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EX-31.2 - EXHIBIT 31.2 - Deerfield Resources, Ltd.exhibit31-2.htm
EX-31.1 - EXHIBIT 31.1 - Deerfield Resources, Ltd.exhibit31-1.htm
EX-32.1 - EXHIBIT 32.1 - Deerfield Resources, Ltd.exhibit32-1.htm
EX-32.2 - EXHIBIT 32.2 - Deerfield Resources, Ltd.exhibit32-2.htm

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

FORM 10−Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: March 31, 2011

[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to _____________

Commission File Number: 333-139660

CHINA TMK BATTERY SYSTEMS INC.
(Exact Name of Registrant as Specified in Its Charter)

Nevada 98-0506246
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)  

Sanjun Industrial Park
No. 2 Huawang Rd., Dalang Street
Bao'an District, Shenzhen 518109
People’s Republic of China
(Address of principal executive offices, Zip Code)

(+86) 755 28109908
(Registrant’s telephone number, including area code)

_____________________________________________________
(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [_] No [_]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [_] Accelerated filer [_]
Non-accelerated filer [_] (Do not check if a smaller reporting company) Smaller reporting company [X]

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

The number of shares outstanding of each of the issuer’s classes of common stock, as of May 12, 2011 is as follows:

Class of Securities Shares Outstanding
Common Stock, $0.001 par value 36,888,000



China TMK Battery Systems Inc.
Quarterly Report on Form 10-Q
Three Months Ended March 31, 2011

TABLE OF CONTENTS

PART I   1
FINANCIAL INFORMATION 1
ITEM 1. FINANCIAL STATEMENTS. 1
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 23
ITEM 4. CONTROLS AND PROCEDURES. 23
PART II   23
OTHER INFORMATION 24
ITEM 1. LEGAL PROCEEDINGS. 24
ITEM 1A. RISK FACTORS. 24
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. 24
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. 24
ITEM 4. (REMOVED AND RESERVED). 24
ITEM 5. OTHER INFORMATION. 24
ITEM 6. EXHIBITS. 24


PART I
FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

CHINA TMK BATTERY SYSTEMS INC.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010

  Page(s)
Financial Statements  

Consolidated Balance Sheets (Unaudited)

2

Consolidated Statements of Operations and Other Comprehensive Income (Unaudited)

4

Consolidated Statement of Changes in Shareholders’ Equity (Unaudited)

5

Consolidated Statements of Cash Flows (Unaudited)

6

Notes to Consolidated Financial Statements (Unaudited)

8– 16

- 1 -



China TMK Battery System Inc.
Consolidated Balance Sheets
(Stated in US dollars)

    March 31, 2011     December 31, 2010  
    (Unaudited)        
             

ASSETS

           

Current assets

           

Cash and cash equivalents

$  658,598   $  356,871  

Short-term investment

  -     1,512,400  

Trade receivables, net

  13,861,533     12,351,588  

VAT recoverable

  376,285     276,768  

Inventories, net

  6,262,645     4,973,989  

Due from related parties

  -     2,269  

Prepaid expenses and other receivables

  298,200     45,372  

Advances to suppliers

  561,056     528,509  

Restricted cash

  365,280     1,270,416  

Deposit for business acquisition

  10,325,084     9,397,891  

Total Current Assets

  32,708,681     30,716,073  
             

Property, equipment and construction in progress, net

17,120,157 17,239,438

Advances for property and equipment purchase

  13,937,119     13,849,212  

Other assets

  46,682     46,516  
             

TOTAL ASSETS

$  63,812,639   $  61,851,239  

LIABILITIES & SHAREHOLDERS’ EQUITY

           
Current Liabilities            

Accounts payable

$  4,278,295   $  4,437,186  

Accrued liabilities and other payable

  1,181,487     576,164  

Customer deposits

  688,864     493,256  

Wages payable

  355,282     398,699  

Corporate tax payable

  658,894     210,717  

Short-term loan

  1,369,800     2,571,080  

Current portion of long-term bank loans

  7,032,069     5,159,422  

Property purchase payable

  502,511     499,342  

Derivative liability

  717,875     1,141,118  

Due to related parties

  15,987     19,695  

Registration rights liability

  411,450     411,450  

Total Current Liabilities

  17,212,514     15,918,129  
             

Long-term bank loans

  10,306,682     12,710,430  

Deferred tax liability

  598,374     598,520  

Due to related parties

  1,474,719     1,465,420  

2



TOTAL LIABILITIES

$  29,592,289   $  30,692,499  
             

SHAREHOLDERS’ EQUITY

           

