—		—		—
Long-term bank loans(1)		12,806		—		7,684		5,122		—
Land use rights payable(2)		3,070		3,070
Capital commitments(2)		8,458		8,458		—		—		—
Future interest payment on short-term bank loans		1,210		1,210		—		—		—
Future interest payment on long -term bank loans		2,550		841		1,336		373		—
Total		115,251		100,736		9,020		5,495		—

          Other than the contractual obligations and commercial commitments set forth above, we did not have any other long-term debt obligations, operating lease obligations, capital commitments, purchase obligations or other long-term liabilities as of December 31, 2006.

(1)

On November 23, 2006, Shenzhen BAK entered into a RMB 200 million (approximately $26 million) long-term loan agreement with Shenzhen Eastern Branch, Agricultural Bank of China, which became effective on December 18, 2006. The long-term loan may be drawn at any time within five years from the effective date of the agreement and will mature five years after it is drawn. As of December 31, 2006, no amount has been drawn under this loan agreement. The above table regarding our contractual obligations and commercial commitments does not include this loan.

(2)

We are required to contribute $20 million in fiscal year 2007 as the first installment of capital to our new subsidiary BAK Tianjin. Such amount would be applied by BAK Tianjin in respect of the acquisition of land use right as well as the facilities. We are also required to contribute the remaining capital of $79.99 million on or before December 11, 2008 to BAK Tianjin. The above table regarding our contractual obligations and commercial commitments does not include such capital contribution requirements.

Off-Balance Sheet Transactions

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

          Under U.S. GAAP, these transactions may not be recorded on our balance sheet or may be recorded in amounts different than the full contract or notional amount of the transaction. Our primary off balance sheet arrangements would result from our loan guaranties in which Shenzhen BAK would provide contractual assurance of the debt, or guarantee the timely re-payment of principal and interest of the guaranteed party.

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

          Transactions described above require accounting treatment under FASB Interpretation 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, or FIN 45. Under that standard, we would be required to recognize the fair value of guarantees issued or modified after December 31, 2002 for non-contingent guarantee obligations, and also a liability for contingent guarantee obligations based on the probability that the guaranteed party will not perform under the contractual terms of the guaranty agreement.

          We have assessed the liabilities arising from these guarantees and considered they are immaterial to the consolidated financial statements. Therefore, no liabilities in respect of the guarantees were recognized as of December 31, 2006. We had guaranteed the timely re-payment of principal and interest of two parties to a bank. The maximum amount of our exposure for those guarantees was $3.8 million at both December 31, 2006 and September 30, 2006.

Critical Accounting Policies

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

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

Recoverability of Long-Lived Assets

          Our business is capital intensive and has required, and will continue to require, significant investments in property, plant and equipment. As of September 30, 2006 and December 31, 2006, the carrying amount of property, plant and equipment, net was $109.4 million and $113.2 million, respectively. We assess the recoverability of property, plant and equipment to be held and used by a comparison of the carrying amount of an asset or group of assets to the future net undiscounted cash flows expected to be generated by the asset or group of assets. If such assets are considered impaired, the impairment recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets.

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

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Inventory Obsolescence

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

Allowance for Doubtful Accounts

          The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our accounts receivable. We determine the allowance based on historical write-off experience, customer specific facts and economic conditions. Bad debt expense is included in the general and administrative expenses. We review outstanding account balances individually for collectibility. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. As of September 30, 2006 and December 31, 2006, we had not charged off any balances as we had yet to exhaust all means of collection.

Stock-Based Compensation

          We have adopted the alternate intrinsic value method recognition provision of SFAS 123. Pursuant to the requirements of SFAS 123, we have disclosed in our annual financial statements for the year ended September 30, 2005 the pro forma effect of application of the preferred fair value method recognition provision. Further, effective October 1, 2005, we adopted the provisions of SFAS 123R, which requires the use of the fair value method of accounting for share-based compensation. Under the fair value based method, compensation cost related to employee stock options or similar equity instruments is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. SFAS 123R also requires measurement of cost of a liability- classified award based on its current fair value. The fair value of the liability-classified award will be subsequently remeasured at each reporting date through the settlement date. Change in fair value during the requisite service period will be recognized as compensation cost over that period. 

          We determine fair value using the Black-Scholes model. Under this model, certain assumptions, including the risk-free interest rate, the expected life of the options and the estimated fair value of our ordinary shares and the expected volatility, are required to determine the fair value of the options. If different assumptions had been used, the fair value of the options would have been different from the amount we computed and recorded, which would have resulted in either an increase or decrease in the compensation expense.

          Pursuant to SFAS 123R, we have recognized compensation costs of $262,000 in relation to stock-based award to our employees and non-employee directors in the three months ended December 31, 2006 as an increase in the operating costs.

