HPJ Highpower International Inc

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(Stated in US Dollars)

The consolidated financial statements include the financial statements of Highpower International, Inc. ("Highpower") and its subsidiaries, Hong Kong Highpower Technology Company Limited ("HKHTC"), Shenzhen Highpower Technology Company Limited ("SZ Highpower"), Springpower Technology (Shenzhen) Company Limited ("SZ Springpower"), Ganzhou Highpower Technology Company Limited ("GZ Highpower"), Icon Energy System Company Limited ("ICON") and Huizhou Highpower Technology Company Limited (“HZ HTC”). Highpower and its subsidiaries are collectively referred to as the "Company".

Basis of presentation

The accompanying consolidated balance sheet as of December 31, 2015, which has been derived from audited financial statements, and the unaudited interim consolidated financial statements as of September 30, 2016 and for the three and nine months ended September 30, 2016 and 2015 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and disclosures, which are normally included in financial statements prepared in accordance with United States generally accepted accounting principles (U.S. GAAP), have been condensed or omitted pursuant to such rules and regulations. The interim financial information should be read in conjunction with the Financial Statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015, previously filed with the SEC on March 29, 2016.

In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair presentation of the Company’s consolidated financial position as of September 30, 2016, its consolidated results of operations and cash flows for the nine months ended September 30, 2016 and 2015, as applicable, have been made. The interim results of operations are not necessarily indicative of the operating results for the full fiscal year or any future periods.

HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(Stated in US Dollars)

Reclassification

The Company has reclassified certain comparative balances in the consolidated balance sheet for December 31, 2015 to conform to the current period’s presentation. The reclassification is related to the aggregation of the balance of prepayments and the balance of other receivables into the balance of prepayments and other receivables. The reclassification did not have an impact on the reported total assets, liabilities and stockholders’ equity.

Concentrations of credit risk

No customer accounted for 10% or more of total sales during the three and nine months ended September 30, 2016 and 2015.

No supplier accounted for 10% or more of the total purchase amount during the three and nine months ended September 30, 2016 and 2015.

No customer accounted for 10% or more of the accounts receivable as of September 30, 2016. As of December 31, 2015, there was one major customer accounted for 11.3% of the accounts receivable.

Long-term investment

Investments in equity securities of privately-held companies in which the Company holds less than 20% voting interest are accounted for under the cost method. Investments in equity securities of privately-held companies in which the Company has between 20% and 50% of ownership interest in the voting stock, and to which the Company does not have the ability to exercise significant influence are accounted for under the cost method. Significant influence is generally considered to exist when the Company has between 20% and 50% of ownership interest in the voting stock, but other factors, such as representation on the board of directors, voting rights and the impact of commercial arrangements, are considered in determining whether the equity method of accounting is appropriate.

Entities in which the Company has the ability to exercise significant influence, but does not have a controlling interest, are accounted for under the equity method.

The Company evaluates potential impairment whenever events or changes in circumstances indicate that the carrying amount of the investments may not be recoverable. For investments carried at cost, the Company recognizes impairment in the event that the carrying value of the investment exceeds the Company’s proportionate share of the net book value of the investee. As of September 30, 2016, management believes no impairment charge is necessary.

Foreign currency translation and transactions

Highpower’s functional currency is the United States dollar ("US$"). HKHTC's functional currency is the Hong Kong dollar ("HK$"). The functional currency of the Company’s subsidiaries in the PRC is the Renminbi ("RMB").

Most of the Company’s oversea sales are priced and settled with US$. At the date a foreign currency transaction is recognized, each asset, liability, revenue, expense, gain, or loss arising from the transaction is measured initially in the functional currency of the recording entity by use of the exchange rate in effect at that date. The increase or decrease in expected functional currency cash flows upon settlement of a transaction resulting from a change in exchange rates between the functional currency and the currency in which the transaction is denominated is recognized as foreign currency transaction gain or loss that is included in determining net income for the period in which the exchange rate changes. At each balance sheet date, recorded balances that are denominated in a foreign currency are adjusted to reflect the current exchange rate.

The Company’s reporting currency is US$. Assets and liabilities of HKHTC and the PRC subsidiaries are translated at the current exchange rate at the balance sheet dates, revenues and expenses are translated at the average exchange rates during the reporting periods, and equity accounts are translated at historical rates. Translation adjustments are reported in other comprehensive income.

HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(Stated in US Dollars)

Recently issued accounting pronouncements

In May 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers, or ASU 2014-09. This new standard will replace all current U.S. GAAP guidance on this topic and eliminate all industry-specific guidance. The new revenue recognition standard provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to correlate with the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. In July 2015, the FASB voted to defer the effective date of ASU 2014-09 by one year, while allowing a company to adopt the new revenue standard early but not before the original effective date. This guidance will be effective as to us on January 1, 2018 and can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. In April and May 2016, the FASB issued Accounting Standards Update 2016-10, Revenue from Contracts with Customers, or ASU 2016-10, and Accounting Standards Update 2016-12, Revenue from Contracts with Customers, or ASU 2016-12, respectively. These new standards will identify performance obligations and narrow aspects on achieving core principle. The Company is currently evaluating the impact of adopting these ASUs on our consolidated financial statements.

On February 25, 2016, the FASB issued Accounting Standards Update (ASU) 2016-02, Leases (Topic 842). It requires that a lessee recognize the assets and liabilities that arise from operating leases. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (i.e., January 1, 2019, for a calendar year entity). Early application is permitted for all public business entities and all nonpublic business entities upon issuance. The Company is currently evaluating the impact of adopting ASU 2016-02 on our consolidated financial statements.

In March 2016, the FASB issued Accounting Standards Update (ASU) 2016-07, Investments-Equity Method and Joint Venture (Topic 323). The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. It is effective for all entities for the fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Earlier application is permitted. The Company did not earlier adopt ASU 2016-07 on our consolidated financial statement.

In August 2016, the FASB issued Accounting Standards Update (ASU) 2016-15, Statement of Cash Flows (Topic 230). The amendments in this Update provide guidance on eight specific cash flow issue. It applies to all entities. For public business entities, the amendments in this Update are effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods. Early adoption is permitted for any entity in any interim or annual period. The Company is currently evaluating the impact of adopting ASU 2016-09 on our consolidated financial statements.

In October 2016, the FASB issued Accounting Standards Update (ASU) 2016-16, Income Taxes (Topic 740). The amendments in this Update is to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory and align the recognition of income tax consequences for intra-entity transfers of assets other than inventory with International Financial Reporting Standards (IFRS). Public business entities should apply the amendments in ASU 2016-16 for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted for any entity in any interim or annual period. The Company is currently evaluating the impact of adopting ASU 2016-16 on our consolidated financial statements.

We do not believe other recently issued but not yet effective accounting standards, if currently adopted, would have a material effect on the consolidated financial position, statements of operations and cash flows.

HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(Stated in US Dollars)

As of September 30, 2016 and December 31, 2015, accounts receivable consisted of the following:

The Company recorded depreciation expenses of $3,629,817 and $3,928,655 for the nine months ended September 30, 2016 and 2015, respectively, and $1,214,256 and $1,466,647 for the three months ended September 30, 2016 and 2015, respectively.

During the nine months ended September 30, 2016, the Company deducted deferred income related to government grants of $33,019 on the carrying amount of property, plant and equipment. During the year ended December 31, 2015, the Company deducted deferred income related to government grants of $2,547,545 on the carrying amount of property, plant and equipment.

HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(Stated in US Dollars)

The real estate properties and buildings in Huizhou and Ganzhou have been pledged as collateral for short-term loans and bank acceptance bills drawn under certain lines of credit as of September 30, 2016 and December 31, 2015. The real estate properties and buildings in Shenzhen have been pledged as collateral for short-term loans and bank acceptance bills drawn under certain lines of credit as of September 30, 2016.

On April 1, 2016, the Company entered into an investment agreement with Huizhou Yipeng Energy Technology Co. Ltd. ("Yipeng"), whereby the Company acquired 5% equity interest of Yipeng for RMB5,000,000 ($748,750). On June 30, 2016, the Company entered into an Agreement for Equity Transfer and Capital Increase and Supplementary Agreements with Yipeng and the shareholders (collectively, the “Equity Purchase Agreement”).

Pursuant to the terms of the Equity Purchase Agreement, the Company will purchase up to 50% of Yipeng’s equity on two dates: (1) on August 10, 2016, in addition to the existing 5% shares of Yipeng, the Company agreed to pay approximately $2.2 million in cash and transfer equipment worth approximately $6.8 million in exchange for the purchase of 30.4% of the shares of Yipeng, and (2) prior to November 5, 2016, provided that Yipeng has been approved to be listed in the catalogue of Industrial Standards of Auto Mobile Power Battery Cell (the “Catalogue”) prior to October 31, 2016, the Company will pay approximately $3.0 million in cash and transfer equipment worth approximately $5.2 million in exchange for an additional 14.6% of the shares of Yipeng. The Company also has the right to purchase in the future an additional 1% of the shares from Yipeng’s founding shareholders at a price of approximately $0.4 million which would result in an aggregate ownership of 51% of Yipeng.