Preferred stock, $0.001 par value, 10,000,000 shares authorized, none issued and outstanding at March 31, 2011 and December 31, 2010

$ - $ -

Common stock, $0.001 par value, 300,000,000 shares authorized, 36,888,000 shares issued and outstanding at March 31, 2011 and December 31, 2010

36,888 36,888

Common stock subscribed

  -     253  

Additional paid-in capital

  10,518,662     11,024,449  

Accumulated other comprehensive income

  1,388,873     1,207,195  

Statutory reserves

  1,038,988     1,038,988  

Retained earnings (unrestricted)

  21,236,939     17,850,967  

TOTAL SHAREHOLDERS’ EQUITY

  34,220,350     31,158,740  
             

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

$ 63,812,639 $ 61,851,239

The accompanying notes are an integrated part of these unaudited consolidated financial statements

- 3-



China TMK Battery System Inc.
Consolidated Statements of Operations and Other Comprehensive Income
(Unaudited)
(Stated in US dollars)

    For the three months ended March 31,  
    2011     2010  
             
Sales revenue $  20,292,808   $  13,264,472  

Cost of goods sold

  (15,426,800 )   (10,105,697 )
Gross profit   4,866,008     3,158,775  
Operating costs and expenses            

Selling expenses

  371,988     234,718  

Depreciation

  60,719     17,505  

Other general and administrative expenses

  417,714     1,822,979  

Research and development

  180,686     165,244  
Total operating costs and expenses   1,031,107     2,240,446  
Income from operations   3,834,901     918,329  

Interest income

  43     -  

Interest expense

  (294,964 )   (241,907 )

Change in fair value of derivative liability

  423,243     (1,725,233 )

Other expense, net

  (4,689 )   (60,381 )
Total other income (expenses)   123,633     (2,027,521 )
 Income (loss) before income taxes   3,958,534     (1,109,192 )
Income taxes   (572,562 )   (358,175 )
             
Net income (loss) $  3,385,972   $  (1,467,367 )
             
Other comprehensive income            

Foreign currency translation adjustments

  181,678     32,218  
Total Comprehensive income (loss) $  3,567,650   $  (1,435,149 )
             
Earnings (loss) per share - basic $  0.09   $  (0.05 )
             
Weighted-average shares outstanding, basic    36,888,000      30,206,111  
             
Earnings (loss) per share - diluted $  0.09   $  (0.05 )
             
Weighted-average shares outstanding, diluted    36,888,000      31,310,314  

The accompanying notes are an integrated part of these unaudited consolidated financial statements

4



China TMK Battery System Inc.
Consolidated Statements of Changes in Shareholders’ Equity
For the Three Months Ended March 31, 2011
(Unaudited)
(Stated in US dollars)

                                  Accumulated                    
    Common Stock     Common Stock Subscribed     Additional     Other     Statutory     Retained     Total  
                            Paid-in     Comprehensive     Reserve     Earnings     Shareholder's  
    Shares     Amount     Shares     Amount     Capital     Income     Fund     (Unrestricted)     Equity  
                                                       
                                                       

Balance at December 31, 2010

  36,888,000   $  36,888   $  253,020     253     11,024,449   $  1,207,195   $  1,038,988   $  17,850,967   $  31,158,740  

Foreign currency translation adjustment

- - - - - 181,678 - - 181,678

Cancellation of common stock subscribed

- - (253,020 ) (253 ) (505,787 ) - - - (506,040 )

Net income for the three months ended March 31, 2011

- - - - - - - 3,385,972 3,385,972

 

                                                     

