ITEM 1. BUSINESS
With respect to this discussion, the terms,
“the Company” “Highpower” “we,” “us,” and “our” refer to Highpower
International, Inc., and its 100%-owned subsidiary Hong Kong Highpower Technology Company Limited (“HKHTC”), HKHTC’s
wholly-owned subsidiaries Shenzhen Highpower Technology Company Limited (“SZ Highpower”), Highpower Energy Technology
(Hui Zhou) Company Limited (“HZ Highpower”), Icon Energy System Company Limited (“ICON”), SZ Highpower’s
wholly owned subsidiary Huizhou Highpower Technology Company Limited (“HZ HTC”) and its 60%-owned subsidiary Ganzhou
Highpower Technology Company Limited (“GZ Highpower”) and SZ Highpower’s and HKHTC’s jointly owned subsidiary,
Springpower Technology (Shenzhen) Company Limited (“SZ Springpower”). Highpower and its subsidiaries are collectively
referred to as the “Company,” unless the context indicates otherwise.
Corporate Information
Highpower International,
Inc. was incorporated in the state of Delaware on January 3, 2006
. HKHTC was incorporated in Hong Kong on July 4, 2003
and organized principally to engage in the manufacturing and trading of nickel metal hydride rechargeable batteries. All other
subsidiaries were incorporated in the People’s Republic of China (“P.R.C.”).
On February
8, 2012, GZ Highpower, which was incorporated on September 21, 2010, increased its registered capital to RMB30,000,000 ($4,762,586)
from RMB2,000,000 ($293,574). SZ Highpower holds 60% of the equity interest of GZ Highpower, while the four founding management
members of GZ Highpower hold the remaining 40%. As of December 31, 2012, the paid-in capital of GZ Highpower was approximately
RMB15,000,000 ($
2,381,293
).
On March 8, 2012, SZ Highpower invested
RMB5,000,000 ($791,377) in HZ HTC, which is a wholly-owned subsidiary of SZ Highpower. HZ HTC engages in the manufacture of Lithium-ion
batteries.
On September 14, 2012, SZ Springpower
increased its registered capital from $1,000,000 to $3,330,000. SZ Highpower paid the increased capital. As of December 31, 2012,
SZ Highpower holds 69.97% of the equity interest of SZ Springpower, and HKHTC holds the remaining 30.03%.
SZ Highpower manufactures Nickel Metal
Hydride (“Ni-MH”) batteries for both consumer and industrial applications. We have developed significant expertise
in Ni-MH battery technology and large-scale manufacturing that enable us to improve the quality of our battery products, reduce
costs, and keep pace with evolving industry standards. In 2008, we commenced manufacturing two lines of Lithium-ion (“Li-ion”)
and Lithium polymer rechargeable batteries through SZ Springpower for higher-tech, high-performance applications, such as laptops,
digital cameras and wireless communication products. Our automated machinery allows us to process key aspects of the manufacturing
process to ensure high uniformity and precision, while leaving the non-key aspects of the manufacturing process to manual labor.
We employ a broad network of salespersons
in China and Hong Kong, which targets key customers by arranging in-person sales presentations and providing after-sales services.
The sales staff works directly with our customers to better address their needs.
In 2010, we began a new materials business
in which we buy and resell certain raw materials related to our battery manufacturing operations. This new materials business
generates revenue and income and helps us understand our raw material supply chain and processing control our raw material costs
and ensure that we have a steady supply of raw materials for battery manufacturing operations to reduce our reliance on external
suppliers. In 2012, we initiated the construction of our Ganzhou recycling plant. Consequently, our materials trading activities
were reduced, so that the company can dedicate more resources to the battery recycling operations.
Industry
General
Rapid advancements in electronic technology
have expanded the number of battery-powered devices in recent years. As these devices have come to feature more sophisticated
functions, more compact sizes and lighter weights, the sources of power that operate these products have been required to deliver
increasingly higher levels of energy. This has stimulated consumer demand for higher-energy batteries capable of delivering longer
service between recharges or battery replacement. In contrast to non-rechargeable batteries, after a rechargeable battery is discharged,
it can be recharged and reused up to 1,000 times. Rechargeable batteries generally can be used in many non-rechargeable battery
applications, as well as high energy drain applications such as electric toys, power tools, portable computers and other electronics,
medical devices, and many other consumer products.
High energy density and long achievable
cycle life are important characteristics of rechargeable battery technologies. Energy density refers to the total electrical energy
per unit volume stored in a battery. High energy density batteries generally are longer lasting power sources providing longer
operating time and necessitating fewer battery recharges. Greater energy density will permit the use of batteries of a given weight
or volume for a longer time period. Long cycle life is a preferred feature of a rechargeable battery because it allows the user
to charge and recharge many times before noticing a difference in performance. Long achievable cycle life, particularly in combination
with high energy density, is desirable for applications requiring frequent battery recharges.
The initial technology for rechargeable
batteries was nickel cadmium (“Ni-Cad”). Ni-Cad batteries are offered in a variety of sizes and shapes but suffer
from low energy density and low cycle life. In addition, disposal of Ni-Cad batteries poses serious environmental and liability
issues due to the high toxicity level of cadmium. To meet the demand for higher performing rechargeable batteries, nickel-metal
hydride (“Ni-MH”) batteries were developed. Electrically, Ni-MH batteries are similar to the Ni-Cad counterparts but
utilize a hydrogen-absorbing alloy instead of cadmium. High capacity Ni-MH batteries can replace Ni-Cad batteries in many devices
because they operate on the same voltage and possess similar power and fast charge capabilities, while offering the advantage
of greater energy density. In devices such as power tools, electric toys, personal portable electronic devices and hybrid electric
vehicles, Ni-MH batteries optimize equipment performance. Ni-MH batteries have several advantages including:
|
—
|
High
capacity
- Because of
the use of hydrogen
as a cathode
material, Ni-MH
batteries have
up to a 40 percent
longer service
life than ordinary
Ni-Cad batteries
of equivalent
size.
|
|
—
|
Long
cycle life
- Up to 1,000
charge/discharge
cycles.
|
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—
|
No
memory effect
- Ni-Cad
batteries suffer
from a memory
effect - when
charging, the
user must ensure
that they are
totally flat
first, otherwise
they “remember”
how much charge
they used to
have and die
much quicker.
Ni-MH batteries
have a negligible
memory effect,
making charging
quicker and more
convenient.
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|
—
|
Performs
at extreme temperatures
- Capable
of operation
on discharge
from -20°C
to 50°C (-4°F
to 122°F)
and charge from
0°C to 45°C
(32°F to
113ºF).
|
|
—
|
Environmentally
friendly
-
Zero percent
cadmium or other
toxic chemicals
such as mercury.
|
|
—
|
Cost
efficiency
-
Rechargeable
Ni-MH batteries
are substantially
less expensive
than rechargeable
lithium batteries.
|
The first rechargeable lithium batteries
were commercialized in 1991. Rechargeable lithium batteries are produced as cylindrical lithium-ion or prismatic lithium-polymer
batteries. The energy density of lithium is typically twice that of the standard nickel-cadmium. Lithium batteries are low maintenance,
with no memory effect and no scheduled cycling required to prolong battery life. In addition, the self-discharge is less than
half compared to nickel-cadmium, making lithium well suited for modern applications, such as power tools, electric bicycles, laptops,
LED lights, portable medical devices, digital cameras, MP3 players, and electric vehicles.
Despite its overall advantages, lithium
battery technology has limitations that include fragility, safety, aging, capacity deterioration and higher manufacturing cost.
Manufacturers are constantly working to improve lithium battery technology with new and enhanced chemical combinations. Lithium
batteries have several advantages including:
|
—
|
High
capacity
- Up to 100%
higher energy
density compared
to standard nickel-cadmium
batteries.
|
|
—
|
Low
self-discharge
- Self-discharge
can be less than
half that of
nickel-based
batteries.
|
|
—
|
Low
maintenance
- No periodic
discharge is
needed and there
is no memory
effect. Specialty
cells can provide
very high current
to applications
such as power
tools.
|
|
—
|
Flexible
form factor
-
Prismatic
lithium polymer
batteries can
be produced in
a wide variety
of form factors
for different
products and
applications.
|
Lithium batteries also have several limitations:
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—
|
Requires
protection circuit
to maintain voltage
and current within
safe limits.
|
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—
|
Poses safety
issues due to
the more-active
characteristics
of its basic
materials.
|
|
—
|
Subject to
aging when not
in use - storage
in a cool place
at 40% charge
reduces the aging
effect.
|
|
—
|
Transportation
restrictions
- shipment of
larger quantities
may be subject
to regulatory
control.
|
|
—
|
Manufacturing
cost is approximately
40% greater than
nickel-cadmium.
|
China
China’s market share of battery production is expected
to increase. China has a number of benefits in battery manufacturing, which are expected to drive this growth:
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—
|
Low
Costs
.
China
continues to
have a significant
low cost of labor
as well as easy
access to raw
materials and
land.
|
|
—
|
Proximity
to electronics
supply chain
.
Electronics
manufacturing
in general continues
to shift to China,
giving China-based
manufacturers
a further cost
and cycle time
advantage.
|
|
—
|
Proximity
to end-markets
.
China
has focused in
recent years
on building its
research, development
and engineering
skill base in
all aspects of
higher end manufacturing,
including batteries.
|
Competitive Strengths
We believe the following competitive strengths contribute to
our success and differentiate us from our competitors:
Experienced management team
Our senior management team has extensive
business and industry experience. Our Chairman and Chief Executive Officer, Mr. Dang Yu Pan, has over 16 years of experience
in China’s battery industry. Our Chief Technology Officer, Mr. Wen Liang Li, has over 22 years of research experience in
advanced battery technologies and products. Additionally, other members of our senior management team have significant experience
with respect to other key aspects of our operations, including product design, manufacturing, and sales and marketing.
Market position
Since the Company’s inception, it
has primarily focused on the research, development and manufacture of Ni-MH battery cells. We have developed significant expertise
in Ni-MH battery technology and large-scale manufacturing that enables us to improve the quality of our products, reduce costs,
and keep pace with evolving industry standards. Our Ni-MH rechargeable batteries have been developed to respond to a number of
specific market requirements such as recyclability, high power, high energy density, long life, low cost and other important characteristics
for consumer and industrial applications. They are suitable for almost all applications where high currents and deep discharges
are required. Our subsidiary, SZ Springpower, is a company that specializes in the research, manufacturing and marketing
of lithium rechargeable batteries and started lithium battery manufacturing operations in 2008. Our lithium battery business has
been growing rapidly and we expect it will continue to grow as we gain more industry knowledge and acquire more customers. It
has become a more and more important segment of our operations, with net sales of lithium batteries accounting for 33.7% of net
sales in 2012, up from 20.5% of our net sales in 2011.
Well-established distribution channels
We sell our products to original equipment
manufacturers and a well-established network of distributors and resellers, which allows us to penetrate customer markets worldwide.
Our relationship with many distributors extends from our inception in 2001. We also continue to screen and identify our strongest
customers in each distribution channel and to focus our sales efforts towards the largest distributors and resellers in the fastest
growing industries, such as the mobile internet device, electric bicycle and electric scooter industries.
Proven product manufacturing capabilities
We selectively use automation in our manufacturing
process to ensure a high uniformity and precision in our products while maintaining our cost-competitiveness. We use automated
machinery in key stages of the manufacturing process while using manual labor for other stages to take advantage of the availability
of low-cost, skilled labor in China. We have received several accreditations, including the International Organization for Standardization
(ISO) 9001: 2000, ISO 14001, Conformity Europende (CE) and Underwriters Laboratories Inc. (UL) that attest to our quality management
requirements, manufacturing safety, controls, procedures and environmental performance.
Customer service expertise
We work closely with our major customers
in order to ensure high levels of customer satisfaction. To provide superior service and foster customer trust and loyalty, we
offer flexible delivery methods and product feedback opportunities to our customers. The Company provides the sales representatives
and marketing personnel with extensive training including necessary skills in answering questions relating to products and services,
proactively introducing potential customers about our products, and promptly responding to customer inquiries.
Our Strategy
Our goal is to become a global leader
in the development and manufacture of rechargeable battery products. We intend to achieve this goal by implementing the following
strategies:
Continue to pursue cost-effective opportunities
Our operating model, coupled with our
modern manufacturing processes, has resulted in economies of scale, a low cost structure, and an ability to respond rapidly to
customer demands. We intend to achieve greater cost-effectiveness by expanding production capacity, increasing productivity and
efficiency and seeking to lower the unit cost of products through the use of advanced technologies.
Aggressively pursue distribution channels
We intend to broaden the scope of our
distribution arrangements to increase sales penetration in targeted markets. We intend to select additional distributors based
on their access to markets and retail outlets that are candidates for our products. In addition, we intend to expand our international
sales presence and diversify our revenue sources by taking efforts to increase the percentage of our net sales attributable to
sales to emerging new markets.
Expand existing and new product offerings
Since the commencement of battery operations
in 2001, we have expanded our product offerings to multiple product lines, which include in each product line batteries of varying
sizes, capacities and voltages. We intend to expand our existing lines of both Ni-MH and lithium batteries for use in other applications,
such as energy storage systems, hybrid-electric cars, pure electric vehicles, and devote resources to the development of higher-end
and higher-performance applications requiring higher ampere hour batteries.
Enhance marketing efforts to increase brand awareness
We continue to devote our efforts towards
brand development and utilize marketing concepts in an attempt to enhance the marketability of our products.
Products
Our Ni-MH rechargeable batteries are versatile
solutions for many diverse applications due to their long life, environmentally friendly materials, high power and energy, low
cost and safe applications. Developed to meet the requirement for increasingly higher levels of energy demanded by today’s
electronic products, our Ni-MH rechargeable batteries offer increased capacity and higher energy density over similarly sized
standard Ni-Cad rechargeable batteries. As a result, users can expect a longer time between charges and longer running time. Our
Ni-MH rechargeable batteries are available in both cylindrical and prismatic shapes.
In 2009, we completed the construction
and build-out of several production lines for the development and manufacturing of a range of lithium rechargeable batteries and
products. We produce Li-ion batteries and Li-polymer batteries with hundreds of different models and specifications. Currently,
we produce an average of 1,800,000 lithium battery units per month.