On August 10, 2016, the Company consummated the first closing pursuant to the terms of the Equity Purchase Agreement. As of September 30, 2016, the Company has invested an aggregate of $9.7 million in exchange for 35.4% of the equity interest of Yipeng, which was recorded under equity method.

Yipeng failed to be listed in the Catalogue prior to October 31, 2016 because the PRC government did not assess any new xEV cell and system manufacturers as originally expected in September. As a result, the Company postponed the second capital injection until Yipeng is listed in the Catalogue.

The equity in earnings of investee was $218,903 for the nine and three months ended September 30, 2016. No impairment was recorded for the long-term investment as of September 30, 2016.

The Company and its subsidiaries file tax returns separately.

1) VAT

Pursuant to the Provisional Regulation of the PRC on VAT and the related implementing rules, all entities and individuals ("taxpayers") that are engaged in the sale of products in the PRC are generally required to pay VAT at a rate of 17% of the gross sales proceeds received, less any deductible VAT already paid or borne by the taxpayers. Further, when exporting goods, the exporter is entitled to a portion of or all the refund of VAT that it has already paid or incurred. The Company’s PRC subsidiaries are subject to VAT at 17% of their revenues.

HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(Stated in US Dollars)

2) Income tax

United States

Highpower was incorporated in Delaware and is subject to U.S. federal income tax with a system of graduated tax rates ranging from 15% to 35%. As Highpower does not conduct any business in the U.S., it is not subject to U.S. federal income tax or Delaware franchise tax. No deferred U.S. taxes are recorded since all accumulated profits in the PRC will be permanently reinvested in the PRC.

Hong Kong

HKHTC, which is incorporated in Hong Kong, is subject to a corporate income tax rate of 16.5%.

PRC

In accordance with the relevant tax laws and regulations of the PRC, a company registered in the PRC is subject to income taxes within the PRC at the applicable tax rate on taxable income.

In China, the companies granted with National High-tech Enterprise (“NHTE”) status enjoy 15% income tax rate. This status needs to be renewed every three years. If these subsidiaries fail to renew NHTE status, they will be subject to income tax at a rate of 25% after the expiration of NHTE status.

All the PRC subsidiaries received NHTE status and enjoy 15% income tax rate for calendar year 2016 and 2015.

HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(Stated in US Dollars)

The components of the provision for income taxes expenses are:

The reconciliation of income tax expense computed at the statutory tax rate applicable to the Company to income tax expense is as follows:

HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(Stated in US Dollars)

3) Deferred tax assets

Deferred tax assets and deferred tax liabilities reflect the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purpose and the tax bases used for income tax purpose. The following represents the tax effect of each major type of temporary difference.

The deferred tax assets arising from net operating losses will expire from 2018 through 2021 if not utilized.

Valuation allowance was provided against deferred tax assets in entities where it was determined it was more likely than not that the benefits of the deferred tax assets will not be realized. The Company had deferred tax assets which consisted of tax loss carry-forwards and others, which can be carried forward to offset future taxable income. The management determines it is more likely than not that part of deferred tax assets could not be utilized, so allowance was provided as of September 30, 2016 and December 31, 2015.

Notes payable presented to certain suppliers as a payment against the outstanding trade payables.

Notes payable are mainly bank acceptance bills which are non-interest bearing and generally mature within six months. The outstanding bank acceptance bills are secured by restricted cash deposited in banks. Outstanding bank acceptance bills were $32,048,210 and $30,379,170 as of September 30, 2016 and December 31, 2015, respectively.

As of September 30, 2016 and December 31, 2015, the outstanding trade acceptances to suppliers were $nil and $110,996, respectively. These trade acceptances were non-interest bearing and mature within one year. No security deposit is needed.

HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(Stated in US Dollars)

As of September 30, 2016 and December 31, 2015, the bank borrowings were for working capital and capital expenditure purposes and were secured by personal guarantees executed by certain directors of the Company, land use right with a carrying amount of $3,792,334 and $3,963,003, and the buildings with carrying amount of $12,419,117 and $12,419,622, respectively.

The loans as of September 30, 2016 and December 31, 2015 were primarily obtained from four banks with interest rates both ranging from 4.35% to 6.06% per annum, respectively. The interest expenses were $631,211 and $620,070 for the nine months ended September 30, 2016 and 2015, respectively. The interest expenses were $209,931 and $200,914 for the three months ended September 30, 2016 and 2015, respectively.