Balance at March 31, 2011

  36,888,000   $  36,888   $  -     -     10,518,662   $  1,388,873   $  1,038,988   $  21,236,939   $  34,220,350  

The accompanying notes are an integrated part of these unaudited consolidated financial statements

5



China TMK Battery Systems Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
(In US Dollars)

    For the Three Months Ended  
    March 31,  
    2011     2010  
             
Cash Flows From Operating Activities            
             

Net income (loss)

$  3,385,972   $  (1,467,367 )

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

Depreciation

  259,831     17,505  

Deferred income

  -     (9,238 )

Deferred tax benefit

  (3,935 )   -  

Change in fair value of derivative liability

  (423,243 )   1,725,233  

Common stocks for service provided

  -     856,250  

Changes in operating assets and liabilities:

           

Accounts receivable

  (1,427,781 )   (2,645,680 )

Advances to suppliers

  (29,116 )   (130,653 )

Other receivable

  (103,871 )   -  

Inventories, net

  (1,253,780 )   295,135  

Accounts payable

  (186,565 )   1,509,993  

Accrued liabilities and other payable

  600,085     (210,925 )

Customer deposits

  191,971     91,871  

Prepaid expenses and other receivables

  (194,055 )   (1,007,486 )

Other assets

  129     (58,519 )

Wages payable

  (45,827 )   (50,855 )

Various taxes payable

  348,162     (62,514 )
Net cash provided by (used in) operating activities   1,117,977     (1,147,250 )
             
Cash Flows From Investing Activities            

Change in restricted cash

  910,800     (96 )

Purchases and advances for property and equipment

  (31,722 )   (2,701,485 )

Deposit for business acquisition

  (865,260 )   (3,172,656 )

Collection of advances/loans - related parties

  2,277     -  

Proceeds from maturity of certificate of deposit

  1,512,832     -  
Net cash provided by (used in) investing activities   1,528,927     (5,874,237 )
             
Cash Flows From Financing Activities            

Borrowing from bank loans

  1,214,400     1,973,161  

Repayments of bank loans

  (3,071,638 )   (2,887,878 )

Net proceeds from share issuance

  (506,040 )   6,302,953  

Proceeds from common stock subscription

  -     1,989,748  

Distribution to former owners

  -     (1,510,000 )

Proceeds from related parties

  37,562     1,120,611  

Repayment to related parties

  (41,288 )   (17,691 )
Net cash provided by(used in) financing activities   (2,367,004 )   6,970,904  

6



Effect of exchange rate changes on cash

  21,827     154,354  
Net increase in cash and cash equivalents   301,727     103,771  
Cash and cash equivalents, beginning of period   356,871     185,590  
Cash and cash equivalents, end of period $  658,598   $  289,361  
             
Supplemental disclosure information:            

Income taxes paid

$  109,810   $  339,411  

Interest paid

$  294,964   $  241,907  

The accompanying notes are an integral part of these unaudited consolidated financial statements.

- 7-



China TMK Battery System, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

NOTE 1: DESCRIPTION OF BUSINESS AND ORGANIZATION

China TMK Battery System Inc. (“TMK US”, or “the Company”) (formerly Deerfield Resource, Ltd.) was incorporated under the laws of the State of Nevada on June 21, 2006. On February 10, 2010, the Company entered into and closed the Share Exchange Agreement with Leading Asia Pacific Investment Limited (“Leading Asia”), a BVI company, and its sole stockholder, Unitech, a BVI company, pursuant to which the Company acquired 100% of the issued and outstanding capital stock of Leading Asia in exchange for 25,250,000 shares of our common stock, par value $0.001, which constituted 90.18% of our issued and outstanding capital stock on a fully-diluted basis as of and immediately after the consummation of the transactions contemplated by the Share Exchange Agreement.

In connection with the reverse acquisition of Leading Asia, Deerfield also entered into the Cancellation Agreement with United Fertilisers, its controlling stockholder, whereby United Fertilisers agreed to the cancellation of 272,250,000 shares of China TMK's common stock owned by it. As a condition precedent to the consummation of the Share Exchange Agreement, on February 10, 2010, China TMK also entered into a termination and release agreement with ASK Prospecting & Guiding Inc., pursuant to which Deerfield terminated that certain Mineral Claim Purchase Agreement, dated as of October 10, 2006. On February 10, 2010, Deerfield Resources, Ltd. changed its name to "China TMK Battery Systems Inc." to more accurately reflect its new business operations.