We produce an extensive line of batteries falling into two
main categories:
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—
|
Consumer
Batteries –
Relative to ordinary
Ni-Cad rechargeable
batteries, as
well as their
non-rechargeable
counterparts,
our Ni-MH and
lithium batteries
offer higher
power capacity
allowing for
longer working
time and shortened
charging time
during equivalent
working periods.
We produce A,
AA and AAA sized
batteries in
blister packing
as well as chargers
and battery packs.
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—
|
Industrial
Batteries –
These batteries
are designed
for electric
bikes, power
tools and electric
toys. They are
specifically
designed for
high-drain discharge
applications
possessing low
internal resistance,
more power, and
longer discharging
time.
|
We also recycle scrap battery materials through outsourcing
and resell the recycled materials to some of our customers. We are currently testing this market and anticipate expanding our
battery recycling operations in the future.
Net sales for each of our product categories as a percentage
of net sales are set forth below:
|
|
Year Ended December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Ni-MH Batteries
|
|
|
63.8
|
%
|
|
|
63.7
|
%
|
Lithium Batteries
|
|
|
33.7
|
%
|
|
|
20.5
|
%
|
Materials
|
|
|
2.5
|
%
|
|
|
15.8
|
%
|
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Supply of Raw Materials
The cost of the raw materials used in
our rechargeable batteries is a key factor in the pricing of our products. We purchase materials in volume, which allows us to
negotiate better pricing with our suppliers. Our purchasing department locates eligible suppliers of raw materials, striving to
use only those suppliers who have previously demonstrated quality control and reliability.
Currently, we purchase raw materials,
consisted primarily of metal materials including nickel oxide, nickel foam, metal hydride alloy and other battery components,
such as membranes, from suppliers located in China and Japan. For lithium batteries, we purchase raw materials consisted
primarily of LiCoO
2
, graphite and electrolyte We believe that the raw materials and components used in manufacturing
rechargeable batteries are available from enough sources to be able to satisfy our manufacturing needs; however, some of our materials
relating to nickel and lithium are available from a limited number of suppliers. Our top three suppliers of nickel account for
41% of our nickel supply. Our top three suppliers of lithium account for approximately 40% of our lithium supply. Presently,
our relationships with suppliers are generally good and we expect that our suppliers will be able to meet the anticipated demand
for our products in the future. Our top suppliers include Jinchuan Group, Baotou Santoku Battery Materials Co. Ltd., and Tianjin
B&M Science & Technology, Ltd.
At times, the pricing and availability
of raw materials can be volatile, attributable to numerous factors beyond the Company’s control, including general economic
conditions, currency exchange rates, industry cycles, production levels or a supplier’s tight supply. To the extent that
we experience cost increases we may seek to pass such cost increases on to our customers, but cannot provide any assurance that
we will be able to do so successfully or that our business, results of operations and financial condition would not be adversely
affected by increased volatility of the cost and availability of raw materials.
Quality Control
We consider quality control an important
element of our business practices. We have stringent quality control systems that are implemented by more than 100 company-trained
staff members to ensure quality control over each phase of the production process, from the purchase of raw materials through
each step in the manufacturing process. Supported by advanced equipment, we utilize a scientific management system and precision
inspection measurement, capable of supplying stable, high-quality rechargeable batteries. Our quality control department executes
the following functions:
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·
|
Setting internal
controls and regulations
for semi-finished
and finished products;
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|
·
|
Testing samples
of raw materials
from suppliers;
|
|
·
|
Implementing
sampling systems
and sample files;
|
|
·
|
Maintaining quality
of equipment and
instruments; and
|
|
·
|
Articulating
the responsibilities
of quality control
staff.
|
We monitor quality and reliability in
accordance with the requirements of QSR, or Quality System Review, and ISO 9001 systems. We have received European Union’s
CE attestation, UL authentication, ISO 9001:2008 and ISO 14001 certification. We have passed stringent quality reviews and thus
obtained OEM qualifications from various domestic cellular phone brand names. With strong technological capabilities and use of
automated equipment for core aspects of the manufacturing process, we believe our product quality meets or even exceeds in certain
key aspects international industry standards.
Manufacturing
The manufacture of rechargeable batteries
requires coordinated use of machinery and raw materials at various stages of manufacturing. We have a large-scale active production
base of 51,932 square meters (not including our new 126,605 square meter facility in Huizhou to which machinery is currently being
deployed), a dedicated design, sales and marketing team, and approximately 3,200 company-trained employees. We use automated machinery
to process key aspects of the manufacturing process to ensure high uniformity and precision, while leaving the non-key aspects
of the manufacturing process to manual labor. We intend to further improve our automated production lines and strive to continue
investing in manufacturing infrastructures to further increase our manufacturing capacity, which help us control the unit cost
of products.
The primary raw materials used in production
of rechargeable batteries include electrode materials, electrolytes, foils, cases and caps and separators. The electrodes are
manufactured using active materials, conductive agents and binder which are mixed with liquid. These mixtures are then uniformly
coated onto the thin metal foil, then after drying, the electrodes are cut down to the designated sizes. The positive electrode
and negative electrode are then wound together with a separator and inserted into a can, and electrolyte is filled. The sealing
completes the battery cell assembly. Some of these cells are then integrated into packages which are customized into a wide variety
of configurations to interface with different electronic devices.
In October 2008, we commenced construction
of our new manufacturing factory in Huizhou, Guangdong Province, P.R.C., which construction was completed in 2012. The new
factory will house a substantial part of the lithium battery production for the Company and be equipped with more automated production
lines. The new factory’s production capacity will be approximately two to three times that of our current lithium battery
production facility in Shenzhen. We expect that the initial phase of machinery deployment will be completed in the second quarter
of 2013 and that we will begin initial production in the factory in the third quarter of 2013. We will also continue to operate
in the old rented factories located in Shenzhen upon completion of the new factory.
In July 2012, we commenced construction
of our materials recycling factory in Ganzhou, Jiangxi Province, P.R.C. We expect that the construction of the factory will
be completed in the second quarter of 2013 and that we will begin initial production in the factory in the third quarter of 2013.
Our Ni-MH facility currently produces
approximately 10 million to 14 million battery units per month and our lithium facility produces approximately 1.5 million to
1.8 million units per month. We are planning for moderate manufacturing capacity growth of approximately 30-40% for the lithium
battery segment in the next 12 months.
Major Customers
During the years ended December 31, 2012
and 2011, approximately 31.7% and 37.9% of our net sales were from our five largest customers, respectively. The percentages of
net sales disclosed for each of our major customers includes sales to groups of customers under common control or that could be
deemed affiliates of such major customers. During the years ended December 31, 2012 and 2011, one major customer, Energizer Battery
Manufacturing, Inc., accounted for 14.8% and 19.7%, respectively, of our net sales. No other customer accounted for more
than 10% of net sales during 2012 and 2011. As of December 31, 2012, we had two major customers who represented 16%
and 5.5% of our accounts receivable as of that date. As of December 31, 2011, we had two major customers who represented
19.7% and 6.3%, respectively, of our accounts receivable as of that date.
Sales and Marketing
We have a broad sales network of approximately
111 sales and marketing staff in China and have one branch office in Hong Kong. Our sales staff in each of our offices targets
key customers by arranging in-person sales presentations and providing after-sales services. Our sales staff works closely with
our customers so that we can better address their needs and improve the quality and features of our products. We offer different
price incentives to encourage large-volume and long-term customers.
Sales to our customers are based primarily
on purchase orders we receive from time to time rather than firm, long-term purchase commitments from our customers. Uncertain
economic conditions and our general lack of long-term purchase commitments with our customers make it difficult for us to predict
revenue accurately over the longer term. Even in those cases where customers are contractually obligated to purchase products
from us, we may elect not to enforce our contractual rights immediately because of the long-term nature of our customer relationships
and for other business reasons, and instead may negotiate accommodations with customers regarding particular situations.
We target sales of our rechargeable batteries
and charging systems through original equipment manufacturers (“OEMs”), as well as distributors and resellers focused
on our target markets. We have contractual arrangements with distributors who market our products on a commission basis in particular
areas. Although OEM agreements typically contain volume-based pricing based on expected volumes, typically prices are rarely adjusted
retroactively if contract volumes are not achieved. We attempt to adjust future prices accordingly, but our ability to adjust
prices is generally based on market conditions which we cannot control.
Net sales based on the location of our customers as a percentage
of net sales is set forth below:
|
|
Year Ended December 31,
|
|
|
|
2012
|
|
|
2011
|
|
China (including Hong Kong)
|
|
|
49.2
|
%
|
|
|
51.9
|
%
|
Europe
|
|
|
23.8
|
%
|
|
|
27.3
|
%
|
North America
|
|
|
13.0
|
%
|
|
|
13.1
|
%
|
Asia
|
|
|
13.0
|
%
|
|
|
7.3
|
%
|
South America, Africa and Others
|
|
|
1.0
|
%
|
|
|
0.4
|
%
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
While the largest portion of our sales
are made to customers in China and Hong Kong, our battery products are integrated in various devices and end-user products and
distributed worldwide, with approximately 49.2% of our products distributed to China and Hong Kong, 23.8% to Europe, 13.0% to
the United States, and 14.0% to other markets in 2012.
We mainly engage in marketing activities
such as attending industry-specific conferences and exhibitions to promote our products and brand name. We believe these activities
help in promoting our products and brand name among key industry participants.
Research and Development
To enhance our product quality, reduce
cost, and keep pace with technological advances and evolving market trends, we have established an advanced research and development
center. Our research and development center is not only focused on enhancing our Ni-MH and Lithium-based technologies by developing
new products and improving the performance of our current products, but also seeks to develop alternative technologies. Our research
and development center is currently staffed with over 126 research and development technicians who overlook our techniques department,
product development department, material analysis lab, and performance testing lab. These departments work together to research
new material and techniques, test battery performance, inspect products and to test performance of machines used in the manufacturing
process.
For the years ended December 31, 2012
and 2011, we expended $4,611,054 and $3,239,436, respectively, in research and development.
Strategic Partnership with Freudenberg Nonwovens
In 2009, we entered into a strategic research
and development partnership with Freudenberg Nonwovens. Freudenberg utilizes our research and development center research
facilities in China to test their various separators. Freudenberg Nonwovens was the first to introduce nonwovens to
the market over 70 years ago and is now the largest and most diverse manufacturer of nonwovens in the world today. Separators
are considered an integral material for Ni-MH rechargeable batteries. We strongly believe the relationship with Freudenberg
Nonwovens will continue to improve our Ni-MH product quality, strengthen our research and development in nonwoven knowledge, which
can create mutual benefits in the Ni-MH battery development.
Competition
We face competition
from many other battery manufacturers, some of which have significantly greater name recognition and financial, technical, manufacturing,
personnel and other resources than we have. We compete against other Ni-MH and lithium battery producers, as well as manufacturers
of other rechargeable and non-rechargeable batteries. The main types of rechargeable batteries currently on the market include:
lead-acid; nickel-cadmium; nickel metal hydride; liquid lithium-ion and lithium-ion polymer. Competition is typically based on
design, quality, stability, and performance. The technology behind Ni-MH rechargeable batteries has consistently improved over
time and we continue to enhance our products to meet the competitive threats from its competitors. Our primary competitors in
the Ni-MH battery market or other similar competing rechargeable battery products include SANYO Electric Co., Ltd. Global, Matsushita
Industrial Co., Ltd. (Panasonic), BYD Company Ltd., GPI International, Ltd., and GS Yuasa Corporation. Our primary competitors
in the lithium battery market or other similar competing rechargeable battery products include Desay Corp., Coslight Group, Tianjin
Lishen Battery Co. Ltd., and
Amperex Technology Limited
.
Seasonality
The first quarter
of each fiscal year tends to be our slow season due to the Chinese New Year holidays. Our factories and operations usually shut
down for 1-2 weeks during this time, resulting in
lower sales during the first quarter.
Intellectual Property
We rely on a combination of patent and
trade secret protection and other unpatented proprietary information to protect our intellectual property rights and to maintain
and enhance our competitiveness in the battery industry. We currently hold 82 patents in China and have 68 patent applications
pending in China. We also have two registered trademarks in China, which include “HFR” and its Chinese equivalent.
SZ Highpower entered into a license agreement
with Ovonic Battery Company, Inc. (“Ovonic”), which was later renewed, under which Ovonic granted SZ Highpower (1)
a royalty-bearing, non-exclusive license to use certain patents owned by Ovonic to manufacture Ni-MH batteries for portable consumer
applications (“Consumer Batteries”) in the P.R.C. and (2) a royalty-bearing, non-exclusive worldwide license to use
certain patents owned by Ovonic to use, sell and distribute Consumer Batteries. The renewed agreement will remain in effect until
the licensed patents under the agreement expire in 2013. Pursuant to the renewed agreement, SZ Highpower paid a license fee of
approximately $0.2 million to Ovonic in 2012.
We also rely on unpatented technologies
to protect the proprietary nature of our product and manufacturing processes. We require that our management team and key employees
enter into confidentiality agreements that require the employees to assign the rights to any inventions developed by them during
the course of their employment with us. The confidentiality agreements include noncompetition and non-solicitation provisions
that remain effective during the course of employment and for periods following termination of employment, which vary depending
on position and location of the employees.
P.R.C. Government Regulations
Business License
Any company that conducts business in
the P.R.C. must have a business license that covers the scope of the business in which such company is engaged. We conduct
our business through our operating subsidiaries, SZ Highpower, SZ Springpower, GZ Highpower and ICON, and each of our operating
subsidiaries holds a business license that covers its present business. Prior to expanding our business beyond the scope
covered by our business licenses, we are required to apply and receive approvals from the relevant P.R.C. authorities (if applicable,
based on the new business in which we intend to engage) and conduct modification registration formalities with the competent administration
of industry and commerce. Companies that operate outside the scope of their licenses can be subjected to a fine of not more than
RMB20,000 if such operations do not violate the P.R.C. Criminal Law, or a fine of not less than RMB20,000 but no more than RMB200,000
if such operations violate the P.R.C. Criminal Law, or a fine of not less than RMB50,000 but not more than RMB500,000 if the such
operations harm human health, have serious hidden hazards to safety, threaten public safety or destroy environmental resources. Other
penalties can include disgorgement of income and being ordered to cease operations.