In April and May, 2016, the Company obtained borrowings from a third party non-financial institution and an individual, which were used for working capital and capital expenditure purposes. The borrowings are personally guaranteed by the Company’s Chief Executive Officer, Mr. Dang Yu Pan.

The interest rate for both borrowings is 5.66% per annum, and would be repaid anytime no later than August 31, 2017. The interest expenses were $99,832 and $66,927 for the nine and three months ended September 30, 2016, respectively.

The following table sets forth the computation of basic and diluted earnings per common share for the nine and three months ended September 30, 2016 and 2015.

HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(Stated in US Dollars)

Full-time employees of the Company in the PRC participate in a government mandated defined contribution plan, pursuant to which certain pension benefits, medical care, employee housing fund and other welfare benefits are provided to employees. Chinese labor regulations require that the PRC operating subsidiaries of the Company make contributions to the government for these benefits based on certain percentages of the employees’ salaries. Except for contributions mentioned above, the Company has no legal obligation for the benefits beyond the contributions made.

The total contributions made, which were expensed as incurred, were $1,203,584 and $1,350,972 for the nine months ended September 30, 2016 and 2015, respectively, and $448,921 and $524,083 for the three months ended September 30, 2016 and 2015, respectively.

Investment commitment

On June 30, 2016, the Company entered into the Equity Purchase Agreement with Yipeng and the shareholders. Up to the date of issuance of this condensed consolidated financial statements, the Company postponed the second closing as a result of the unfulfilled contract conditions (see Note 6).

Contingencies

On January 14, 2016, FirsTrust China, Ltd filed an amended complaint in the Delaware Chancery Court (amending its initial complaint filed February 25, 2015) naming Highpower as the defendant asserting a cause of action for breach of contract and conversion of stock, and seeking damages in the form of issuance of 150,000 shares or the value of such shares, plus interest thereon, attorneys’ fees and costs and expenses. On February 4, 2016, Highpower filed an answer, affirmative defenses and counterclaim against FirsTrust asserting claims for equitable rescission, declaratory relief and breach of contract, and seeking rescission of the contract, return of the 200,000 warrants and 150,000 shares of Highpower stock previously issued to FirsTrust, plus interest, attorneys’ fees and costs and expenses. Highpower has also added as counter-defendants four individuals to whom it issued shares pursuant to FirsTrust’s request. In April 2016, FirsTrust filed a motion for judgment on the pleadings with respect to its complaint and a hearing date is scheduled for January 2017. FirsTrust has also filed a notice of a motion to dismiss Highpower’s counterclaim. The Company believes that it has meritorious defenses to this claim and intends to defend the claim vigorously.

HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(Stated in US Dollars)

The reportable segments are components of the Company that offer different products and are separately managed, with separate financial information available that is separately evaluated regularly by the Company’s chief operating decision maker (“CODM”), the Chief Executive Officer, in determining the performance of the business. The Company categorizes its business into three reportable segments, namely (i) Lithium Batteries; (ii) Ni-MH Batteries; and (iii) New Materials.

The CODM evaluates performance based on each reporting segment’s net sales, cost of sales, gross profit and total assets. Net sales, cost of sales, gross profit and total assets by segments were set out as follows:

HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(Stated in US Dollars)

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

Related party balance

The outstanding amounts of Yipeng were as follow:

HIGHPOWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(Stated in US Dollars)

Related party transaction

The details of the related party transactions were as follows:

The Company has evaluated subsequent events through the issuance of the condensed consolidated financial statements and no subsequent event is identified.

Item2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion relates to the financial condition and results of operations of Highpower International, Inc. (the “Company”) and its wholly-owned subsidiary, Hong Kong Highpower Technology Company Limited (“HKHTC”), HKHTC’s wholly-owned subsidiaries Shenzhen Highpower Technology Company Limited (“SZ Highpower”) and Icon Energy System Company Limited (“ICON”); SZ Highpower’s wholly-owned subsidiary, Huizhou Highpower Technology Company Limited (“HZ HTC”) and its 70%-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”).

Forward-Looking Statements

This management’s discussion and analysis of financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and the related notes that are included in this Quarterly Report and the audited consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended December 31, 2015 filed with SEC on March 29, 2016 (the “Annual Report”).