The transaction has been treated as a recapitalization of Leading Asia and its subsidiaries, with China TMK Battery Systems Inc. (the legal acquirer of Leading Asia and its subsidiaries, including the consolidation of the TMK Power Industries Ltd.) considered the accounting acquiree, and Leading Asia whose management took control of China TMK Battery Systems Inc. (the legal acquiree of Leading Asia) considered the accounting acquirer. The Company did not recognize goodwill or any intangible assets in connection with the transaction. All costs related to the transaction are being charged to operations as incurred. The 25,250,000 shares of common stock issued to the shareholders and designees of China TMK BVI in conjunction with the Share Exchange have been presented as outstanding for all periods. The historical consolidated financial statements include the operations of the accounting acquirer for all periods presented.

Leading Asia Pacific Investment Limited (“Leading Asia”) was incorporated in British Virgin Islands on July 08, 2008. Leading Asia had 50,000 capital shares authorized with $1.00 par value and 50,000 shares issued and outstanding.

Good Wealth Capital Investment Limited (“Good Wealth”) was incorporated in Hong Kong on May 16, 2008. The Company had 10,000 capital shares authorized with 1.00 HK dollar par value and 10,000 shares issued and outstanding. On August 12, 2008, Leading Asia acquired Good Wealth and became the sole shareholder.

In September 2008, Good Wealth entered into an ownership transfer agreement with TMK Power Industries (SZ) Co., Ltd. and its shareholders. Pursuant to the agreement, TMK's shareholders agreed to transfer their 100% ownership interest to Good Wealth at a price of $1,510,000. The ownership transfer was approved and completed by the appropriate China government department in February 2010. TMK Power Industries (SZ) Co., Ltd. (“TMK Shenzhen”) was incorporated in Shenzhen, People's Republic of China (“PRC”) on September 3, 2001. The Company had an authorized and invested capital of $362,911 (or RMB 3 million). On August 1, 2005, the Company increased its authorized and invested capital from $362,911 (or RMB 3 million) to $1,218,451 (or RMB 10 million). The Company's primary business activities involve research, development, production, marketing and sales of environment-friendly batteries including lithium batteries and nickel metal hydride batteries.

For accounting purposes, the reorganization above has been accounted for as a combination between entities under common control as the companies were controlled by the same persons before and after the reorganization. The Company accounted for them at historical cost similar to a pooling of interest transaction. The financial statements presented in this 10K have been prepared as if the existing corporate structure had been in existence throughout all periods and the reorganization had occurred as of the beginning of the earliest period presented in the accompanying financial statements.

On July 14, 2009, TMK Shenzhen acquired 100% of the ownership of Shenzhen Borou Industrial Co., Ltd. ("Borou"), a PRC based company specializing in domestic and international trade business. Pursuant to the ownership transfer agreement, TMK Shenzhen became the parent and sole owner of Borou.

8


TMK US and its subsidiaries - Leading Asia Pacific Investment Limited, Good Wealth Capital Investment Limited, TMK Power Industries (SZ) Co., Ltd., and Shenzhen Borou Industrial Co., Ltd – are collectively referred to as the “Company.”

All of our business operations are conducted through our Chinese subsidiaries.

NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

a. Basis of preparation

The unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP") for interim financial information and the instructions to Form 10-Q and Article 10-01 of Regulation S-X of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for annual financial statements. These consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company and notes thereto contained in our Annual Report on Form 10-K filed on March 31, 2011.

In the opinion of management, the interim financial statements reflect all normal adjustments that are necessary to provide a fair presentation of the financial results for the interim periods presented. Operating results for interim periods are not necessarily indicative of results that may be expected for an entire fiscal year. All significant inter-company balances and transactions have been eliminated in consolidation.

b. Foreign currency translation

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

The functional currency of TMK Shenzhen and Borou is the Renminbi (“RMB”), the PRC’s currency. These two companies maintain their financial statements using their own functional currency. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency at rates of exchange prevailing at the balance sheet dates. Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income (loss) for the respective periods.