Environmental Regulations
The major environmental regulations applicable
to us include the P.R.C. Environmental Protection Law, the P.R.C. Law on the Prevention and Control of Water Pollution and its
Implementation Rules, the P.R.C. Law on the Prevention and Control of Air Pollution and its Implementation Rules, the P.R.C. Law
on the Prevention and Control of Solid Waste Pollution, and the P.R.C. Law on the Prevention and Control of Noise Pollution. We
aim to comply with environmental laws and regulations and have acquired an ISO14004:2004 Environment Systems Certification and
QC080000 Hazardous Substance Process Management System.
We constructed our manufacturing facilities
with the P.R.C.’s environmental laws and requirements in mind. We currently outsource the disposal of solid waste to a third
party-contractor. In 2012, we renewed our environmental permit, which expired in December 2012, from the Shenzhen Environment
Protection Bureau Longgang Bureau covering our manufacturing operations and providing for an annual output limit of Ni-MH rechargeable
batteries. Our new permit will expire on December 30, 2013,. If we fail to comply with the provisions of the renewed permit, we
could be subject to fines, criminal charges or other sanctions by regulators, including the suspension or termination of our manufacturing
operations.
Our operating subsidiaries have received
certifications from the relevant P.R.C. government agencies in charge of environmental protection, which indicate that their business
operations are in material compliance with the relevant P.R.C. environmental laws and regulations. We have committed significant
attention and efforts to quality and environmental protection during our production process. In November 2010, we received a Clean
Production Award from the Guangdong Economic and Information Commission and Environmental Bureau of Hong Kong. We are not
currently subject to any pending actions alleging any violations of applicable P.R.C. environmental laws. We do not believe the
existence of these environmental laws, as currently written and interpreted, will materially hinder or adversely affect our business
operations; however, there can be no assurances of future events or changes in laws, or the interpretation of laws, governing
our industry. Failure to comply with P.R.C. environmental protection laws and regulations may subject us to fines up to RMB1,000,000,
the exact amount of which is determined on a case by case basis, or disrupt our operations and the construction of our new facility,
result in the shutdown of our operations temporarily or permanently, which may materially and adversely affect our business, results
of operations and financial condition.
During the year ended December 31, 2012,
we expended approximately $13,841 related to our compliance with environmental regulations.
Patent Protection in China
The P.R.C.’s intellectual property
protection regime is consistent with those of other modern industrialized countries. The P.R.C. has domestic laws for the protection
of rights in copyrights, patents, trademarks and trade secrets. The P.R.C. is also a signatory to most of the world’s major
intellectual property conventions, including:
|
—
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Convention
establishing
the World Intellectual
Property Organization
(WIPO Convention)
(June 4, 1980);
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|
—
|
Paris Convention
for the Protection
of Industrial
Property (March
19, 1985);
|
|
—
|
Patent Cooperation
Treaty (January
1, 1994); and
|
|
—
|
The Agreement
on Trade-Related
Aspects of Intellectual
Property Rights
(TRIPs) (November
11, 2001).
|
Patents in the P.R.C. are governed by
the China Patent Law and its Implementing Regulations, each of which went into effect in 1985. Amended versions of the China Patent
Law and its Implementing Regulations came into effect in 2001 and 2003, respectively.
The P.R.C. is signatory to the Paris Convention
for the Protection of Industrial Property, in accordance with which any person who has duly filed an application for a patent
in one signatory country shall enjoy, for the purposes of filing in the other countries, a right of priority during the period
fixed in the convention (12 months for inventions and utility models, and 6 months for industrial designs).
The Patent Law covers three kinds of patents,
i.e., patents for inventions, utility models and designs respectively. The Chinese patent system adopts the principle of first
to file. This means that, where more than one person files a patent application for the same invention, a patent can only be granted
to the person who first filed the application. Consistent with international practice, the P.R.C. only allows the patenting of
inventions or utility models that possess the characteristics of novelty, inventiveness and practical applicability. For a design
to be patentable, it should not be identical with or similar to any design which, before the date of filing, has been publicly
disclosed in publications in the country or abroad or has been publicly used in the country, and should not be in conflict with
any prior right of another.
P.R.C. law provides that anyone wishing
to exploit the patent of another must conclude a written licensing contract with the patent holder and pay the patent holder a
fee. One rather broad exception to this, however, is that, where a party possesses the means to exploit a patent but cannot obtain
a license from the patent holder on reasonable terms and in reasonable period of time, the P.R.C. State Intellectual Property
Office, or SIPO, is authorized to grant a compulsory license. A compulsory license can also be granted where a national emergency
or any extraordinary state of affairs occurs or where the public interest so requires. SIPO, however, has not granted any compulsory
license up to now. The patent holder may appeal such decision within three months from receiving notification by filing a suit
in a people’s court.
P.R.C. law defines patent infringement
as the exploitation of a patent without the authorization of the patent holder. A patent holder who believes his patent is being
infringed may file a civil suit or file a complaint with a P.R.C. local Intellectual Property Administrative Authority, which
may order the infringer to stop the infringing acts. Preliminary injunction may be issued by the People’s Court upon the
patentee’s or the interested parties’ request before instituting any legal proceedings or during the proceedings.
Evidence preservation and property preservation measures are also available both before and during the litigation. Damages in
the case of patent infringement is calculated as either the loss suffered by the patent holder arising from the infringement or
the benefit gained by the infringer from the infringement. If it is difficult to ascertain damages in this manner, damages may
be reasonably determined in an amount ranging from one to more times of the license fee under a contractual license. The infringing
party may be also fined by Administration of Patent Management in an amount of up to three times the unlawful income earned by
such infringing party. If there is no unlawful income so earned, the infringing party may be fined in an amount of up to RMB500,000,
or approximately $80,240.
Product Liability and Consumers Protection
Product liability claims may arise if
the products sold have any harmful effect on the consumers. The injured party may make a claim for damages or compensation. The
General Principles of the Civil Law of the P.R.C., which became effective in January 1987, state that manufacturers and sellers
of defective products causing property damage or injury shall incur civil liabilities for such damage or injuries.
The Product Quality Law of the P.R.C.
was enacted in 1993 and amended in 2000 to strengthen the quality control of products and protect consumers’ rights and
interests. Under this law, manufacturers and distributors who produce or sell defective products may be subject to confiscation
of earnings from such sales, revocation of business licenses and imposition of fines, and in severe circumstances, may be subject
to criminal liability.
The Law of the P.R.C. on the Protection
of the Rights and Interests of Consumers was promulgated on October 31, 1993 and became effective on January 1, 1994 to protect
consumers’ rights when they purchase or use goods or services. All business operators must comply with this law when they
manufacture or sell goods and/or provide services to customers.
The Tort Law of the P.R.C. effective on
July 1, 2010 requires that when the product defect endangers people’s life or property, the injured party may hold the producer
or the seller liable in tort and require that it remove obstacles, eliminate danger, or take other action. The Tort Law also requires
that when a product is found to be defective after it is put into circulation, the producer and the seller shall give timely warnings,
recall the defective product, or take other remedial measures.
Employment Laws
We are subject to laws and regulations
governing our relationship with our employees, including: wage and hour requirements, working and safety conditions, and social
insurance, housing funds and other welfare. These include local labor laws and regulations, which may require substantial
resources for compliance.
China’s National Labor Law, which
became effective on January 1, 1995, and China’s National Labor Contract Law, which became effective on January 1, 2008,
permit workers in both state and private enterprises in China to bargain collectively. The National Labor Law and the National
Labor Contract Law provide for collective contracts to be developed through collaboration between the labor union (or worker representatives
in the absence of a union) and management that specify such matters as working conditions, wage scales, and hours of work. The
laws also permit workers and employers in all types of enterprises to sign individual contracts, which are to be drawn up in accordance
with the collective contract. The National Labor Contract Law has enhanced rights for the nation’s workers, including
permitting open-ended labor contracts and severance payments. The legislation requires employers to provide written contracts
to their workers, restricts the use of temporary labor and makes it harder for employers to lay off employees. It also requires
that employees with fixed-term contracts be entitled to an indefinite-term contract after a fixed-term contract is renewed once
or the employee has worked for the employer for a consecutive ten-year period.
Tax
Pursuant to the Provisional Regulation
of China on Value Added Tax and their implementing rules, all entities and individuals that are engaged in the sale of goods,
the provision of repairs and replacement services and the importation of goods in China are generally required to pay VAT at a
rate of 17.0% of the gross sales proceeds received, less any deductible VAT already paid or borne by the taxpayer. Further, when
exporting goods, the exporter is entitled to a portion of or all the refund of VAT that it has already paid or borne.
Foreign Currency Exchange
The principal regulations governing foreign
currency exchange in China are the Foreign Exchange Administration Regulations promulgated by the State Council, as amended on
August 5, 2008, or the Foreign Exchange Regulations. Under the Foreign Exchange Regulations, the Renminbi is freely convertible
for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange
transactions. Conversion of Renminbi for capital account items, such as direct investments, loans, repatriation of investments
and investments in securities outside of China, however, is still subject to the approval of the P.R.C. State Administration of
Foreign Exchange, or SAFE. Foreign-invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized
to conduct foreign exchange business after providing valid commercial documents and, in the case of capital account item transactions,
obtaining approval from the SAFE. Capital investments by foreign-invested enterprises outside of China are also subject to limitations,
which include approvals by the Ministry of Commerce, the SAFE and the State Reform and Development Commission.
Dividend Distributions
Under applicable P.R.C. regulations, enterprises
in China may pay dividends only out of their accumulated profits, if any, determined in accordance with P.R.C. accounting standards
and regulations. In addition, enterprises in China is required to set aside at least 10.0% of its after-tax profit based on P.R.C.
accounting standards each year as its statutory general reserves until the accumulative amount of such reserves reach 50.0% of
its registered capital. These reserves are not distributable as cash dividends. The board of directors of enterprise has the discretion
to allocate a portion of its after-tax profits to staff welfare and bonus funds, which may not be distributed to equity owners
except in the event of liquidation.
Foreign Ownership of P.R.C. Operating Subsidiaries
The establishment, approval and registered
capital requirement matters of wholly foreign-owned enterprises, such as our P.R.C. subsidiaries, SZ Highpower, SZ Springpower,
HZ Highpower and ICON, are regulated by the Wholly Foreign-owned Enterprise Law of the P.R.C. promulgated and effective on April
12, 1986, as amended on October 31, 2000, and the Implementation Rules of the Wholly Foreign-owned Enterprise Law of the P.R.C.
effective on December 12, 1990, as amended in 2001. The procedures of establishing SZ Highpower, SZ Springpower, HZ Highpower
and ICON as wholly foreign-owned enterprises complied with such law and regulation.
Investment activities in the P.R.C. by
foreign investors are principally governed by the Guidance Catalogue of Industries for Foreign Investment, or the Catalogue, which
was promulgated and is amended from time to time by the Ministry of Commerce and the National Development and Reform Commission. The
Catalogue divides industries into three categories: encouraged, restricted and prohibited. An industry not listed in the
Catalogue is generally open to foreign investment unless it is specifically restricted by other P.R.C. regulations. In addition,
the establishment of wholly foreign-owned enterprises is generally permitted in most industries except for the restricted industries
which are listed in the Catalogue or restricted by other government regulations (which are subject to governmental approvals)
and industries prohibited from foreign investments. Pursuant to the currently effective Catalogue (2007 version) and other
P.R.C. regulations, the business scope of SZ Highpower, SZ Springpower, HZ Highpower, GZ Highpower and ICON as indicated on their
business licenses does not fall within the restricted or prohibited industries and is not restricted by other P.R.C. regulations
and, therefore, HKHTC is permitted to invest in SZ Highpower, SZ Springpower, HZ Highpower and ICON in the form of a wholly foreign-owned
enterprise.
Employees
On December 31, 2012, we had approximately
3,200 employees, all of whom were employed full-time. There are no collective bargaining contracts covering any of our employees.
We have not experienced any work stoppages and consider our relations with employees to be good.
Any investment in our common stock involves
a high degree of risk. Potential investors should carefully consider the material risks described below and all of the information
contained in this Form 10-K before deciding whether to purchase any of our securities. Our business, financial condition or results
of operations could be materially adversely affected by these risks if any of them actually occur. The trading price of our shares
of common stock listed on the NASDAQ Global Market could decline due to any of these risks, and an investor may lose all or part
of his investment. Some of these factors have affected our financial condition and operating results in the past or are currently
affecting us. This report also contains forward-looking statements that involve risks and uncertainties. Our actual results could
differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks
faced described below and elsewhere in this Form 10-K.
RISKS RELATED TO OUR OPERATIONS
Our business depends in large part on the growth in demand
for portable electronic devices.
Many of our battery products are used
to power various portable electronic devices. Therefore, the demand for our batteries is substantially tied to the market demand
for portable electronic devices. A growth in the demand for portable electronic devices will be essential to the expansion of
our business. Our results of operations may be adversely affected by decreases in the general level of economic activity. Decreases
in consumer spending that may result from the current global economic downturn may weaken demand for items that use our battery
products. A decrease in the demand for portable electronic devices would likely have a material adverse effect on our results
of operations. We are unable to predict the duration and severity of the current disruption in financial markets and the
global adverse economic conditions and the effect such events might have on our business.
Our success depends on the success of manufacturers of the
end applications that use our battery products.
Because our products are designed to be
used in other products, our success depends on whether end application manufacturers will incorporate our batteries in their products.
Although we strive to produce high quality battery products, there is no guarantee that end application manufacturers will accept
our products. Our failure to gain acceptance of our products from these manufacturers could result in a material adverse effect
on our results of operations.
Additionally, even if a manufacturer decides
to use our batteries, the manufacturer may not be able to market and sell its products successfully. The manufacturer’s
inability to market and sell its products successfully could materially and adversely affect our business and prospects because
this manufacturer may not order new products from us. Therefore, our business, financial condition, results of operations and
future success would be materially and adversely affected.
We are and will continue to be subject
to declining average selling prices of consumer electronic devices, which may harm our results of operations.
Portable consumer electronic devices,
such as cellular phones, DVD players, laptop computers and tablets are subject to rapid declines in average selling prices due
to rapidly evolving technologies, industry standards and consumer preferences. Therefore, electronic device manufacturers expect
suppliers, such as our company, to cut their costs and lower the price of their products to lessen the negative impact on the
electronic device manufacturer’s own profit margins. As a result, we have previously reduced the price of some of our battery
products and expect to continue to face market-driven downward pricing pressures in the future. Our results of operations will
suffer if we are unable to offset any declines in the average selling prices of our products by developing new or enhanced products
with higher selling prices or gross profit margins, increasing our sales volumes or reducing our production costs.