This report contains forward-looking statements that involve substantial risks and uncertainties. All statements other than historical facts contained in this report, including statements regarding our future financial position, results of operations, cash flows, business strategy and plans and objectives of management for future operations, are forward-looking statements. The words “anticipates,” “believes,” “expects,” “plans,” “intends,” “seeks,” “estimates,” “projects,” “predicts,” “could,” “should,” “would,” “will,” “may,” “might,” and similar expressions, or the negative of such expressions, are intended to identify forward-looking statements. Such statements reflect management’s current views with respect to future events and financial performance and involve risks and uncertainties, including, without limitation, economic downturn and uncertainty in Asia and Europe adversely affecting demand for our products; fluctuations in the cost of raw materials; our dependence on, or inability to attract additional, major customers for a significant portion of our net sales; our ability to increase manufacturing capabilities to satisfy orders from new customers; our ability to maintain increased margins; changes in the laws of the PRC that affect our operations; the devaluation of the U.S. Dollar relative to the Renminbi; our dependence on the growth in demand for portable electronic devices and the success of manufacturers of the end applications that use our battery products; our responsiveness to competitive market conditions; our ability to successfully manufacture our products in the time frame and amounts expected; the market acceptance of our battery products, including our lithium products; our ability to successfully develop products for and penetrate the electric transportation market; our ability to continue R&D development to keep up with technological changes; our exposure to product liability, safety, and defect claims; rising labor costs, volatile metal prices, and inflation; changes in foreign, political, social, business and economic conditions that affect our production capabilities or demand for our products; and various other matters, many of which are beyond our control. Actual results may vary materially and adversely from those anticipated, believed, estimated or otherwise indicated should one or more of these risks or uncertainties occur or if any of the risks or uncertainties described elsewhere in this report or in the “Risk Factors” section of our Annual Report occur. Consequently, all of the forward-looking statements made in this filing are qualified by these cautionary statements and there can be no assurance of the actual results or developments.

Overview

Highpower was incorporated in the state of Delaware on January 3, 2006 and was originally organized as a “blank check” shell company to investigate and acquire a target company or business seeking the perceived advantages of being a publicly held corporation. On November 2, 2007, we closed a share exchange transaction, pursuant to which we (i) became the 100% parent of HKHTC and its wholly-owned subsidiary, SZ Highpower, (ii) assumed the operations of HKHTC and its subsidiary and (iii) changed our name to Hong Kong Highpower Technology, Inc. We subsequently changed our name to Highpower International, Inc. in October 2010.

HKHTC was incorporated in Hong Kong in 2003 under the Companies Ordinance of Hong Kong. HKHTC formed HZ Highpower and SZ Springpower in 2008.HZ Highpower was dissolved in 2015. On October 8, 2013, SZ Springpower further increased its registered capital to $15,000,000. SZ Highpower holds 69.97% of the equity interest of SZ Springpower, and HKHTC holds the remaining 30.03%. In February 2011, HKHTC formed another wholly-owned subsidiary, Icon Energy System Company Limited, a company organized under the laws of the PRC, which commenced operations in July 2011.

On May 15, 2013, GZ Highpower increased its paid-in capital from RMB15,000,000 ($2,381,293) to RMB30,000,000 ($4,807,847). On November 13, 2014, GZ Highpower increased its paid-in capital from RMB30,000,000 ($4,898,119) to RMB40,000,000 ($6,530,825) and the additional capital of RMB10,000,000 was contributed by SZ Highpower. As of September 30, 2016, SZ Highpower holds 70% of the equity interest of GZ Highpower, and four individuals hold the remaining 30%.

Through SZ Highpower, we manufacture Nickel Metal Hydride (“Ni-MH”) batteries for both consumer and industrial applications. We have developed significant expertise in Ni-MH battery technology and large-scale manufacturing that enables us to improve the quality of our battery products, reduce costs, and keep pace with evolving industry standards. In 2008, we commenced manufacturing two lines of Lithium-Ion (“Li-ion”) and Lithium polymer rechargeable batteries through SZ Springpower for higher-end, high-performance applications, such as laptops, digital cameras and wireless communication products. In March 2012, SZ Highpower formed a wholly-owned subsidiary HZ HTC. In March 2015, HZ HTC increased its paid-in capital to RMB60,000,000 ($9,496,526). Through HZ HTC, we manufacture Lithium batteries that consist of xEV batteries, polymer rechargeable batteries and cylindrical batteries. 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.