Changes in Accounting Standards

          In July 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes an Interpretation of FASB Statement No. 109,” or FIN 48, which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that we recognize in our consolidated financial statements the impact of a tax position if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for us on October 1, 2007, with the cumulative effect of the change in accounting principle, if any, recorded as an adjustment to opening retained earnings. We are currently evaluating the impact of adopting FIN 48 on its consolidated financial statements.

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          In September 2006, the FASB issued SFAS 157, “Fair Value Measurements,” or SFAS 157, which defines fair value, establishes a framework for measuring fair value in U.S. GAAP, and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements, where fair value is the relevant measurement attribute. The standard does not require any new fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the impact of adopting SFAS 157 on its consolidated financial statements.

          In September 2006, the SEC issued SAB No. 108, which provides guidance on the process of quantifying financial statement misstatements. In SAB No. 108, the SEC staff establishes an approach that requires quantification of financial statement errors, under both the iron-curtain and the roll-over methods, based on the effects of the error on each of our financial statements and the related financial statement disclosures. SAB No. 108 is generally effective for annual financial statements in the first fiscal year ending after November 15, 2006. The transition provisions of SAB No. 108 permits existing public companies to record the cumulative effect in the first year ending after November 15, 2006 by recording correcting adjustments to the carrying values of assets and liabilities as of the beginning of that year with the offsetting adjustment recorded to the opening balance of retained earnings. We do not expect that the adoption of SAB No. 108 would have a material effect on our consolidated financial statements.

Exchange Rates

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

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

	RMB per U.S. Dollar
	2006		2005
Balance sheet items as of December 31		7.8087		N/A
Amounts included in the statement of income and comprehensive income, statement of changes in stockholders’ equity and statement of cash flows for the years ended September 30		7.8647		8.0833
Balance sheet items as of September 30		7.9087		N/A

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

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Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

          We are exposed to interest rate risk primarily with respect to our short-term bank loans and long-term bank loans. Although the interest rates, based on the banks’ prime rates for short-term loans and the benchmark rate of the People’s Bank of China for three to five year long term loan for long-term bank loan, are fixed for the terms of the loans, the terms are typically five to twelve months for short-term bank loans and interest rates are subject to change upon renewal.

          The term of long term bank loan is 4 year and interest rates are subject to the changing the benchmark rate of the Peoples Bank of China announced. There were no material changes in interest rates for short-term bank loans renewed during the three months ended December 31, 2006. A hypothetical 1.0% increase in the annual interest rates for all of our credit facilities at December 31, 2006 would decrease net income before provision for income taxes by $208,000 or 6.1% for the three months ended December 31, 2006. Management monitors the banks’ prime rates in conjunction with our cash requirements to determine the appropriate level of debt balances relative to other sources of funds. We have not entered into any hedging transactions in an effort to reduce our exposure to interest rate risk.

Foreign Exchange Risk

          Although our reporting currency is the U.S. dollar, the financial records of our operating subsidiaries are maintained in their local currency, the RMB, which is the functional currency. Approximately 72.9% of our revenues and 94.0% of our costs and expenses for the three months ended December 31, 2006 are denominated in RMB, with the balance denominated in U.S. dollars. Approximately 95.1% of our assets except for cash were denominated in RMB as of December 31, 2006. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between U.S. dollars and RMB. If the RMB depreciates against the U.S. dollar, the value of our Renminbi revenues, earnings and assets as expressed in our U.S. dollar financial statements will decline. Assets and liabilities of our operating subsidiaries are translated into U.S. dollars at the exchange rate at the balance sheet date, their equity accounts are translated at historical exchange rate and their income and expenses items are translated using the average rate for the period. Any resulting exchange differences are recorded in accumulated other comprehensive income or loss. An average appreciation (depreciation) of the RMB against the U.S. dollar of 5% would increase (decrease) our comprehensive income by $5.4 million based on our outstanding revenues, costs and expenses, assets and liabilities denominated in RMB as of December 31, 2006. As of December 31, 2006, our accumulated other comprehensive income (loss) was $5.0 million. We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.

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Item 4.  Controls and Procedures.

(a)          Disclosure Controls and Procedures

          As required by Rule 13a-15 under the Securities Exchange Act, our management has carried out an evaluation, with the participation and under the supervision of our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2006. Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating and implementing possible controls and procedures.

          Management conducted its evaluation of disclosure controls and procedures under the supervision of our chief executive officer and our chief financial officer. Based upon, and as of the date of this evaluation, our chief executive officer and chief financial officer, concluded that our disclosure controls and procedures were not effective, because of the material weaknesses described in Item 9A of the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2006 (the “2006 Form 10-K”), which we are still in the process of remediating. Investors are directed to Item 9A of the 2006 Form 10-K for the description of these weaknesses.