Our success is highly dependent on
continually developing new and advanced products, technologies, and processes and failure to do so may cause us to lose our competitiveness
in the battery industry and may cause our profits to decline.
To remain competitive in the battery industry,
it is important to continually develop new and advanced products, technologies, and processes. There is no assurance that competitors’
new products, technologies, and processes will not render our existing products obsolete or non-competitive. Alternately, changes
in legislative, regulatory or industry requirements or in competitive technologies may render certain of our products obsolete
or less attractive. Our competitiveness in the battery market therefore relies upon our ability to enhance our current products,
introduce new products, and develop and implement new technologies and processes. We predominately manufacture and market
Ni-MH batteries, and to a lesser extent, Li-ion and Li-polymer batteries. If our competitors develop alternative products
with more enhanced features than our products, our financial condition and results of operations would be materially and adversely
affected.
The research and development of new products
and technologies is costly and time consuming, and there are no assurances that our research and development of new products will
either be successful or completed within anticipated timeframes, if at all. Our failure to technologically evolve and/or develop
new or enhanced products may cause us to lose competitiveness in the battery market and may cause our profits to decline. In addition,
in order to compete effectively in the battery industry, we must be able to launch new products to meet our customers’ demands
in a timely manner. However, we cannot provide assurance that we will be able to install and certify any equipment needed to produce
new products in a timely manner, or that the transitioning of our manufacturing facility and resources to full production under
any new product programs will not impact production rates or other operational efficiency measures at our manufacturing facility.
In addition, new product introductions and applications are risky, and may suffer from a lack of market acceptance, delay in related
product development and failure of new products to operate properly. Any failure by us successfully to launch new products, or
a failure by our customers to accept such products, could adversely affect our operating results.
We have historically depended on a
limited number of customers for a significant portion of our revenues and this dependence is likely to continue.
We have historically depended on a limited
number of customers for a significant portion of our net sales. Our top five customers accounted for approximately 31.7% and 37.9%
of our net sales for the years ended December 31, 2012 and 2011, respectively. One customer, Energizer Battery Manufacturing,
Inc., accounted for 14.8% and 19.7% of our net sales for the years ended December 31, 2012 and 2011, respectively. We anticipate
that a limited number of customers will continue to contribute to a significant portion of our net sales in the future. Maintaining
the relationships with these significant customers is vital to the expansion and success of our business, as the loss of a major
customer could expose us to risk of substantial losses. Our sales and revenue could decline and our results of operations could
be materially adversely affected if one or more of these significant customers stops or reduces its purchasing of our products,
or if we fail to expand our customer base for our products.
Significant order cancellations, reductions or delays by
our customers could materially adversely affect our business.
Our sales are typically made pursuant
to individual purchase orders, and we generally do not have long-term supply arrangements with our customers, but instead work
with our customers to develop nonbinding forecasts of future requirements. Based on these forecasts, we make commitments regarding
the level of business that we will seek and accept, the timing of production schedules and the levels and utilization of personnel
and other resources. A variety of conditions, both specific to each customer and generally affecting each customer’s industry,
may cause customers to cancel, reduce or delay orders that were either previously made or anticipated. Generally, customers may
cancel, reduce or delay purchase orders and commitments without penalty, except for payment for services rendered or products
competed and, in certain circumstances, payment for materials purchased and charges associated with such cancellation, reduction
or delay. Significant or numerous order cancellations, reductions or delays by our customers could have a material adverse effect
on our business, financial condition or results of operations.
Substantial defaults by our customers
on accounts receivable or the loss of significant customers could have a material adverse effect on our business.
A substantial portion of our working capital
consists of accounts receivable from customers. One customer represented an aggregate of 16% of our accounts receivable as of
December 31, 2012. If customers responsible for a significant amount of accounts receivable were to become insolvent or otherwise
unable to pay for products and services, or to make payments in a timely manner, our business, results of operations or financial
condition could be materially adversely affected. An economic or industry downturn could materially adversely affect the servicing
of these accounts receivable, which could result in longer payment cycles, increased collection costs and defaults in excess of
management’s expectations. A significant deterioration in our ability to collect on accounts receivable could also impact
the cost or availability of financing available to us.
A change in our product mix may cause
our results of operations to differ substantially from the anticipated results in any particular period.
Our overall profitability may not meet
expectations if our products, customers or geographic mix are substantially different than anticipated. Our profit margins vary
among our battery and new materials products, our customers and the geographic markets in which we sell our products. Consequently,
if our mix of any of these is substantially different from what is anticipated in any particular period, our profitability could
be lower than anticipated.
Certain disruptions in supply of and
changes in the competitive environment for raw materials integral to our products may adversely affect our profitability.
We use a broad range of materials and
supplies, including metals, chemicals and other electronic components in our products. A significant disruption in the supply
of these materials could decrease production and shipping levels, materially increase our operating costs and materially adversely
affect our profit margins. Shortages of materials or interruptions in transportation systems, labor strikes, work stoppages, war,
acts of terrorism or other interruptions to or difficulties in the employment of labor or transportation in the markets in which
we purchase materials, components and supplies for the production of our products, in each case may adversely affect our ability
to maintain production of our products and sustain profitability. If we were to experience a significant or prolonged shortage
of critical components from any of our suppliers and could not procure the components from other sources, we would be unable to
meet our production schedules for some of our key products and to ship such products to our customers in timely fashion, which
would adversely affect our sales, margins and customer relations.
Our industry is subject to supply shortages
and any delay or inability to obtain product components may have a material adverse effect on our business.
Our industry is subject to supply shortages,
which could limit the amount of supply available of certain required battery components. Any delay or inability to obtain supplies
may have a material adverse effect on our business. During prior periods, there have been shortages of components in the battery
industry and the availability of raw materials has been limited by some of our suppliers. We cannot assure investors that any
future shortages or allocations would not have such an effect on our business. A future shortage can be caused by and result from
many situations and circumstances that are out of our control, and such shortage could limit the amount of supply available of
certain required materials and increase prices affecting our profitability.
Our future operating results may be affected by fluctuations
in costs of raw materials, such as nickel.
Our principal raw material is nickel,
which is available from a limited number of suppliers in China. The price of nickel was volatile during 2011 and 2012 and could
be volatile again. The price of nickel decreased 32% from January 2011 to December 2011 and 23% from January 2012 to December
2012. The prices of nickel and other raw materials used to make our batteries increase and decrease due to factors beyond our
control, including general economic conditions, domestic and worldwide demand, labor costs or problems, competition, import duties,
tariffs, energy costs, currency exchange rates and those other factors described under “Certain disruptions in supply of
and changes in the competitive environment for raw materials integral to our products may adversely affect our profitability.”
In an environment of increasing prices for nickel and other raw materials, competitive conditions may impact how much of the price
increases we can pass on to our customers and to the extent we are unable to pass on future price increases in our raw materials
to our customers, our financial results could be adversely affected.
Our operations would be materially
adversely affected if third-party carriers were unable to transport our products on a timely basis.
All of our products are shipped through
third party carriers. If a strike or other event prevented or disrupted these carriers from transporting our products, other carriers
may be unavailable or may not have the capacity to deliver our products to our customers. If adequate third party sources to ship
our products are unavailable at any time, our business would be materially adversely affected.
We may not be able to increase our
manufacturing output in order to maintain our competitiveness in the battery industry.
We believe that our ability to provide
cost-effective products represents a significant competitive advantage over our competitors. In order to continue providing such
cost-effective products, we must maximize the efficiency of our production processes and increase our manufacturing output to
a level that will enable us to reduce the unit production cost of our products. Our ability to increase our manufacturing output
is subject to certain significant limitations, including:
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Our ability raise
capital to acquire
additional raw materials
and expand our manufacturing
facilities;
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Delays and cost
overruns, due to
increases in raw
material prices and
problems with equipment
vendors;
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Delays or denial
of required approvals
and certifications
by relevant government
authorities;
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Diversion of
significant management
attention and other
resources; and
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Failure to execute
our expansion plan
effectively
.
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If we are not able to increase our manufacturing
output and reduce our unit production costs, we may be unable to maintain our competitive position in the battery industry. Moreover,
even if expand our manufacturing output, we may not be able to generate sufficient customer demand for our products to support
our increased production output.
The market for our products and services
is very competitive and, if we cannot effectively compete, our business will be harmed.
The market for our products and services
is very competitive and subject to rapid technological change. Many of our competitors are larger and have significantly greater
assets, name recognition and financial, personnel and other resources than we have. As a result, our competitors may be in a stronger
position to respond quickly to potential acquisitions and other market opportunities, new or emerging technologies and changes
in customer requirements. We cannot assure that we will be able to maintain or increase our market share against the emergence
of these or other sources of competition. Failure to maintain and enhance our competitive position could materially adversely
affect our business and prospects.
Our business may be adversely affected
by the global economic downturn, in addition to the continuing uncertainties in the financial markets.
The global economy is currently in a pronounced
economic downturn. Global financial markets are continuing to experience disruptions, including severely diminished liquidity
and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates, and uncertainty
about economic stability. Given these uncertainties, there is no assurance that there will not be further deterioration in the
global economy, the global financial markets and consumer confidence. If economic conditions deteriorate further, our business
and results of operations could be materially and adversely affected.
Additionally, sales of consumer items
such as portable electronic devices, have slowed and there have been adverse changes in employment levels, job growth, consumer
confidence and interest rates. Our future results of operations may experience substantial fluctuations from period to period
as a consequence of these factors, and such conditions and other factors affecting consumer spending may affect the timing of
orders. Thus, any economic downturns generally would have a material adverse effect on our business, cash flows, financial condition
and results of operations.
Additionally, the inability of our customers
and suppliers to access capital efficiently, or at all, may have other adverse effects on our financial condition. For example,
financial difficulties experienced by our customers or suppliers could result in product delays; increase accounts receivable
defaults; and increase our inventory exposure. The inability of our customers to borrow money to fund purchases of our products
reduces the demand for our products and services and may adversely affect our results from operations and cash flow. These risks
may increase if our customers and suppliers do not adequately manage their business or do not properly disclose their financial
condition to us.
Although we believe we have adequate liquidity
and capital resources to fund our operations internally, in light of current market conditions, our inability to access the capital
markets on favorable terms, or at all, may adversely affect our financial performance. The inability to obtain adequate financing
from debt or capital sources could force us to self-fund strategic initiatives or even forego certain opportunities, which in
turn could potentially harm our performance.
Maintaining and expanding our manufacturing
operations requires significant capital expenditures, and our inability or failure to maintain and expand our operations would
have a material adverse impact on our market share and ability to generate revenue.
We had capital expenditures of approximately
$13.0 million and $7.7 million in the years ended December 31, 2012 and 2011, respectively. We may incur significant additional
capital expenditures as a result of our expansion of our operations into our new production factory, as well as unanticipated
events, regulatory changes and other events that impact our business. If we are unable or fail to adequately maintain our manufacturing
capacity or quality control processes or adequately expand our production capabilities, we could lose customers and there could
be a material adverse impact on our market share and our ability to generate revenue.
Warranty claims, product liability
claims and product recalls could harm our business, results of operations and financial condition.
Our business inherently exposes us to
potential warranty and product liability claims, in the event that our products fail to perform as expected or such failure of
our products results, or is alleged to result, in bodily injury or property damage (or both). Such claims may arise despite our
quality controls, proper testing and instruction for use of our products, either due to a defect during manufacturing or due to
the individual’s improper use of the product. In addition, if any of our designed products are or are alleged to be defective,
then we may be required to participate in a recall of them.
Existing P.R.C. laws and regulations do
not require us to maintain third party liability insurance to cover product liability claims. Although we have obtained products
liability insurance, if a warranty or product liability claim is brought against us, regardless of merit or eventual outcome,
or a recall of one of our products is required, such claim or recall may result in damage to our reputation, breach of contracts
with our customers, decreased demand for our products, costly litigation, additional product recalls, loss of revenue, and the
inability to commercialize some products. Additionally, our insurance policy imposes a ceiling for maximum coverage and high
deductibles and we may be unable to obtain sufficient amounts from our policy to cover a product liability claim. We may
not be able to obtain any insurance coverage for certain types of product liability claims, as our policy excludes coverage of
certain types of claims. In such cases, we may still incur substantial costs related to a product liability claim, which
could adversely affect our results of operations.
Manufacturing or use of our battery
products may cause accidents, which could result in significant production interruption, delay or claims for substantial damages.
Our batteries, especially lithium batteries,
can pose certain safety risks, including the risk of fire. While we implement stringent safety procedures at all stages of battery
production that minimize such risks, accidents may still occur. Any accident, regardless of where it occurs, may result in significant
production interruption, delays or claims for substantial damages caused by personal injuries or property damages.
Our labor costs have increased and are likely to continue
to increase as a result of changes in Chinese labor laws.
We expect to experience an increase in
our cost of labor due to recent changes in Chinese labor laws which are likely to increase costs further and impose restrictions
on our relationship with our employees. In June 2007, the National People’s Congress of the P.R.C. enacted new labor law
legislation called the Labor Contract Law and more strictly enforced existing labor laws. The law, which became effective on January
1, 2008, amended and formalized workers’ rights concerning overtime hours, pensions, layoffs, employment contracts and the
role of trade unions. As a result of the law, we have had to increase the salaries of our employees, provide additional benefits
to our employees, and revise certain other of our labor practices. The increase in labor costs has increased our operating costs,
which we have not always been able to pass on to our customers. In addition, under the law, employees who either have worked for
us for 10 years or more or who have had two consecutive fixed-term contracts must be given an “open-ended employment contract”
that, in effect, constitutes a lifetime, permanent contract, which is terminable only in the event the employee materially breaches
our rules and regulations or is in serious dereliction of his or her duties. Such non-cancelable employment contracts have substantially
increased our employment-related risks and limit our ability to downsize our workforce in the event of an economic downturn. No
assurance can be given that we will not in the future be subject to labor strikes or that we will not have to make other payments
to resolve future labor issues caused by the new laws. Furthermore, there can be no assurance that labor laws in the P.R.C. will
not change further or that their interpretation and implementation will vary, which may have a negative effect upon our business
and results of operations.
We cannot guarantee the protection
of our intellectual property rights and if infringement of our intellectual property rights occurs, including counterfeiting of
our products, our reputation and business may be adversely affected.