On August 30, 2016, HKHTC entered into a non-binding Cooperation Framework Agreement (the “Framework Agreement”) with Anshan Co-operation (Group) Co., Ltd. (“ACOC”) under which ACOC proposed to purchase newly issued shares of SZ Highpower, SZ Springpower and ICON for RMB540 million (approximately $81.0 million), which would be paid directly to the subsidiaries. As a result of its purchase, ACOC would hold more than 50% in each PRC subsidiary. The Framework Agreement includes a 90 day exclusivity provision and supersedes the non-binding proposal from ACOC received by the Company on November 27, 2015. In 2015, after receiving the original non-binding proposal, the Company's Board of Directors formed a special committee consisting of the following independent directors to consider the proposed transaction: Ping Li, who serves as chairman, Xinhai Li and T. Joseph Fisher, III. The special committee retained independent legal and financial advisors to assist it in the process. The special committee is continuing to review the proposed transaction.

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

Critical Accounting Policies

See note 2 to the accompanying unaudited condensed consolidated financial statements for our critical accounting policies.

Results of Operations

The following table sets forth the unaudited consolidated statements of operations of the Company for the three and nine months ended September 30, 2016 and 2015, both in dollars and as a percentage of net sales.

Three months ended September 30, 2016 and 2015

Net sales

We generate revenues from the sale of our Lithium batteries, Ni-MH batteries and new materials for three months ended September 30, 2016 and 2015. Revenues by segment were as follows (in thousands):

Net sales for the three months ended September 30, 2016 were $54.1 million compared to $37.6 million for the three months ended September 30, 2015, an increase of $16.5 million, or 44.2%. The increase was mainly due to a $17.6 million increase in net sales of our Lithium batteries (resulting from a 129.4% increase in the volume, measured in ampere hour, of batteries sold and a 11.3% decrease in the average selling price of such batteries).

Cost of sales

Cost of sales mainly consists of nickel, cobalt, lithium derived materials, labor, and overhead. Costs of sales were $40.5 million for the three months ended September 30, 2016, as compared to $30.3 million for the comparable period in 2015. The increase was mainly due to the increase in net sales of our Lithium batteries.

Gross profit

Gross profit for the three months ended September 30, 2016 was $13.7 million, or 25.2% of net sales, compared to $7.2 million, or 19.2% of net sales for the comparable period in 2015. Management considers gross profit margin a key performance indicator in managing our business. Gross profit margins are usually a factor of cost of sales, product mix and demand for product. This increase was attributed to the increase in volume of sales of our Lithium batteries, the reduction in the material purchase cost for the Lithium and Ni-MH Batteries, and improvement in our labor efficiency.

To cope with pressure on our gross margins we control production costs by preparing budgets for each department and comparing actual costs with our budgeted figures monthly and quarterly. Additionally, we have reorganized the Company’s production structure and have focused more attention on employee training to enhance efficiency.

Research and development

Research and development expenses were $3.0 million, or 5.6% of net sales, for the three months ended September 30, 2016, as compared to $2.0 million, or 5.2% of net sales for the comparable period in 2015. This increase was primarily due to the increase of technology input on Lithium batteries.

Selling and distribution expenses

Selling and distribution expenses were $1.9 million, or 3.5% of net sales, for the three months ended September 30, 2016 compared to $1.7 million, or 4.6% of net sales, for the comparable period in 2015.

General and administrative expenses

General and administrative expenses were $5.9 million, or 11.0% of net sales, for the three months ended September 30, 2016, compared to $3.3 million, or 8.8% of net sales, for the comparable period in 2015. This increase was primarily due to a one-time expense of $1.7 from the allowance for doubtful accounts.

Foreign currency transaction gain

We experienced a gain of $0.1 million for the three months ended September 30, 2016 and a gain of $1.5 million for the three months ended September 30, 2015 on the exchange rate difference between the U.S. Dollar and the RMB. The gain in exchange rate difference was due to the influence of the RMB relative to the U.S. Dollar over the respective periods.

Interest expenses

Interest expenses were $0.3 million for the three months ended September 30, 2016, as compared to $0.2 million for the comparable period in 2015. The increase was mainly due to the increase of non-financial borrowings.

Other income

Other income, which consists of bank interest income, government grants and sundry income, was approximately $0.5 million for the three months ended September 30, 2016, as compared to approximately $0.2 million for the comparable period in 2015, an increase of $0.3 million. The increase was mainly due to the increase of income from government subsidies.

Investment income

Investment income, which represents a gain from a related party (Yipeng), was approximately $0.2 million for the three months ended September 30, 2016.

Change in fair value change of warrant liabilities

Change in fair value change of warrant liabilities was a loss of $11,150 for the three months ended September 30, 2016, as compared to a gain of $0.5 million, for the comparable period in 2015. It represented the fair value change of 500,000 shares of warrants issued on April 17, 2014.

Income tax expense

During the three months ended September 30, 2016, we recorded provision for income tax expense of $0.8 million as compared to income tax expense of $0.3 million for the comparable period in 2015.