(b)          Remediation Measures of Material Weaknesses

          To remediate the first five material weaknesses reported in Item 9A, “Controls and Procedures — Management’s Report on Internal Control over Financial Reporting” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2006, we have implemented the measures described below. We will continue to evaluate the effectiveness of such measures, and may in the future implement additional measures, as necessary, to remediate such weaknesses.

          1.  We planned remediation measures of hiring and training of personnel which are intended to generally address these material weaknesses by ensuring that we will have sufficient personnel with knowledge, experience and training in the application of U.S. GAAP commensurate with our financial reporting requirements. These measures include the following:

          i)  We hired a U.S. accountant in May 2006 with relevant accounting experience, skills and knowledge in the preparation of financial statements under the requirements of U.S. GAAP and financial reporting disclosure under the requirement of SEC rules;

          ii)  We plan to train our accounting personnel in the application of U.S. GAAP commensurate with our financial reporting requirements, which include: (a) basic accounting personnel will be participating in training programs concerning general accounting policies and principles provided by the governmental agencies and professional accounting firms; (b) key accounting personnel, including the U.S. accountant, finance manager, finance controller and chief financial officer, are participating in special training programs (in addition to the training of general accounting policies and principles described in item i) above) provided by professional accounting firms retained by us concerning the difference between U.S. GAAP and the accounting principles generally accepted in the People’s Republic of China, SEC rules, recent developments in accounting policies, with particular attention to the areas where errors in the preparation and disclosure of our financial statements were previously identified.

          2.  We intend to engage outside consultants, with relevant accounting experience, skills and knowledge, working under the supervision and direction of our management, to supplement our existing accounting personnel on U.S. GAAP;

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          3.  We retained and intend to continue to retain the services of outside U.S. counselors to advise us on the SEC disclosure requirements;

          Management believes that these measures, all of which were undertaken during the fiscal year 2006 and the first quarter of fiscal year 2007, or would be undertaken subsequent to December 31, 2006, will address those five material weaknesses. However, such measures have not yet been in place long enough to be adequately tested. Following the implementation and the completion of testing, management will evaluate whether the material weaknesses have been successfully remediated.

          To remediate the last two material weaknesses described in Item 9A, “Controls and Procedures -- Management’s Report on Internal Control over Financial Reporting” in our Annual Report Form 10-K for the fiscal year ended September 30, 2006, we have implemented the measures described below. We will continue to evaluate the effectiveness of such measures, and may in the future implement additional measures, as necessary, to remediate such weaknesses.

          4.  We implemented procedures to ensure construction in progress projects are recorded based on the expenditures actually incurred on a quarterly basis and to be reviewed accordingly, including:

          i)  Engaging an independent construction surveyor company to supervise the progress of the construction projects and report the expenditures actually incurred in the form of project progress reports to us on a quarterly basis;

          ii)  Requiring our construction manager of the Company to review and approve the project progress reports and the finance department records construction in progress based on the approved project progress reports on a quarterly basis;

          iii)  Requiring the finance manager to review the accounting entry as well as the approved project progress reports.

          5.  We implemented procedures to ensure construction in progress is transferred to property, plant, and equipment in order to commence depreciation of the asset when it is ready for intended use and to be reviewed accordingly, including:

          i)  Finance department transfers construction in progress to cost of property, plant and equipment when it is ready for its intended use, at which time depreciation charges commence thereon.  The criteria used to determine when an asset is ready for intended use are based on policies that are consistent with U.S. GAAP.

          ii)  Independent construction surveyors are retained to assist management in the determination of  readiness for construction projects that meet certain minimum criteria.

          iii)  Finance manager reviews the accounting entry and time of transfer.

          iv)  Estimated unbilled costs and costs to complete assets that have been determined to be ready for their intended use are based on relevant historical cost and budget information by authorized personnel within the finance department.

          Management has successfully completed implementation of all measures described above during fiscal year 2006 and the first quarter of fiscal year 2007 and believes that the implementation of such measures, which were designed to remediate those two material weakness, will provide sufficient basis to conclude as to the absence of these material weaknesses at such time that formal testing as completed. However, until such testing of operation of the implemented measures has been completed, we lack sufficient evidence to conclude as to absence of the material weaknesses.

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          We believe that we are taking the steps necessary for remediation of the material weaknesses identified above, and we will continue to monitor the effectiveness of these steps and to make any changes that our management deems appropriate.

Changes in Internal Controls over Financial Reporting

          Other than the remediation measures described above, there were no changes in our internal controls over financial reporting after September 30, 2006 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

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PART II — OTHER INFORMATION

Item 1.  Legal Proceedings.