To protect the reputation of our products,
we have sought to file or register intellectual property, as appropriate, in the P.R.C. where we have our primary business presence.
As of December 31, 2012, we have registered two trademarks as used on our battery products, one in English and the other in its
Chinese equivalent. Our products are currently sold under these trademarks in the P.R.C., and we plan to expand our products to
other international markets. There is no assurance that there will not be any infringement of our brand name or other registered
trademarks or counterfeiting of our products in the future, in China or elsewhere. Should any such infringement and/or counterfeiting
occur, our reputation and business may be adversely affected. We may also incur significant expenses and substantial amounts of
time and effort to enforce our trademark rights in the future. Such diversion of our resources may adversely affect our existing
business and future expansion plans.
As of December 31, 2012, we held 82 Chinese
patents and had 68 Chinese patent applications pending. Additionally, we have licensed patented technology from Ovonic Battery
Company, Inc. related to the manufacture of Ni-MH batteries. We believe that obtaining patents and enforcing other proprietary
protections for our technologies and products have been and will continue to be very important in enabling us to compete effectively.
However, there can be no assurance that our pending patent applications will issue, or that we will be able to obtain any new
patents, in China or elsewhere, or that our or our licensors’ patents and proprietary rights will not be challenged or circumvented,
or that these patents will provide us with any meaningful competitive advantages. Furthermore, there can be no assurance that
others will not independently develop similar products or will not design around any patents that have been or may be issued to
us or our licensors. Failure to obtain patents in certain foreign countries may materially adversely affect our ability to compete
effectively in those international markets. If a sufficiently broad patent were to be issued from a competing application in China
or elsewhere, it could have a material adverse effect upon our intellectual property position in that particular market.
In addition, our rights to use the licensed
proprietary technologies of our licensors depends on the timely and complete payment for such rights pursuant to license agreements
between the parties; failure to adhere to the terms of these agreements could result in the loss of such rights and could materially
and adversely affect our business.
If our products are alleged to or found
to conflict with patents that have been or may be granted to competitors or others, our reputation and business may be adversely
affected.
Rapid technological developments in the
battery industry and the competitive nature of the battery products market make the patent position of battery manufacturers subject
to numerous uncertainties related to complex legal and factual issues. Consequently, although we either own or hold licenses to
certain patents in the P.R.C., and are currently processing several additional patent applications in the P.R.C., it is possible
that no patents will issue from any pending applications or that claims allowed in any existing or future patents issued or licensed
to us will be challenged, invalidated, or circumvented, or that any rights granted thereunder will not provide us adequate protection.
As a result, we may be required to participate in interference or infringement proceedings to determine the priority of certain
inventions or may be required to commence litigation to protect our rights, which could result in substantial costs. Further,
other parties could bring legal actions against us claiming damages and seeking to enjoin manufacturing and marketing of our products
for allegedly conflicting with patents held by them. Any such litigation could result in substantial cost to us and diversion
of effort by our management and technical personnel. If any such actions are successful, in addition to any potential liability
for damages, we could be required to obtain a license in order to continue to manufacture or market the affected products. There
can be no assurance that we would prevail in any such action or that any license required under any such patent would be made
available on acceptable terms, if at all. Failure to obtain needed patents, licenses or proprietary information held by others
may have a material adverse effect on our business. In addition, if we were to become involved in such litigation, it could consume
a substantial portion of our time and resources. Also, with respect to licensed technology, there can be no assurance that the
licensor of the technology will have the resources, financial or otherwise, or desire to defend against any challenges to the
rights of such licensor to its patents.
We rely on trade secret protections
through confidentiality agreements with our employees, customers and other parties; the breach of such agreements could adversely
affect our business and results of operations.
We rely on trade secrets, which we seek
to protect, in part, through confidentiality and non-disclosure agreements with our employees, customers and other parties. There
can be no assurance that these agreements will not be breached, that we would have adequate remedies for any such breach or that
our trade secrets will not otherwise become known to or independently developed by competitors. To the extent that consultants,
key employees or other third parties apply technological information independently developed by them or by others to our proposed
projects, disputes may arise as to the proprietary rights to such information that may not be resolved in our favor. We may be
involved from time to time in litigation to determine the enforceability, scope and validity of our proprietary rights. Any such
litigation could result in substantial cost and diversion of effort by our management and technical personnel.
The failure to manage growth effectively
could have an adverse effect on our employee efficiency, product quality, working capital levels, and results of operations.
Any significant growth in the market for
our products or our entry into new markets may require and expansion of our employee base for managerial, operational, financial,
and other purposes. As of December 31, 2012, we had approximately 3,216 full-time employees. During any growth, we may face problems
related to our operational and financial systems and controls, including quality control and delivery and service capacities.
We would also need to continue to expand, train and manage our employee base. Continued future growth will impose significant
added responsibilities upon the members of management to identify, recruit, maintain, integrate, and motivate new employees.
Aside from increased difficulties in the
management of human resources, we may also encounter working capital issues, as we will need increased liquidity to finance the
purchase of raw materials and supplies, development of new products, and the hiring of additional employees. For effective growth
management, we will be required to continue improving our operations, management, and financial systems and control. Our failure
to manage growth effectively may lead to operational and financial inefficiencies that will have a negative effect on our profitability.
We cannot assure investors that we will be able to timely and effectively meet that demand and maintain the quality standards
required by our existing and potential customers.
We are dependent on certain key personnel
and loss of these key personnel could have a material adverse effect on our business, financial condition and results of operations.
Our success is, to a certain extent, attributable
to the management, sales and marketing, and operational and technical expertise of certain key personnel. Each of the named executive
officers performs key functions in the operation of our business. The loss of a significant number of these employees could have
a material adverse effect upon our business, financial condition, and results of operations.
We are dependent on a technically trained
workforce and an inability to retain or effectively recruit such employees could have a material adverse effect on our business,
financial condition and results of operations.
We must attract, recruit and retain a
sizeable workforce of technically competent employees to develop and manufacture our products and provide service support. Our
ability to implement effectively our business strategy will depend upon, among other factors, the successful recruitment and retention
of additional highly skilled and experienced engineering and other technical and marketing personnel. There is significant competition
for technologically qualified personnel in our business and we may not be successful in recruiting or retaining sufficient qualified
personnel consistent with our operational needs.
Our planned expansion into new and
existing international markets poses additional risks and could fail, which could cost us valuable resources and affect our results
of operations.
We are expanding sales of our products
into new and existing international markets including developing and developed countries, such as Japan, Russia, India, Turkey
and Brazil. These markets are untested for our products and we face risks in expanding the business overseas, which include
differences in regulatory product testing requirements, intellectual property protection (including patents and trademarks), taxation
policy, legal systems and rules, marketing costs, fluctuations in currency exchange rates and changes in political and economic
conditions.
Our expansion into the Lithium battery
business is subject to substantial risks, which could result in a material adverse effect on our results of operations.
In September 2008, we completed the construction
and build-out of two production lines for the development and manufacturing of a range of lithium rechargeable batteries and products.
Prior to September 2008, we had very limited experience in the development and production of lithium batteries. While we are expanding
our production capabilities of lithium batteries, we may be unable to manufacture lithium battery products in the time frame and
amounts expected or may be unable to increase our sales of lithium products. The lithium ion battery market is competitive and
risky and we are unsure whether our lithium products will continue to gain market acceptance. We are competing against numerous
competitors with greater financial resources than us, and due to the difficulties of entry into these markets, we may be unsuccessful
and not be able to compete effectively in the lithium battery industry.
Adverse capital and credit market conditions
may significantly affect our ability to meet liquidity needs, access to capital and cost of capital.
The capital and credit markets have been
experiencing extreme volatility and disruption, including, among other things, extreme volatility in securities prices, severely
diminished liquidity and credit availability, ratings downgrades of certain investments and declining valuations of others. Governments
have taken unprecedented actions intended to address extreme market conditions that have included severely restricted credit and
declines in real estate values. In some cases, the markets have exerted downward pressure on availability of liquidity and credit
capacity for certain issuers. While currently these conditions have not impaired our ability to utilize our current credit facilities
and finance our operations, there can be no assurance that there will not be a further deterioration in financial markets and
confidence in major economies such that our ability to access credit markets and finance our operations, including the financing
of the construction of our new recycling facility in Ganzhou and of the machinery for our new lithium battery production facility
in Huizhou, might be impaired. Without sufficient liquidity, we may be forced to curtail our operations and our planned expansion
of our new lithium battery line and construction of our new materials recycling facility. Adverse market conditions may limit
our ability to replace, in a timely manner, maturing liabilities and access the capital necessary to operate and grow our business.
As such, we may be forced to delay raising capital or bear an unattractive cost of capital which could decrease our profitability
and significantly reduce our financial flexibility. The current tightening of credit in financial markets could adversely affect
the ability of our customers to obtain financing for purchases of our products and could result in a decrease in or cancellation
of orders for our products. Our results of operations, financial condition, cash flows and capital position could be materially
adversely affected by disruptions in the financial markets.
Our quarterly results may fluctuate
because of many factors and, as a result, investors should not rely on quarterly operating results as indicative of future results.
Fluctuations in operating results or the
failure of operating results to meet the expectations of public market analysts and investors may negatively impact the value
of our securities. Quarterly operating results may fluctuate in the future due to a variety of factors that could affect revenues
or expenses in any particular quarter. Fluctuations in quarterly operating results could cause the value of our securities to
decline. Investors should not rely on quarter-to-quarter comparisons of results of operations as an indication of future performance.
As a result of the factors listed below, it is possible that in the future periods results of operations may be below the expectations
of public market analysts and investors. This could cause the market price of our securities to decline. Factors that may affect
our quarterly results include:
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Vulnerability
of our business to
a general economic
downturn in China;
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Fluctuation and
unpredictability
of costs related
to the raw materials
used to manufacture
our products;
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Seasonality of
our business;
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Changes in the
laws of the P.R.C.
that affect our operations;
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Competition from
our competitors;
and
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Our ability to
obtain necessary
government certifications
and/or licenses to
conduct our business.
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Our stock price may be negatively affected
if we become subject to the recent scrutiny, criticism and negative publicity involving U.S. listed Chinese companies.
Recently, U.S. public companies that have
substantially all of their operations in China, particularly companies like us which have completed share exchanges or reverse
merger transactions, have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators
and regulatory agencies, such as the SEC. Much of the scrutiny, criticism and negative publicity has centered around financial
and accounting irregularities and mistakes, a lack of effective internal controls over financial accounting, inadequate corporate
governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result of the scrutiny, criticism
and negative publicity, the publicly traded stock of many U.S.-listed Chinese companies has sharply decreased in value and, in
some cases, has become virtually worthless. Many of these companies are now subject to shareholder lawsuits and SEC enforcement
actions, and are conducting internal and external investigations into the allegations. It is not clear what effect this sector-wide
scrutiny, criticism and negative publicity will have on our Company, our business and our stock price. If we become the subject
of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources
to investigate such allegations and/or defend our company. This situation will be costly and time consuming and distract our management
from growing our company. If such allegations are not proven to be groundless, our company and business operations will be severely
negatively affected and your investment in our stock could be rendered worthless.
The disclosures in our reports and other filings with the
SEC and our other public pronouncements are not subject to the scrutiny of any regulatory bodies in the P.R.C. Accordingly, our
public disclosure should be reviewed in light of the fact that no governmental agency that is located in the P.R.C. where substantially
all of our operations are located has conducted any due diligence on our operations or reviewed or cleared any of our disclosures.
We are regulated by the SEC and our reports
and other filings with the SEC are subject to SEC review in accordance with the rules and regulations promulgated by the SEC under
the Securities Act and the Exchange Act. Unlike public reporting companies whose operations are located primarily in the United
States, however, substantially all of our operations are located in China. Because substantially all of our operations and business
take place in China, it may be more difficult for the staff of the SEC to overcome the geographic and cultural obstacles that
are present when reviewing our disclosures. These same obstacles are not present for similar companies whose operations or business
take place entirely or primarily in the United States. Furthermore, our SEC reports and other disclosures and public pronouncements
are not subject to the review or scrutiny of any P.R.C. regulatory authority. For example, the disclosure in our SEC reports and
other filings are not subject to the review of China Securities Regulatory Commission, a PRC regulator that is tasked with oversight
of the capital markets in China. Accordingly, you should review our SEC reports, filings and our other public pronouncements with
the understanding that no local regulator has done any due diligence on our company and with the understanding that none of our
SEC reports, other filings or any of our other public pronouncements has been reviewed or otherwise been scrutinized by any local
regulator.
RISKS RELATED TO DOING BUSINESS IN CHINA
Substantially all of our assets are
located in the P.R.C. and substantially all of our revenues are derived from our operations in China, and changes in the political
and economic policies of the P.R.C. government could have a significant impact upon the business we may be able to conduct in
the P.R.C. and accordingly on the results of our operations and financial condition.
Our business operations may be adversely
affected by the current and future political environment in the P.R.C. The Chinese government exerts substantial influence and
control over the manner in which we must conduct our business activities. Our ability to operate in China may be adversely affected
by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental
regulations, land use rights, property and other matters. Under the current government leadership, the government of the P.R.C.
has been pursuing economic reform policies that encourage private economic activities and greater economic decentralization. There
is no assurance, however, that the government of the P.R.C. will continue to pursue these policies, or that it will not significantly
alter these policies from time to time without advance notice.
Our operations are subject to P.R.C.
laws and regulations that are sometimes vague and uncertain. Any changes in such P.R.C. laws and regulations, or the interpretations
thereof, may have a material and adverse effect on our business.
The P.R.C.’s legal system is a civil
law system based on written statutes. Unlike the common law system prevalent in the United States, decided legal cases have little
value as precedent in China. There are substantial uncertainties regarding the interpretation and application of P.R.C. laws and
regulations, including but not limited to, governmental approvals required for conducting business and investments, laws and regulations
governing the battery industry, national security-related laws and regulations and export/import laws and regulations, as well
as commercial, antitrust, patent, product liability, environmental laws and regulations, consumer protection, and financial and
business taxation laws and regulations.
The Chinese government has been developing
a comprehensive system of commercial laws, and considerable progress has been made in introducing laws and regulations dealing
with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. However,
because these laws and regulations are relatively new, and because of the limited volume of published cases and judicial interpretation
and their lack of force as precedents, interpretation and enforcement of these laws and regulations involve significant uncertainties.
New laws and regulations that affect existing and proposed future businesses may also be applied retroactively.