For financial reporting purposes, the financial statements of Good Wealth, which are prepared in HKD, are translated into the Company’s reporting currency, United States Dollars (“USD”); the financial statements of TMK Shenzhen and Borou, which are prepared in RMB, are translated into the Company’s reporting currency, USD. Balance sheet accounts are translated using the closing exchange rate in effect at the balance sheet date and income and expense accounts are translated using the average exchange rate prevailing during the reporting period. Adjustments resulting from the translation, if any, are included in accumulated other comprehensive income (loss) in stockholder’s equity.

The exchange rates used for foreign currency translation were as follows (USD$1 = RMB):

Period Covered Balance Sheet Date Rates Average Rates
     
Year ended December 31, 2010 6.61201 6.75950
Quarter ended March 31, 2011 6.57030 6.58762
Quarter ended March 31, 2010 6.83620 6.81896

- 9-


The exchange rates used for foreign currency translation were as follows (USD$1 = HKD):

Period Covered Balance Sheet Date Rates Average Rates
     
Year ended December 31, 2010 7.80000 7.80000
Quarter ended March 31, 2011 7.80000 7.80000
Quarter ended March 31, 2010 7.80000 7.80000

c. Fair values of financial instruments

US GAAP requires certain disclosures about fair value of financial instruments. The Company defines fair value, using the required three-level valuation hierarchy for disclosures of fair value measurement, the enhanced disclosures requirements for fair value measures. Current assets and current liabilities qualified as financial instruments and management believes their carrying amounts are a reasonable estimate of fair value because of the short period of time between the origination of such instruments and their expected realization and if applicable, their current interest rate is equivalent to interest rates currently available. The three levels are defined as follows:

  • Level 1 — inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
  • Level 2 — inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.
  • Level 3 — inputs to the valuation methodology are unobservable and significant to the fair value.

Assets and liabilities measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010 are as follows:

    Fair Value Measurements at Reporting Date Using  
    Quoted Prices     Significant              
    in Active     Other     Significant        
    Markets for     Observable     Unobservable        
    Identical Assets     Inputs     Inputs        
    (Level 1)   (Level 2)   (Level 3)   Total  
                         
At March 31, 2011                        
Assets - Short Term Investment                        
  $  —   $  —   $  —   $  —  
Liabilities - Derivative liability $  —   $  —   $  717,875   $  717,875  
                         
At December 31, 2010                        
Assets - Short Term Investment     $  1,512,400   $  —   $  1,512,400  
Liabilities - Derivative liability $  —   $  —   $  1,141,118   $  1,141,118  

The fair value of derivative classified as Level 3 in the fair value hierarchy changed as follows during this quarter:

    Three Months Ended March 31  
    2011     2010  
Fair Value Measurements Using Significant Unobservable Inputs (Level 3)            
   Beginning balance $  (1,141,118 ) $  (1,218,744 )
   Total gain (loss) included in earnings   423,243     (1,725,233 )
Included in other comprehensive income   -     -  
Ending balance $  (717,875 ) $  (2,943,977 )

- 10-



d. Derivative liability

The Company granted a total of 3,401,320 warrants in connection with their private placement in February 2010. Because of the reset provision, the warrant agreement is considered not indexed to the Company’s stock and therefore the 3,401,320 warrants were determined to be derivative liability under ASC 815-15 and ASC 815-20. The fair value of these warrants were valued using the Multinomial Lattice models at each reporting periods, gain or loss from change in fair value of derivative liability are recorded in other income (expense).

NOTE 3: Advance for Business Acquisition

On January 4, 2010, the Company entered into a Memorandum of Understanding (MOU) with Shenzhen DongFang Hualian Technology Ltd. (“Hualian”). The Company paid $9,397,891 as acquisition deposit during 2010 and $865,260 during the first quarter of 2011, which shall be withdrawn based upon the MOU if Hualian fails the due diligence and external audit procedures. The Company completed the due diligence efforts in March 2011 and are currently negotiating with Hualian’s management on the acquisition price/structure. The Company expected to finalize the acquisition by the end of May 2011.