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

          On September 12, 2006, Hydro-Quebec, a Canadian company, and the Board of Regents of the University of Texas System brought a federal patent infringement suit in the United States District Court for the Northern District of Texas against us. We have an agreement with A123Systems, Inc., under which we agree to manufacture products for A123Systems, Inc. according to the specifications furnished by, and using the finished electrodes and other materials consigned by, A123Systems, Inc. to us. The plaintiffs alleged that by manufacturing rechargeable lithium cells for one of our customers, A123Systems, Inc., for use in DeWalt 36-volt cordless power tools manufactured by Black & Decker Corporation, we had infringed two U.S. patents owned by and exclusively licensed to the plaintiffs. The plaintiffs seek injunctive relief and damages in an unspecified amount. If the court issues an adverse decision, we may be required to pay the plaintiffs substantial monetary damages, terminate our existing production of rechargeable lithium cells manufactured for A123Systems, Inc., or pay royalties to continue such production. The court has not yet issued a decision on this matter and we are unable to quantify the extent of any possible award of damages that might become payable by us.

          Furthermore, if A123Systems, Inc. is found liable for the infringement, it may not be able to continue its cooperation with us at all or on terms and conditions acceptable to us, which in turn would adversely affect our ability to execute our strategy to expand our production of cells for power tools and capture high-margin businesses. Accordingly, our revenues and business prospects would be materially adversely affected.

          We are liable for liquidated damages to certain shareholders whose shares were included in a resale registration statement on Form SB-2 that we filed pursuant to a registration rights agreement that we entered into with such shareholders in September 2005. Under the registration rights agreement, if a registration statement filed pursuant thereto ceases to be effective after its effective date to cover the resale of the shares for more than 30 trading days, while the relevant shares could not be put back to us, we would be liable to pay partial liquidated damages equal to 1.0% of the aggregate investment amount paid by those selling shareholders for the shares, and on each monthly anniversary thereafter until the default is cured, an additional 1.5% on a daily pro-rata basis. On August 15, 2006, the SEC declared effective a post-effective amendment we filed on August 4, 2006 to terminate the effectiveness of the resale registration statement on Form SB-2 that included the resale of the shares held by those selling shareholders. On October 11, 2006, we filed a registration statement on Form S-1 that covers resales of the shares held by those shareholders, which was declared to be effective on October 19, 2006.  Because the interval from August 15, 2006 to October 19, 2006 exceeds 30 trading days, those selling shareholders will be eligible for the liquidated damages of $487,946 from us based on the formula specified in the registration rights agreement. The liquidated damage of $290,575, which was incurred before September 30, 2006, has been charged to our statement of income and comprehensive income of fiscal year 2006 and $197,371 has also been charged to our statement of income and comprehensive income for the three months ended December 31, 2006.

Item 1A.  Risk Factors.

          See Item 1A. “Risk Factors” included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2006.

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

          None. 

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Item 3. Defaults Upon Senior Securities

          None.

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

          None.

Item 5. Other Information.

          None.

Item 6. Exhibits.

Number	Description
3.1	Articles of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to China BAK Battery, Inc.’s Annual Report on Form 10-K for the fiscal year ended September 30, 2006)
3.2	Bylaws of the Registrant (incorporated by reference to Exhibit 3.2 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006)
10.1	Form of Restricted Stock Grant Agreement
10.2	Summary of loan Agreement, dated October 23, 2006, by and between Shenzhen Eastern Branch, Agricultural Bank of China and Shenzhen BAK Battery Co., Ltd.
10.3	Summary of loan agreement, dated November 15, 2006, by and between Shenzhen Eastern Branch, Agricultural Bank of China and Shenzhen BAK Battery Co., Ltd.
10.4	Summary of loan agreement, dated November 23, 2006, by and between Shenzhen Eastern Branch, Agricultural Bank of China and Shenzhen BAK Battery Co., Ltd.
10.5	Mortgage Contract, dated November 23, 2006, by and between Shenzhen Eastern Branch, Agricultural Bank of China and Shenzhen BAK Battery Co., Ltd.
31.1	Chief Executive Officer Certification furnished pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Chief Financial Officer Certification furnished pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Chief Executive Officer and Chief Financial Officer Certifications furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

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

Date: February 9, 2007	CHINA BAK BATTERY, INC.
	By:	/s/ Xiangqian Li
		Xiangqian Li, Chief Executive Officer
		(Principal Executive Officer)
	By:	/s/ Yongbin Han
		Yongbin Han, Chief Financial Officer
		(Principal Financial Officer and Principal Accounting Officer)

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