Our principal operating subsidiaries,
SZ Highpower and SZ Springpower are considered foreign invested enterprises under P.R.C. laws, and as a result are required to
comply with P.R.C. laws and regulations, including laws and regulations specifically governing the activities and conduct of foreign
invested enterprises. We cannot predict what effect the interpretation of existing or new P.R.C. laws or regulations may have
on our businesses. If the relevant authorities find us in violation of P.R.C. laws or regulations, they would have broad discretion
in dealing with such a violation, including, without limitation:
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Revoking our
business license,
other licenses or
authorities;
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Requiring that
we restructure our
ownership or operations;
and
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Requiring that
we discontinue any
portion or all of
our business.
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The scope of our business license in
China is limited, and we may not expand or continue our business without government approval and renewal, respectively.
Our principal operating subsidiaries,
SZ Highpower and ICON, are wholly foreign-owned enterprises, commonly known as WFOEs. A WFOE can only conduct business within
its approved business scope, which appears on the business license since its inception. Our license permits us to design, manufacture,
sell and market battery products throughout the P.R.C. Any amendment to the scope of our business requires further application
and government approval. Prior to expanding our business and engaging in activities that are not covered by our current business
licenses, we are required to apply and receive approval from the relevant P.R.C. government authorities. In order for us
to expand business beyond the scope of our license, we will be required to enter into a negotiation with the authorities for the
approval to expand the scope of our business. P.R.C. authorities, which have discretion over business licenses, may reject our
request to expand the scope of our business licenses to include our planned areas of expansion. We will be prohibited from
engaging in any activities that the P.R.C. authorities do not approve in our expanded business licenses. Companies that operate
outside the scope of their licenses can be subjected to fines, disgorgement of income and ordered to cease operations. Our
business and results of operations may be materially and adversely affected if we are unable to obtain the necessary government
approval for expanded business licenses that cover any areas in which we wish to expand.
We are subject to a variety of environmental
laws and regulations related to our manufacturing operations. Our failure to comply with environmental laws and regulations may
have a material adverse effect on our business and results of operations.
We are subject to various environmental
laws and regulations in China that require us to obtain environmental permits for our battery manufacturing operations. Our current
environmental permit from the Shenzhen Environment Protection Bureau Longgang Sub-bureau (the “Bureau”) covering our
manufacturing operations expires on December 30, 2013. Historically, under a previous permit which expired in September 2007,
we substantially exceeded the approved annual output limit of Ni-MH rechargeable batteries set forth in the permit. Although we
do not currently exceed the approved annual output limits under the new permit, we cannot guarantee that this will continue to
be the case. Additionally, our current permit does not cover one of our existing premises at our manufacturing facility. If we
fail to comply with the provisions of our permit, we could be subject to fines, criminal charges or other sanctions by regulators,
including the suspension or termination of our manufacturing operations.
To the extent we ship our products outside
of the P.R.C., or to the extent our products are used in products sold outside of the P.R.C., they may be affected by the following:
The transportation of non-rechargeable and rechargeable lithium batteries is regulated by the International Civil Aviation Organization
(ICAO), and corresponding International Air Transport Association (IATA), Pipeline & Hazardous Materials Safety Administration
(PHMSA), Dangerous Goods Regulations and the International Maritime Dangerous Goods Code (IMDG), and in the P.R.C. by General
Administration of Civil Aviation of China and Maritime Safety Administration of People’s Republic of China. These regulations
are based on the United Nations (UN) Recommendations on the Transport of Dangerous Goods Model Regulations and the UN Manual of
Tests and Criteria. We currently ship our products pursuant to ICAO, IATA and PHMSA hazardous goods regulations. New regulations
that pertain to all lithium battery manufacturers went into effect in 2003 and 2004, and additional regulations went into effect
on October 1, 2009. The regulations require companies to meet certain testing, packaging, labeling and shipping specifications
for safety reasons. We comply with all current P.R.C. and international regulations for the shipment of our products, and will
comply with any new regulations that are imposed. We have established our own testing facilities to ensure that we comply with
these regulations. If we were unable to comply with the new regulations, however, or if regulations are introduced that limit
our ability to transport products to customers in a cost-effective manner, this could have a material adverse effect on our business,
financial condition and results of operations.
We cannot assure that at all times we
will be in compliance with environmental laws and regulations or our environmental permits or that we will not be required to
expend significant funds to comply with, or discharge liabilities arising under, environmental laws, regulations and permits. Additionally,
these regulations may change in a manner that could have a material adverse effect on our business, results of operations and
financial condition. We have made and will continue to make capital and other expenditures to comply with environmental requirements.
Furthermore, our failure to comply with
applicable environmental laws and regulations worldwide could harm our business and results of operations. The manufacturing,
assembling and testing of our products require the use of hazardous materials that are subject to a broad array of environmental,
health and safety laws and regulations. Our failure to comply with any of these applicable laws or regulations could result in:
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Regulatory penalties,
fines and legal liabilities;
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Suspension of
production;
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Alteration of
our fabrication,
assembly and test
processes; and
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Curtailment of
our operations or
sales.
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In addition, our failure to manage the
use, transportation, emission, discharge, storage, recycling or disposal of hazardous materials could subject us to increased
costs or future liabilities. Existing and future environmental laws and regulations could also require us to acquire pollution
abatement or remediation equipment, modify our product designs or incur other expenses associated with such laws and regulations.
Many new materials that we are evaluating for use in our operations may be subject to regulation under existing or future environmental
laws and regulations that may restrict our use of one or more of such materials in our manufacturing, assembly and test processes
or products. Any of these restrictions could harm our business and results of operations by increasing our expenses or requiring
us to alter our manufacturing processes.
P.R.C. regulations relating to acquisitions
of P.R.C. companies by foreign entities may create regulatory uncertainties that could restrict or limit our ability to operate,
including our ability to pay dividends. Our failure to obtain the prior approval of the China Securities Regulatory Commission,
or the CSRC, for any offering of our common stock could have a material adverse effect on our business, operating results, reputation
and trading price of our common stock.
The P.R.C. State Administration of Foreign
Exchange, or “SAFE,” issued a public notice in November 2005, known as Circular 75, concerning the use of offshore
holding companies in mergers and acquisitions in China. The public notice provides that if an offshore company controlled by P.R.C.
residents intends to acquire a P.R.C. company, such acquisition will be subject to registration with the relevant foreign exchange
authorities. The public notice also suggests that registration with the relevant foreign exchange authorities is required for
any sale or transfer by the P.R.C. residents of shares in an offshore holding company that owns an onshore company. The P.R.C.
residents must each submit a registration form to the local SAFE branch with respect to their ownership interests in the offshore
company, and must also file an amendment to such registration if the offshore company experiences material events, such as changes
in the share capital, share transfer, mergers and acquisitions, spin-off transactions or use of assets in China to guarantee offshore
obligations. If any P.R.C. resident stockholder of an offshore holding company fails to make the required SAFE registration and
amended registration, the onshore P.R.C. subsidiaries of that offshore company may be prohibited from distributing their profits
and the proceeds from any reduction in capital, share transfer or liquidation to the offshore entity. In May 2011, the SAFE promulgated
new operational rules, known as Notice 19, for the implementation of Circular 75. Failure to comply with the SAFE registration
and amendment requirements of Circular 75, as applied by SAFE in accordance with Notice 19 could result in liability under P.R.C.
laws for evasion of applicable foreign exchange restrictions. Most of our P.R.C. resident stockholders, as defined in the SAFE
notice, have not registered with the relevant branch of SAFE, as currently required, in connection with their former ownership
of equity interests in HKHTC. Because of uncertainty of how the SAFE notice will be further interpreted and enforced, we cannot
be sure how it will affect our business operations or future plans. For example, our subsidiaries’ ability to conduct foreign
exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance
with the SAFE notice by our P.R.C. resident beneficial holders. Failure by our P.R.C. resident beneficial holders could subject
these P.R.C. resident beneficial holders to fines or legal sanctions, restrict our overseas or cross-border investment activities,
limit our subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, which could adversely
affect our business and prospects.
On August 8, 2006, the P.R.C. Ministry
of Commerce (“MOFCOM”), joined by the State-owned Assets Supervision and Administration Commission of the State Council,
the State Administration of Taxation, the State Administration for Industry and Commerce, the China Securities Regulatory Commission
and SAFE, released a substantially amended version of the Provisions for Foreign Investors to Merge with or Acquire Domestic Enterprises
(the “Revised M&A Regulations”), which took effect on September 8, 2006. These rules significantly revised China’s
regulatory framework governing onshore-to-offshore restructurings and foreign acquisitions of domestic enterprises. These rules
implemented greater P.R.C. government attention to cross-border merger, acquisition and other investment activities, by confirming
MOFCOM as a key regulator for issues related to mergers and acquisitions in China and requiring MOFCOM approval of a broad range
of merger, acquisition and investment transactions. Further, the rules established reporting requirements for acquisition of control
by foreigners of companies in key industries, and reinforce the ability of the Chinese government to monitor and prohibit foreign
control transactions in key industries.
Among other things, the Revised M&A
Regulations include provisions that require that an offshore special purpose vehicle, or SPV, formed for listing purposes and
controlled directly or indirectly by P.R.C. companies or individuals must obtain the approval of the CSRC prior to the listing
and trading of such SPV’s securities on an overseas stock exchange. On September 21, 2006, the CSRC published on its official
website procedures specifying documents and materials required to be submitted to it by SPVs seeking CSRC approval of their overseas
listings. Highpower’s P.R.C. counsel, Zhong Lun Law Firm has advised us that because we completed our onshore-to-offshore
restructuring before September 8, 2006, the effective date of the new regulation, it is not necessary for us to submit the application
to the CSRC for its approval, and the listing and trading of our common stock does not require CSRC approval.
If the CSRC or another P.R.C. regulatory
agency subsequently determines that CSRC approval was required for any transaction prior to September 21, 2006 not receiving prior
approval, we may face regulatory actions or other sanctions from the CSRC or other P.R.C. regulatory agencies. These regulatory
agencies may impose fines and penalties on our operations in the P.R.C., limit our operating privileges in the P.R.C., delay or
restrict the repatriation of the proceeds from an offering of securities into the P.R.C., or take other actions that could have
a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the
trading price of our common stock. The CSRC or other P.R.C. regulatory agencies also may take actions requiring us, or making
it advisable for us, to halt any offering before settlement and delivery of the securities offered. Consequently, if investors
engage in market trading or other activities in anticipation of and prior to settlement and delivery, they do so at the risk that
settlement and delivery may not occur.
Also, if later the CSRC requires that
we obtain its approval for any transaction not receiving prior approval, we may be unable to obtain a waiver of the CSRC approval
requirements, if and when procedures are established to obtain such a waiver. Any uncertainties and/or negative publicity regarding
this CSRC approval requirement could have a material adverse effect on the trading price of our common stock.
Furthermore, the Circular on establishing
the Security Review System for Merger and Acquisition of Domestic Enterprise by Foreign Investors was promulgated by the General
Office of the State Council on February 3, 2011 and the Ministry of Commerce issued the corresponding implementation rules on
August 25, 2011. According to these rules, a foreign investor’s acquisitions of Chinese companies in the fields of military,
energy and resources, infrastructure, important agricultural products, infrastructure, transport service, key technology and major
equipment manufacturing, and other restricted fields requires security review by a ministerial panel established and governed
under the direction of the State Council and led by the National Development and Reform Commission and Ministry of Commerce.
Complying with the requirements of the
above rules to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval
from P.R.C. Ministry of Commerce, may delay or inhibit our ability to complete such transactions, which could also affect our
ability to expand our business.
If our land use rights or the land use rights of our landlord
are revoked, we would be forced to relocate operations.
Under Chinese
law land is owned by the state or rural collective economic organizations. The state issues to the land users the land use right
certificates. Land use rights can be revoked and the land users forced to vacate at any time when redevelopment of the land is
in the public interest. The public interest rationale is interpreted quite broadly and the process of land appropriation may be
less than transparent. We acquired approximately 126,605 square meters of land equity in Huizhou from the Huizhou State-Owned
Land Resource in 2007 upon which we began constructing our new manufacturing facility. We also acquired 58,669 square meters of
land equity in Ganzhou, Guangdong, China in February 2012 from the
Ganzhou Land and Resource Bureau upon which we have
started construction of a new facility to house our new materials business.
Besides the land use rights
in Huizhou and Ganzhou, we rely on the land use rights of our landlords for other facilities, and the loss of our own land use
rights or our landlords’ land use rights would require us to identify and relocate our operations, which could have a material
adverse effect on our financial condition and results of operations. Any loss of this land use right would require us to identify
and relocate our manufacturing and other facilities, which could have a material adverse effect on our financial condition and
results of operations.
We will not be able to complete an
acquisition of prospective acquisition targets in the P.R.C. unless their financial statements can be reconciled to U.S. generally
accepted accounting principles in a timely manner.
Companies based in the P.R.C. may not
have properly kept financial books and records that may be reconciled with U.S. generally accepted accounting principles. If we
attempt to acquire a significant P.R.C. target company and/or its assets, we would be required to obtain or prepare financial
statements of the target that are prepared in accordance with and reconciled to U.S. generally accepted accounting principles.
Federal securities laws require that a business combination meeting certain financial significance tests require the public acquirer
to prepare and file historical and/or pro forma financial statement disclosure with the SEC. These financial statements must be
prepared in accordance with, or be reconciled to U.S. generally accepted accounting principles and the historical financial statements
must be audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), or PCAOB. If
a proposed acquisition target does not have financial statements that have been prepared in accordance with, or that can be reconciled
to, U.S. generally accepted accounting principles and audited in accordance with the standards of the PCAOB, we will not be able
to acquire that proposed acquisition target. These financial statement requirements may limit the pool of potential acquisition
targets with which we may acquire and hinder our ability to expand our retail operations. Furthermore, if we consummate an acquisition
and are unable to timely file audited financial statements and/or pro forma financial information required by the Exchange Act,
such as Item 9.01 of Form 8-K, we will be ineligible to use the SEC’s short-form registration statement on Form S-3 to raise
capital, if we are otherwise eligible to use a Form S-3. If we are ineligible to use a Form S-3, the process of raising capital
may be more expensive and time consuming and the terms of any offering transaction may not be as favorable as they would have
been if we were eligible to use Form S-3.