NOTE 4: SHORT-TERM BANK LOANS

Short term bank loans consist of the following:

  March 31, 2011     December 31, 2010  
Bank Loans borrowed by TMK Shenzhen            
Shenzhen Development Bank   -     1,209,920  
             
Bank Loans borrowed by Borou            
Industrial Bank Co. Ltd.   1,369,800     1,361,160  
             
Short-term loans $  1,369,800   $  2,571,080  

On October 20, 2010, TMK Shenzhen obtained a three-month loan in the amount of RMB 8,000,000 (or approximately $1,209,920) from Shenzhen Development Bank bearing interest at approximately 4.86% with maturity date on January 19, 2011. The loan was fully repaid in January 2011.

On November 22, 2010, Borou obtained a six-month term loan in the amount of RMB 9,000,000 (or approximately $1,361,160) from Industrial Bank Co., Ltd. bearing interest at 6.116% with maturity date on May 22, 2011. The loan is guaranteed by Mr. Wu, Henian, Mr. Tu, Jun, Mr. Wu, Jie and Shenzhen Shenhang Guarantee Company. This loan is borrowed under a line of credit in the amount of RMB 10,000,000 (approximately $1,512,400) that is available from November 19, 2010 to November 19, 2011.

The unused line of credit amounted to $152,200 and $151,240 at March 31, 2011 and December 31, 2010, respectively.

NOTE 5: LONG-TERM BANK LOANS

Long term bank loans consist of the following:

    March 31, 2011     December 31, 2010  
DBS Bank $  1,357,751   $  1,535,932  
China Construction Bank Shenzhen Branch   2,283,000     2,722,320  
Bank of Shanghai Shenzhen Branch   7,610,000     7,562,000  
Bank of China Shenzhen Branch   6,088,000     6,049,600  
             
Less current portion   (7,032,069 )   (5,159,422 )
Long -term portion $  10,306,682   $  12,710,430  

- 11-



On November 16, 2009, TMK Shenzhen obtained a three-year term loan from DBS Bank (China) Limited Shenzhen Branch (“DBS”) in the amount of RMB 15,300,000 (approximately $2,237,778) bearing interest at approximately 130% of the prevailing PRC prime rate (“prime rate”) at the time of the loan (approximately 7.02% per annum) paid monthly. The loan can only be used for equipment purchase (RMB 11,318,500) and working capital purpose (RMB 3,981,500). DBS requires the Company to deposit RMB 3,000,000 (approximately $438,780) as security (was refunded to the Company during 2010). Based on the agreement, DBS has right to request the Company to repay the outstanding balance immediately if the Company does not meet any of the following: (a) the Company should provide audited financial within six months of year-end; (b) the Company cannot pledge its account receivables to any other third parties without DBS permission; (c) the Company's account receivable settlements (cash collections) should be maintained at RMB 40,000,000 (approximately $5,850,400) annually and RMB 10,000,000 (approximately $1,462,600) quarterly. The Company did not violate any of the above covenants as of and for the three months ended March 31, 2011.

On December 30, 2008, TMK Shenzhen obtained a three-year term loan from China Construction Bank Shenzhen Branch (“CCB”) in the amount of RMB 30,000,000 (approximately $4,400,698) bearing interest at approximately 105% of the prevailing prime rate at the time of the loan (approximately 5.67% per annum and subject to adjustment every 12 months) paid monthly. Pursuant to the loan agreement, the principal needs to be made at a fixed amount of RMB 1,000,000 (approximately $146,260) starting from the 13th month until maturity date. In the event the Company defaults on the loan, the interest rate will be increased to 150% of the prime rate. In addition, the loan should be used for working capital purpose only. If violated, the interest rate will be increased to 200% of the prime rate and the penalty will be computed at 11.34% of violated amount. The terms of the loan also called for a deposit of RMB 1,800,000 to Shenzhen General Chamber of Commerce (SGCC) to secure the loan until the term loan is repaid in full. During 2010, the Company made addition deposit of RMB 600,000 to SGCC as requested by CCB. The loan with CCB is personally guaranteed by Mr. Wang, Zongfu and Mr. Huang, Junbiao and secured by the Company’s property with fair value of RMB 3,000,000 (approximately $440,070) and the Company's equipment with fair value of RMB 20,030,700 (approximately $2,938,302). The Company did not violate any of the above covenants as of and for the three months ended March 31, 2011.