Net income

Net income attributable to the Company (excluding net loss attributable to non-controlling interest) for the three months ended September 30, 2016 was $2.7, compared to net income attributable to the Company (excluding net loss attributable to non-controlling interest) of $1.9 million for the comparable period in 2015.

Nine months Ended September 30, 2016 and 2015

Net sales

We generate revenues from the sale of our Lithium batteries, Ni-MH batteries and new materials. Revenues by segment were as follows (in thousands):

Net sales for the nine months ended September 30, 2016 were $120.0 million compared to $108.3 million for the nine months ended September 30, 2015, an increase of $11.7 million, or 10.7%. The increase was due to a $17.7 million increase in net sales of our Lithium batteries (resulting from a 62.0% increase in the volume and a18.7% decrease in the average selling price of such batteries).

Cost of sales

Cost of sales mainly consists of nickel, cobalt, lithium derived materials, labor, and overhead. Costs of sales were $92.8 million for the nine months ended September 30, 2016, as compared to $87.0 million for the comparable period in 2015. The increase was due to the increase in net sales of our Lithium batteries.

Gross profit

Gross profit for the nine months ended September 30, 2016 was $27.2 million, or 22.7% of net sales, compared to $21.3 million, or 19.7% of net sales for the comparable period in 2015. Management considers gross profit margin a key performance indicator in managing our business. Gross profit margins are usually a factor of cost of sales, product mix and demand for product. This increase was attributed to an increase in sales volume of our Lithium batteries, the reduction in the material purchase cost for the Lithium and Ni-MH Batteries, and improvement in our labor efficiency.

To cope with pressure on our gross margins we control production costs by preparing budgets for each department and comparing actual costs with our budgeted figures monthly and quarterly. Additionally, we have reorganized the Company’s production structure and have focused more attention on employee training to enhance efficiency.

Research and development

Research and development expenses were approximately $6.7 million, or 5.6% of net sales, for the nine months ended September 30, 2016 as compared to approximately $5.6 million, or 5.2% of net sales, for the comparable period in 2015. This increase was primarily due to the increase of technology input on Lithium batteries.

Selling and distribution expenses

Selling and distribution expenses were $5.0 million, or 4.1% of net sales, for the nine months ended September 30, 2016 compared to $5.1 million, or 4.7% of net sales, for the comparable period in 2015.

General and administrative expenses

General and administrative expenses were $12.3 million, or 10.2% of net sales, for the nine months ended September 30, 2016, compared to $9.7 million, or 9.0% of net sales, for the comparable period in 2015. This increase was primarily due to a one-time expense of $1.7 million from the allowance for doubtful accounts.

Foreign currency transaction gain

We experienced a gain of $0.6 million for the nine months ended September 30, 2016 and a gain of $1.9 million for the nine months ended September 30, 2015 on the exchange rate difference between the U.S. Dollar and the RMB. The gain in exchange rate difference was due to the depreciation of the RMB relative to the U.S. Dollar over the respective periods.

Interest expenses

Interest expenses were $1.1 million for the nine months ended September 30, 2016, as compared to $0.8 million for the comparable period in 2015. The increase in interest expense was due to an increase in borrowing.

Other income

Other income, which consists of bank interest income, government grants and sundry income, was approximately $1.7 million for the nine months ended September 30, 2016, as compared to approximately $0.7 million for the comparable period in 2015. The increase was mainly due to an increase of $1.1 million income from government subsidiary.

Investment income

Investment income, which represents a gain from a related party (Yipeng), was approximately $0.2 million for the nine months ended September 30, 2016.

Gain on fair value change of warrant liabilities

Gain on fair value change of warrant liabilities was $0.1 million for the nine months ended September 30, 2016, as compared to $0.9 million for the nine months ended September 30, 2015. It represented the fair value change of 500,000 shares of warrants issued on April 17, 2014.

Income tax expense

During the nine months ended September 30, 2016, we recorded provision for income tax expense of $1.0 million as compared to income tax expense of $0.2 million for the comparable period in 2015.

Net income

Net income attributable to the Company (excluding net loss attributable to non-controlling interest) for the nine months ended September 30, 2016 was $4.4 million, compared to net income attributable to the Company (excluding net loss attributable to non-controlling interest) of $3.7 million for the comparable period in 2015.