We face risks related to natural disasters,
terrorist attacks or other events in China that may affect usage of public transportation, which could have a material adverse
effect on our business and results of operations.
Our business could be materially and adversely
affected by natural disasters, terrorist attacks or other events in China. For example, in early 2008, parts of China suffered
a wave of strong snow storms that severely impacted public transportation systems. In May 2008, Sichuan Province in China suffered
a strong earthquake measuring approximately 8.0 on the Richter scale that caused widespread damage and casualties. The May
2008 Sichuan earthquake has had a material adverse effect on the general economic conditions in the areas affected by the earthquake. Any
future natural disasters, terrorist attacks or other events in China could cause a reduction in usage of or other severe disruptions
to, public transportation systems and could have a material adverse effect on our business and results of operations.
We face uncertainty from China’s
Circular on Strengthening the Administration of Enterprise Income Tax on Non-Resident Enterprises' Share Transfer (“Circular
698”) that was released in December 2009 with retroactive effect from January 1, 2008.
The Chinese State Administration of Taxation
(SAT) released a circular (Guoshuihan No. 698 – Circular 698) on December 15, 2009 that addresses the transfer of shares
by nonresident companies. Circular 698, which is effective retroactively to January 1, 2008, may have a significant impact
on many companies that use offshore holding companies to invest in China. Circular 698, which provides parties with a short
period of time to comply its requirements, indirectly taxes foreign companies on gains derived from the indirect sale of a Chinese
company. Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares
in an offshore holding company, and the latter is located in a country or jurisdiction where the effective tax burden is less
than 12.5% or where the offshore income of his, her, or its residents is not taxable, the foreign investor is required to provide
the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers.
Moreover, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through an abuse of
form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided,
the P.R.C. tax authority will have the power to re-assess the nature of the equity transfer in accordance with P.R.C.’s
“substance-over-form” principle and deny the existence of the offshore holding company that is used for tax planning
purposes.
The SAT issued Bulletin of the State of
Taxation [2011] No. 24 (Bulletin) on March 28, 2011, in which various issues regarding the tax administration for non-PRC resident
enterprises and clarifications on Circular 698 were addressed. The Bulletin defined some parameters stipulated in Circular 698,
which, if a non-resident enterprise were to fall under, would be subject to the Circular requirements including that (a) “foreign
investor (party with effective control)” applies to all foreign investors who have indirectly transferred a Chinese resident
enterprise and (b) that “effective tax burden” refers to the effective tax imposed on the gains on the share transfer
transaction per se. However, the SAT is expected to issue further clarification and guidance with regard to how to decide “abuse
of form of organization” and “reasonable commercial purpose,” which can be utilized by us to determine if we
comply with Circular 698.
If we fail to comply with the requirements
under Circular 698 and the Bulletin, we may become at risk of being taxed and we may also be required to expend valuable resources
to comply with Circular 698 and the Bulletin or to establish that we should not be taxed, which could have a material adverse
effect on our financial condition and results of operations.
The foreign currency exchange rate between U.S. Dollars
and Renminbi could adversely affect our financial condition.
To the extent that we need to convert
U.S. Dollars into Renminbi for our operational needs, our financial position and the price of our common stock may be adversely
affected should the Renminbi appreciate against the U.S. Dollar at that time. Conversely, if we decide to convert Renminbi into
U.S. Dollars for the operational needs or paying dividends on our common stock, the dollar equivalent of our earnings from our
subsidiaries in China would be reduced should the dollar appreciate against the Renminbi.
Until 1994, the Renminbi experienced a
gradual but significant devaluation against most major currencies, including dollars, and there was a significant devaluation
of the Renminbi on January 1, 1994 in connection with the replacement of the dual exchange rate system with a unified managed
floating rate foreign exchange system. Since 1994, the value of the Renminbi relative to the U.S. Dollar has remained stable and
has appreciated slightly against the U.S. Dollar. Countries, including the United States, have argued that the Renminbi is artificially
undervalued due to China’s current monetary policies and have pressured China to allow the Renminbi to float freely in world
markets. In July 2005, the P.R.C. government changed its policy of pegging the value of the Renminbi to the dollar. Under the
new policy the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of designated foreign currencies.
While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international
pressure on the P.R.C. government to adopt an even more flexible currency policy, which could result in further and more significant
appreciation of the Renminbi against the dollar.
Because most of our sales are made in U.S. Dollars and most
of our expenses are paid in RMB, devaluation of the U.S. Dollar could negatively impact our results of operations.
The value of RMB is subject to changes
in China’s governmental policies and to international economic and political developments. In January 1994, the P.R.C. government
implemented a unitary managed floating rate system. Under this system, the People’s Bank of China, or PBOC, began publishing
a daily Base Exchange Rate with reference primarily to the supply and demand of RMB against the U.S. Dollar and other foreign
currencies in the market during the previous day. Authorized banks and financial institutions are allowed to quote buy and sell
rates for RMB within a specified band around the central bank’s daily exchange rate. On July 21, 2005, PBOC announced an
adjustment of the exchange rate of the U.S. Dollar to RMB and modified the system by which the exchange rates are determined,
which has resulted in an appreciation of the RMB against the U.S. Dollar. During the year ended December 31, 2012, the exchange
rate of the RMB to the U.S. Dollar increased approximately 1.1% from the level at the end of December 31, 2011. While the international
reaction to the RMB revaluation has generally been positive, there remains significant international pressure on the P.R.C. government
to adopt an even more flexible currency policy, which could result in further fluctuations of the exchange rate of the U.S. Dollar
against the RMB, including future devaluations. Because most of our net sales are made in U.S. Dollars and most of our expenses
are paid in RMB, any future devaluation of the U.S. Dollar against the RMB could negatively impact our results of operations.
Inflation in the P.R.C. could negatively affect our profitability
and growth.
While the P.R.C. economy has experienced
rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas of the country.
Rapid economic growth can lead to growth in the money supply and rising inflation. According to the National Bureau of Statistics
of China, China’s Average consumer Price Index was 2.7% in 2012. If prices for our products and services rise at a rate
that is insufficient to compensate for the rise in the costs of supplies such as raw materials, it may have an adverse effect
on our profitability.
Furthermore, In order to control inflation
in the past, the P.R.C. government has imposed controls on bank credits, limits on loans for fixed assets and restrictions on
state bank lending. In January 2010, the Chinese government took steps to tighten the availability of credit including ordering
banks to increase the amount of reserves they hold and to reduce or limit their lending. The implementation of such policies may
impede economic growth. In October 2004, the People’s Bank of China, the P.R.C.’s central bank, raised interest rates
for the first time in nearly a decade and indicated in a statement that the measure was prompted by inflationary concerns in the
Chinese economy. In April 2006, the People’s Bank of China raised the interest rate again. Repeated rises in interest rates
by the central bank would likely slow economic activity in China which could, in turn, materially increase our costs and also
reduce demand for our products and services.
Because our funds are held in banks
which do not provide insurance, the failure of any bank in which we deposit our funds could affect our ability to continue in
business.
Banks and other financial institutions
in the P.R.C. do not provide insurance for funds held on deposit. A significant portion of our assets are in the form of cash
deposited with banks in the P.R.C., and in the event of a bank failure, we may not have access to our funds on deposit. Depending
upon the amount of money we maintain in a bank that fails, our inability to have access to our cash could impair our operations,
and, if we are not able to access funds to pay suppliers, employees and other creditors, we may be unable to continue in business.
Failure to comply with the United States
Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences.
As our ultimate holding company is a Delaware
corporation, we are subject to the United States Foreign Corrupt Practices Act, which generally prohibits United States companies
from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business.
Foreign companies, including some that may compete with us, are not subject to these prohibitions. Corruption, extortion, bribery,
pay-offs, theft and other fraudulent practices may occur from time-to-time in the P.R.C. We can make no assurance, however, that
our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other
agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material
adverse effect on our business, financial condition and results of operations.
If we make equity compensation grants
to persons who are P.R.C. citizens, they may be required to register with the State Administration of Foreign Exchange of the
P.R.C., or SAFE. We may also face regulatory uncertainties that could restrict our ability to adopt an equity compensation plan
for our directors and employees and other parties under P.R.C. law.
On April 6, 2007, SAFE issued the “Operating
Procedures for Administration of Domestic Individuals Participating in the Employee Stock Ownership Plan or Stock Option Plan
of An Overseas Listed Company, also known as “Circular 78.” It is not clear whether Circular 78 covers all forms of
equity compensation plans or only those which provide for the granting of stock options. For any plans which are so covered and
are adopted by a non-P.R.C. listed company after April 6, 2007, Circular 78 requires all participants who are P.R.C. citizens
to register with and obtain approvals from SAFE prior to their participation in the plan. In addition, Circular 78 also requires
P.R.C. citizens to register with SAFE and make the necessary applications and filings if they participated in an overseas listed
company’s covered equity compensation plan prior to April 6, 2007. In 2008, we adopted the Highpower International, Inc.
2008 Omnibus Incentive Plan (the “Plan”) under which we make option grants and other equity awards to our officers,
directors and other eligible participants under the plan. Circular 78 may require our officers and directors who receive
option grants and are P.R.C. citizens to register with SAFE. We believe that the registration and approval requirements contemplated
in Circular 78 will be burdensome and time consuming. If it is determined that the Plan is subject to Circular 78, failure to
comply with such provisions may subject us and participants of the Plan who are P.R.C. citizens to fines and legal sanctions and
prevent us from being able to grant equity compensation to our P.R.C. employees. In that case, our ability to compensate our employees
and directors through equity compensation would be hindered and our business operations may be adversely affected. We
have granted options to various employees and officers located in the P.R.C., including a grant of options to one executive in
the P.R.C. in March 2012. We have complied with all of the relevant regulations imposed upon us related to such grants and assisted
our grantees with their compliance with their individual registration requirements.
We have enjoyed certain preferential
tax concessions and the loss of these preferential tax concessions may cause our tax liabilities to increase and its profitability
to decline.
Our operating subsidiary, SZ Highpower,
enjoyed preferential tax concessions in the P.R.C., which were only granted to high-technology enterprises operating in the Shenzhen
Special Economic Zone. From 2005 to 2007, SZ Highpower enjoyed a preferential income tax rate of 7.5% due to its status as a new
business and high-tech enterprise status from the Shenzhen level. That status expired on December 31, 2007. In 2008, SZ Highpower
received the National High-technology Enterprise status, and then enjoyed a preferential tax rate of 15%. This status expired
on December 31, 2010. In 2011, we renewed our status, which expires on December 31, 2013. Our subsidiary, SZ Springpower, is currently
in the 25% tax bracket. It will be eligible to apply for the hi-tech enterprise status in order to receive a preferential tax
rate of 15% when it reaches profitability, which is expected to occur in 2013. The expiration of the preferential tax treatment
will increase our tax liabilities and reduce our profitability. Additionally, the P.R.C. Enterprise Income Tax Law (the “EIT
Law”) was enacted on March 16, 2007. Under the EIT Law, which became effective on January 1, 2008, China adopted a uniform
tax rate of 25% for all enterprises (including foreign-invested enterprises) and canceled several tax incentives enjoyed by foreign-invested
enterprises. However, for foreign-invested enterprises established before the promulgation of the EIT Law, a five-year transition
period is provided during which the tax rate gradually increased starting in 2008 and will be equal to the new 25% tax rate at
the end of the transition period. We believe that our profitability will be negatively affected in the near future as a result
of the new EIT Law. Any future increase in the enterprise income tax rate applicable to us or other adverse tax treatments could
increase our tax liabilities and reduce net income.
Under the EIT Law, Highpower International
and HKHTC may be classified as “resident enterprises” of China for tax purpose, which may subject Highpower International
and HKHTC to P.R.C. income tax on taxable global income.
Under the P.R.C. Enterprise Income Tax
Law (the “EIT Law”) and its implementing rules, both of which became effective on January 1, 2008, enterprises are
classified as resident enterprises and non-resident enterprises. An enterprise established outside of China with its “de
facto management bodies” located within China is considered a “resident enterprise,” meaning that it can be
treated in a manner similar to a Chinese domestic enterprise for enterprise income tax purposes. The implementing rules of the
EIT Law define de facto management body as a managing body that in practice exercises “substantial and overall management
and control over the production and operations, personnel, accounting, and properties” of the enterprise. Due to the short
history of the EIT Law and lack of applicable legal precedents, it remains unclear how the P.R.C. tax authorities will determine
the P.R.C. tax resident treatment of a foreign company such as Highpower International and HKHTC. Both Highpower International
and HKHTC’s members of management are located in China. If the P.R.C. tax authorities determine that Highpower International
or HKHTC is a “resident enterprise” for P.R.C. enterprise income tax purposes, a number of P.R.C. tax consequences
could follow. First, they may be subject to the enterprise income tax at a rate of 25% on their worldwide taxable income, including
interest income on the proceeds from this offering, as well as P.R.C. enterprise income tax reporting obligations. Second, the
EIT Law provides that dividend paid between “qualified resident enterprises” is exempted from enterprise income tax.
A recent circular issued by the State Administration of Taxation regarding the standards used to classify certain Chinese-invested
enterprises controlled by Chinese enterprises or Chinese group enterprises and established outside of China as “resident
enterprises” clarified that dividends and other income paid by such “resident enterprises” will be considered
to be P.R.C. source income, subject to P.R.C. withholding tax, currently at a rate of 10%, when recognized by non-P.R.C. shareholders.
It is unclear whether the dividends that Highpower International or HKHTC receive from SZ Highpower and SZ Springpower will constitute
dividends between “qualified resident enterprises” and would therefore qualify for tax exemption, because the definition
of qualified resident enterprises is unclear and the relevant P.R.C. government authorities have not yet issued guidance with
respect to the processing of outbound remittances to entities that are treated as resident enterprises for P.R.C. enterprise income
tax purposes. We are actively monitoring the possibility of “resident enterprise” treatment for the applicable tax
years and are evaluating appropriate organizational changes to avoid this treatment, to the extent possible. As a result of the
EIT Law, our historical operating results will not be indicative of our operating results for future periods and the value of
our common stock may be adversely affected.
Dividends payable by us to our foreign
investors and any gain on the sale of our shares may be subject to taxes under P.R.C. tax laws.
If dividends payable to our shareholders
are treated as income derived from sources within China, then the dividends that shareholders receive from us, and any gain on
the sale or transfer of our shares, may be subject to taxes under P.R.C. tax laws.