On June 22, 2010, TMK Shenzhen obtained a three-year term loan from Shanghai Bank Shenzhen Branch (“SHB”) in the amount of RMB 50,000,000 (approximately $7,562,000) bearing interest at 5.508% annually with maturity date on June 28, 2013. Pursuant to the loan agreement, the principal needs to be paid at a fixed amount of RMB 2,000,000 (approximately $320,480) starting from the 13th month until maturity date. In the event the Company defaults on the loan, the interest rate will be increased to 150% of the prime rate. In addition, the loan should be used for the purchase of production materials only. If violated, the interest rate will be increased to 200% of the prime rate. The agreement also requires that during the 12-month period after signing of the loan agreement, the Company needs to generate international sales of no less than RMB 50 million (approximately $7,562,000) and domestic sales of no less than RMB 100 million (approximately $15,124,000). The loan is guaranteed by Dongguan Yikang Metal Material Company’s properties and Mr. Wu, Henian’s personal property. The Company did not violate any of the above covenants as of and for the three months ended March 31, 2011.

On August 05, 2009, Borou obtained a three-year term loan from Bank of China Shenzhen Branch (“BOC”) in the amount of RMB 40,000,000 (approximately $5,850,400) bearing interest at approximately 110% of the prevailing prime rate at the time of the loan (approximately 5.94% per annum) paid monthly. Pursuant to the loan agreement, the loan can only be used for working capital purposes (RMB 20,000,000) and fixed asset purchases (RMB 20,000,000). If violated, a penalty will be charged 100% interest rate on the violated amount. The loan is guaranteed by TMK Shenzhen and secured by Mr. Wu Henian, Mr. Huang Junbiao, and Mr. Wang Zongfu's ownerships in TMK Shenzhen. In addition, the loan is secured by property owned by Deli Investment Limited Co. with fair value of RMB 20,000,000 (approximately $2,925,200) and one of Borou's properties with fair value of RMB 20,000,000 (approximately $2,925,200). Based on the loan agreement, BOC also has the right to request the Company to repay the outstanding balance immediately if Borou does not meet any of the following: (a) Borou cannot distribute any bonus or dividend if it incurs an after-tax loss, or its pretax net income is not significant enough to pay for its prior year loss. Any pretax net income should be used to pay off principal and interests; (b) Borou should pay off the bank before it pays off borrowing from its shareholders and other debt; (c) Fixed asset purchase loans can only be used for equipment purchases. The proceeds will be sent to the equipment vendor directly. Any new equipment purchased under the loan should be added to bank collateral 30 days after a payment is made; (d) Prior to loan payoff date, Borou should maintain monthly purchase settlements of not less than RMB 8,000,000 (approximately $1,170,080) with the bank (note purchase settlements are accounted for as the total of each cash-in and cash-out transaction amounts). Borou did not violate any of the above covenants as of and for the three months ended March 31, 2011. In accordance with the loan agreement, Borou also agreed to pay RMB 1,200,000 of bank charge in three years with annual bank charge of RMB 400,000 made prior to August 30 each year.

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The terms of the long-term bank loans require the Company to maintain a deposit at the bank to secure the loans as follows:

    March 31, 2011     December 31, 2010  
China Construction Bank $  365,280   $  362,976  
Jiangsu Bank   -     907,440  
Restricted Cash $  365,280   $  1,270,416  

The Company was in the process of negotiating a new loan with Jiangsu Bank and agreed to make a deposit of RMB 6,000,000 (approximately $907,440) with Jiangsu Bank Shenzhen Branch at December 31, 2010. The Company did not reach to an agreement with Jiangsu Bank and the deposit was refunded to the Company in March 2011.