Foreign Currency and Exchange Risk

Though the reporting currency is the U.S. Dollar, the Company maintains its financial records in the functional currency of Renminbi (“RMB”). Substantially all of our operations are conducted in the PRC and we pay the majority of our expenses in RMB. Approximately 43.0% of our sales are made in U.S. Dollars. During the nine months ended September 30, 2016, the exchange rate of the RMB to the U.S. Dollar devaluated 2.7% from the level at the end of December 31, 2015. Appreciation of the RMB against the U.S. Dollar would increase our costs when translated into U.S. Dollars and could adversely affect our margins unless we make sufficient offsetting sales. Exchange rate fluctuations may also affect the value, in U.S. Dollar terms, of our net assets. In addition, the RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. Due to the volatility of the US Dollar to our functional currency the Company put into place a hedging program to attempt to protect it from significant changes to the US Dollar which affects the value of its US dollar receivables and sales.

Liquidity and Capital Resources

We had cash of approximately $13.5 million as of September 30, 2016, as compared to $5.8 million as of December 31, 2015. Our funds are kept in financial institutions located in the PRC, which do not provide insurance for amounts on deposit. Moreover, we are subject to the regulations of the PRC which restrict the transfer of cash from the PRC, except under certain specific circumstances. Accordingly, such funds may not be readily available to us to satisfy obligations incurred outside the PRC.

To provide liquidity and flexibility in funding our operations, we borrowed funds under bank facilities and other external sources of financing. As of September 30, 2016, we had lines of credit with 6 financial institutions aggregating $57.9 million. The maturity of these facilities is generally from one year to three years. The facilities are subject to regular review and approval. Certain of these banking facilities are guaranteed by our Chief Executive Officer, Mr. Dang Yu Pan, pledged by land use right and buildings, and contain customary affirmative and negative covenants for secured credit facilities of this type. Interest rates are generally based on the banks’ reference lending rates. No significant commitment fees are required to be paid for the banking facilities. As of September 30, 2016, we had utilized approximately $40.0 million under such general credit facilities and had available unused credit facilities of $17.9 million.

For the nine months ended September 30, 2016, net cash provided by operating activities was approximately $7.2 million, as compared to $6.1 million used in operating activities for the comparable period in 2015. The net cash increase of $13.3 million provided by operating activities is primarily attributable to, among other items, an increase of $18.0 million in cash inflow from accounts payable, an increase of $8.9 million in outflow from accounts receivable and an increase of $2.8 million in inflow from other payables.

Net cash used in investing activities was $11.5 million for the nine months ended September 30, 2016 compared to $7.3 million for the comparable period in 2015. The net increase of $4.2 million of cash used in investing activities was attributable to an increase of $3.0 million in cash outflow from payment for long-term investment and an increase of $1.1 million in cash outflow from acquisition of plant and equipment.

Net cash provided by financing activities was $13.3 million during the nine months ended September 30, 2016, as compared to $7.2 million provided by financing activities for the comparable period in 2015. The net increase of $6.1 million in net cash provided by financing activities was primarily attributable to an increase of $6.9 million in proceeds from short-term bank loans and an increase of $4.6 million in proceeds from non-financial institution borrowing, a decrease of $7.4 million in proceeds from notes payable, a decrease of $4.1 million in repayment of notes payable, and a decrease of $1.9 million in change in restricted cash.

For the nine months ended September 30, 2016 and 2015, our inventory turnover was 6.1 times and 5.2 times, respectively. The average days outstanding of our accounts receivable at September 30, 2016 was 94 days, as compared to 85 days at September 30, 2015. Inventory turnover and average days outstanding of accounts receivable are key operating measures that management relies on to monitor our business.

In the next 12 months, we expect to expand our research, development and manufacturing capacity of lithium-based batteries and we anticipate additional capital expenditures. Currently our lithium batteries production capacity has been almost full, which limited our ambition to meet increasing demand from lithium market. Considering the current debt ratio, it is not easy to get sufficient debt loan to support our production capacity expansion blueprint. That’s the main reason that we are now focus on equity financing to support the company long term development.

The use of working capital is primarily for the maintenance of our accounts receivable and inventory. We provide our major customers with payment terms ranging from 30 to 90 days. Additionally, our production lead time is approximately 30 to 40 days, from the inspection of incoming materials, to production, testing and packaging. We need to keep a large supply of raw materials, work-in-process and finished goods inventory on hand to ensure timely delivery of our products to customers. We use two methods to support our working capital needs: (i) paying our suppliers under payment terms ranging from 60 to 120 days; and (ii) using short-term bank loans. Upon receiving payment for our accounts receivable, we pay our short-term loans. Our working capital management practices are designed to ensure that we maintain sufficient working capital.

Recent Accounting Pronouncements

Please refer to Note 2 (Recently issued accounting pronouncements).