Under the EIT Law and its implementing
rules, P.R.C. enterprise income tax at the rate of 10% is applicable to dividends payable by us to our investors that are non-resident
enterprises so long as such non-resident enterprise investors do not have an establishment or place of business in China or, despite
the existence of such establishment of place of business in China, the relevant income is not effectively connected with such
establishment or place of business in China, to the extent that such dividends have their sources within the P.R.C. Similarly,
any gain realized on the transfer of our shares by such investors is also subject to a 10% P.R.C. income tax if such gain is regarded
as income derived from sources within China and Highpower International is considered as a resident enterprise which is domiciled
in China for tax purpose. Additionally, there is a possibility that the relevant P.R.C. tax authorities may take the view that
the Highpower International and HKHTC are holding SZ Highpower and SZ Springpower, and the capital gain derived by our overseas
shareholders or investors from the share transfer is deemed China-sourced income, in which case such capital gain may be subject
to a P.R.C. withholding tax at the rate of up to 10%. If we are required under the EIT Law to withhold P.R.C. income tax on our
dividends payable to our foreign shareholders or investors who are non-resident enterprises, or if investors are required to pay
P.R.C. income tax on the transfer or our shares under the circumstances mentioned above, the value of investors’ investment
in our shares may be materially and adversely affected.
In January, 2009, the State Administration
of Taxation promulgated the Provisional Measures for the Administration of Withholding of Enterprise Income Tax for Non-resident
Enterprises (“Measures”), pursuant to which, the entities which have the direct obligation to make the following payment
to a non-resident enterprise shall be the relevant tax withholders for such non-resident enterprise, and such payment includes:
incomes from equity investment (including dividends and other return on investment), interests, rents, royalties, and incomes
from assignment of property as well as other incomes subject to enterprise income tax received by non-resident enterprises in
China. Further, the Measures provides that in case of equity transfer between two non-resident enterprises which occurs outside
China, the non-resident enterprise which receives the equity transfer payment shall, by itself or engage an agent to, file tax
declaration with the P.R.C. tax authority located at place of the P.R.C. company whose equity has been transferred, and the P.R.C.
company whose equity has been transferred shall assist the tax authorities to collect taxes from the relevant non-resident enterprise.
However, it is unclear whether the Measures refer to the equity transfer by a non-resident enterprise which is a direct or an
indirect shareholder of the said P.R.C. company. Given these Measures, there is a possibility that we may have an obligation to
withhold income tax in respect of the dividends paid to non-resident enterprise investors.
Any recurrence of Severe Acute Respiratory
Syndrome (SARS), Avian Flu, or another widespread public health problem, such as the spread of H1N1 (“Swine”) Flu,
in the P.R.C. could adversely affect our operations.
A renewed outbreak of SARS, Avian Flu
or another widespread public health problem, such as the spread of H1N1 (“Swine”) Flu, in China, where all of our
operations are located and where the substantial portion of our sales occur, could have a negative effect on our operations. Our
business is dependent upon our ability to continue to manufacture battery products. Such an outbreak could have an impact on the
Company’s operations as a result of:
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Quarantines or
closures of some
of our manufacturing
facilities, which
would severely disrupt
our operations;
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The sickness
or death of our key
officers and employees;
and
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A general slowdown
in the Chinese economy.
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Any of the foregoing events or other unforeseeable
consequences of public health problems could adversely affect our operations.
A downturn in the economy of the P.R.C. may slow our growth
and profitability.
The growth of the Chinese economy has
been uneven across geographic regions and economic sectors. There can be no assurance that growth of the Chinese economy will
be steady or that any downturn will not have a negative effect on our business, especially if it results in either a decreased
use of our products or in pressure on us to lower our prices.
Because our business is located in
the P.R.C., we may have difficulty establishing adequate management, legal and financial controls, which are required in order
to comply with U.S. securities laws.
P.R.C. companies have historically not
adopted a western style of management and financial reporting concepts and practices, which includes strong corporate governance,
internal controls and, computer, financial and other control systems. Most of our middle and top management staff are not educated
and trained in the Western system, and we may have difficulty in hiring new employees in the P.R.C. with such training. In addition,
we may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the P.R.C. As a result of
these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data
and preparing financial statements, books of account and corporate records and instituting business practices that meet Western
standards. Therefore, we may, in turn, experience difficulties in implementing and maintaining adequate internal controls as required
under Section 404 of the Sarbanes-Oxley Act of 2002. This may result in significant deficiencies or material weaknesses in our
internal controls which could impact the reliability of our financial statements and prevent us from complying with SEC rules
and regulations and the requirements of the Sarbanes-Oxley Act of 2002. Any such deficiencies, weaknesses or lack of compliance
could have a materially adverse effect on our business.
Investors may experience difficulties
in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based upon U.S. laws,
including the federal securities laws or other foreign laws against us or our management.
Most of our current operations, including
the manufacture and distribution of our products, are conducted in China. Moreover, most of our directors and officers are nationals
and residents of China or Hong Kong. All or substantially all of the assets of these persons are located outside the United States
and in the P.R.C. As a result, it may not be possible to effect service of process within the United States or elsewhere outside
China upon these persons. In addition, uncertainties exist as to whether the courts of China would recognize or enforce judgments
of U.S. courts obtained against us or such officers and/or directors predicated upon the civil liability provisions of the securities
laws of the United States or any state thereof, or be competent to hear original actions brought in China against us or such persons
predicated upon the securities laws of the United States or any state thereof.
Contract drafting, interpretation and enforcement in China
involve significant uncertainties.
We have entered into numerous contracts
governed by P.R.C. law, many of which are material to our business. As compared with contracts in the United States, contracts
governed by P.R.C. law tend to contain less detail and are not as comprehensive in defining contracting parties’ rights
and obligations. As a result, contracts in China are more vulnerable to disputes and legal challenges. In addition, contract interpretation
and enforcement in China is not as developed as in the United States, and the result of any contract dispute is subject to significant
uncertainties. Therefore, we cannot assure that we will not be subject to disputes under our material contracts, and if such disputes
arise, we cannot assure that we will prevail.
We could be liable for damages for defects in our products
pursuant to the Tort Liability Law of the P.R.C.
The Tort Liability Law of the People’s
Republic of China, which was passed during the 12th Session of the Standing Committee of the 11th National People’s Congress
on December 26, 2009, states that manufacturers are liable for damages caused by defects in their products and sellers are liable
for damages attributable to their fault. If the defects are caused by the fault of third parties such as the transporter or storekeeper,
manufacturers and sellers are entitled to claim for compensation from these third parties after paying the compensation amount.
RISKS RELATED TO OUR CAPITAL STRUCTURE
The price of our common stock is volatile
and investors might not be able to resell their securities at or above the price they have paid.
Since our initial public offering and
listing of our common stock in October 2007, the price at which our common stock had traded has been highly volatile, with the
lowest and highest sales price of $0.93 and $9.82, respectively. Investors might not be able to resell the shares of our common
stock at or above the price they have paid. The stock market has experienced extreme volatility that often has been unrelated
to the performance of its listed companies. Moreover, only a limited number of our shares are traded each day, which could increase
the volatility of the price of our stock. These market fluctuations might cause our stock price to fall regardless of our performance.
The market price of our common stock might fluctuate significantly in response to many factors, some of which are beyond our control,
including the following:
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Actual or anticipated
fluctuations in our
annual and quarterly
results of operations;
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Changes in securities
analysts’ expectations;
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Variations in
our operating results,
which could cause
us to fail to meet
analysts’ or
investors’
expectations;
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Announcements
by our competitors
or us of significant
new products, contracts,
acquisitions, strategic
partnerships, joint
ventures or capital
commitments;
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Conditions and
trends in our industry;
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General market,
economic, industry
and political conditions;
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Changes in market
values of comparable
companies;
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Additions or
departures of key
personnel;
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Stock market
price and volume
fluctuations attributable
to inconsistent trading
volume levels; and
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Future sales
of equity or debt
securities, including
sales which dilute
existing investors.
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A few principal stockholders have significant influence
over us.
Three of our stockholders beneficially
own or control approximately 47% of our outstanding shares. If these stockholders were to act as a group, they would have a controlling
influence in determining the outcome of any corporate transaction or other matters submitted to our stockholders for approval,
including mergers, consolidations and the sale of all or substantially all of our assets, election of directors, and other significant
corporate actions. Such stockholders may also have the power to prevent or cause a change in control. In addition, without the
consent of these three stockholders, we could be prevented from entering into transactions that could be beneficial to us. The
interests of these three stockholders may differ from the interests of our other stockholders.
Compliance with changing regulation of corporate governance
and public disclosure will result in additional expenses.
Changing laws, regulations and standards
relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 and related SEC regulations,
have created uncertainty for public companies and significantly increased the costs and risks associated with accessing the public
markets and public reporting. For example, on January 30, 2009, the SEC adopted rules requiring companies to provide their
financial statements in interactive data format using the Extensible Business Reporting Language, or XBRL. The Company had
to comply with these rules since June 15, 2011. Our management team has to invest significant management time and financial
resources to comply with both existing and evolving standards for public companies, which will lead to increased general and administrative
expenses and a diversion of management time and attention from revenue generating activities to compliance activities.
If we fail to maintain effective internal
controls over financial reporting, the price of our common stock may be adversely affected.
We are required to establish and maintain
appropriate internal controls over financial reporting. Failure to establish those controls, or any failure of those controls
once established, could adversely impact our public disclosures regarding our business, financial condition or results of operations.
Any failure of these controls could also prevent us from maintaining accurate accounting records and discovering accounting errors
and financial frauds. Rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual assessment
of our internal control over financial reporting. The standards that must be met for management to assess the internal control
over financial reporting as effective are complex, and require significant documentation, testing and possible remediation to
meet the detailed standards. We may encounter problems or delays in completing activities necessary to make an assessment of our
internal control over financial reporting. In addition, the attestation process by our independent registered public accountants
is new and we may encounter problems or delays in completing the implementation of any requested improvements and receiving an
attestation of our assessment by our independent registered public accountants. If we cannot assess our internal control over
financial reporting as effective, or our independent registered public accountants are unable to provide an unqualified attestation
report on such assessment, investor confidence and share value may be negatively impacted.
In addition, management’s assessment
of internal controls over financial reporting may identify weaknesses and conditions that need to be addressed in our internal
controls over financial reporting or other matters that may raise concerns for investors. Any actual or perceived weaknesses and
conditions that need to be addressed in our internal control over financial reporting, disclosure of management’s assessment
of our internal controls over financial reporting, or disclosure of our public accounting firm’s attestation to or report
on management’s assessment of our internal controls over financial reporting may have an adverse impact on the price of
our common stock.
Compliance with changing regulations of corporate governance
and public disclosure will result in additional expenses.
Changing laws, regulations and standards
relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 and related SEC regulations,
have created uncertainty for public companies and significantly increased the costs and risks associated with accessing the public
markets and public reporting. Our management team will need to invest significant management time and financial resources to comply
with both existing and evolving standards for public companies, which will lead to increased general and administrative expenses
and a diversion of management time and attention from revenue generating activities to compliance activities.
We have adopted the Highpower International,
Inc. 2008 Omnibus Incentive Plan (the “Plan”) under which we may grant securities to compensate employees and other
services providers, which could result in increased share-based compensation expenses and, therefore, reduce net income.
Under current accounting rules, we would
be required to recognize share-based compensation as compensation expense in our statement of operations, based on the fair value
of equity awards on the date of the grant, and recognize the compensation expense over the period in which the recipient is required
to provide service in exchange for the equity award. We made grants of equity awards in 2011 and 2012, and accordingly our results
of operations for the years ended December 31, 2012 and 2011 contain share-based compensation charges. If we grant equity compensation
to attract and retain key personnel, the expenses associated with share-based compensation may adversely affect our net income.
However, if we do not grant equity compensation, we may not be able to attract and retain key personnel or be forced to expend
cash or other compensation instead. Furthermore, the issuance of equity awards would dilute the stockholders’ ownership
interests in our company.
Our certificate of incorporation and
bylaws and Delaware law may have anti-takeover effects that could discourage, delay or prevent a change in control, which may
cause our stock price to decline.
Our certificate of incorporation and bylaws
and Delaware law could make it more difficult for a third party to acquire us, even if closing such a transaction would be beneficial
to our stockholders. We are authorized to issue up to 10,000,000 shares of preferred stock. This preferred stock may be issued
in one or more series, the terms of which may be determined at the time of issuance by our board of directors without further
action by stockholders. The terms of any series of preferred stock may include voting rights (including the right to vote as a
series on particular matters), preferences as to dividend, liquidation, conversion and redemption rights and sinking fund provisions.
No preferred stock is currently outstanding. The issuance of any preferred stock could materially adversely affect the rights
of the holders of our common stock, and therefore, reduce the value of our common stock. In particular, specific rights granted
to future holders of preferred stock could be used to restrict our ability to merge with, or sell our assets to, a third party
and thereby preserve control by the present management.
Provisions of our certificate of incorporation
and bylaws and Delaware law also could have the effect of discouraging potential acquisition proposals or making a tender offer
or delaying or preventing a change in control, including changes a stockholder might consider favorable. Such provisions may also
prevent or frustrate attempts by our stockholders to replace or remove our management. In particular, the certificate of incorporation
and bylaws and Delaware law, as applicable, among other things:
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provide the board
of directors with
the ability to alter
the bylaws without
stockholder approval;
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place limitations
on the removal of
directors; and
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provide that
vacancies on the
board of directors
may be filled by
a majority of directors
in office, although
less than a quorum.
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We are also subject to Section 203 of
the Delaware General Corporation Law which, subject to certain exceptions, prohibits “business combinations” between
a publicly-held Delaware corporation and an “interested stockholder,” which is generally defined as a stockholder
who becomes a beneficial owner of 15% or more of a Delaware corporation’s voting stock for a three-year period following
the date that such stockholder became an interested stockholder.
We do not foresee paying cash dividends in the foreseeable
future and, as a result, our investors’ sole source of gain, if any, will depend on capital appreciation, if any.
We do not plan to declare or pay any cash
dividends on our shares of common stock in the foreseeable future and currently intend to retain any future earnings for funding
growth. As a result, Investors should not rely on an investment in our securities if they require the investment to produce dividend
income. Capital appreciation, if any, of our shares may be investors’ sole source of gain for the foreseeable future. Moreover,
investors may not be able to resell their shares in our company at or above the price they paid for them.