NOTE 6: RELATED PARTY TRANSACTIONS

The related parties consist of the following:

Wu, Henian CEO, Chairman & Shareholder
Tu, Lanzhen Wu, Henian's wife
Wang, Zongfu Director (since inception of the Company) & Shareholder
Yu, Zhengfei Wang, Zongfu’s wife
Liu, Xiangjun General Manager
Huang, Junbiao Director (since inception of the Company) & Shareholder
Q-Lite Industrial Co., Ltd. Yu, Zhengfei holds 25% of ownership
Liu, Jun Sales Manager

Due from related parties

Due from related parties consists of the following:

    March 31, 2011     December 31, 2010  
Liu, Xiangjun $  -   $  2,269  
Total $  -   $  2,269  

The above amount is advance to Mr. Liu, Xiangjun for regular business expense paid by her on behalf of the Company. The amount is non-secured, non-interest bearing, and is considered to be short-term. The due from balance was repaid during the first quarter of 2011and no loans to Liu, Xiangjun are outstanding at March 31, 2011.

Due to related party

Due to related party consists of the following:

    March 31, 2011     December 31, 2010  
Q-Lite Industrial Co., Ltd $  766   $  4,474  
Wu, Henian   908,062     902,335  
Wang, Zongfu   378,394     376,008  
Huang, Junbiao   187,878     186,692  
Liu, Jun   15,606     15,606  
Total $  1,490,706   $  1,485,115  

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During 2010, the Company borrowed $1,465,035 from Mr. Wu, Henian, Mr. Wang, Zongfu and Mr. Huang, Junbiao to support its operational funding needs. There was no formal agreement between the Company and those parties, the borrowing bears no interests and will be due on demand agreed by the related parties.

NOTE 7: INCOME TAX

Leading Asia is registered in BVI and under the current laws of the BVI, is not subject to income taxes.

Good Wealth is a holding company registered in Hong Kong and has no operating profit for tax liabilities.

TMK Shenzhen is registered in the PRC and has tax advantages granted by the local government for corporate income taxes and sales taxes commencing 2005. The Company was entitled to have a full tax exemption for the first two profitable years, followed by a 50% reduction on normal tax rate of 24% for the following three consecutive years. The Company was approved by local government as a high-tech company and granted tax benefits for corporate income taxes and sales taxes commencing 2007.

Borou is registered in PBC and is subject to regular corporate income tax rate. The assessment of its tax liabilities is combined with that of TMK Shenzhen.

Beginning January 1, 2008, the new Enterprise Income Tax (“EIT”) law has replaced the old laws for Domestic Enterprises (“DES”) and Foreign Invested Enterprises (“FIEs”). The new standard EIT rate of 25% replaces the 33% rate applicable to both DES and FIEs, except for High Tech companies that pay a reduced rate of 15%, subject to government verification for Hi-Tech company status in every three years. Companies established before March 16, 2007 continue to benefit from tax holiday treatment approved by the local government for a grace period of either the next 5 years or until the tax holiday term is completed, whichever is sooner.

A reconciliation between the income tax computed at the PRC statutory rate and the Company's provision for income tax is as follows:

                                                                                                                                                                                        For three months ended March 31,  
                                                                                                                                                                                          2011     2010  
U.S. statutory rate   34.0%     34.0%  
Foreign income not recognized in the U.S.   -34.0%     -34.0%  
PRC preferential enterprise income tax rate   25.0%     25.0%  
Tax holiday and relief granted to the Subsidiary   -10.0%     -10.0%  
Other   0.5%     17.3%  
Provision for income tax   14.5%     32.3%  

The tax authority of the PRC Government conducts periodic and ad hoc tax filing reviews on business enterprises operating in the PRC after those enterprises have completed their relevant tax filings, hence the Company's tax filings may not be finalized. It is therefore uncertain as to whether the PRC tax authority may take different views about the Company's tax filings which may lead to additional tax liabilities.

Accounting for Uncertainty in Income Taxes

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

NOTE 8: COMMON STOCK SUBSCRIPTION

In December, 2010, the Company entered into common share subscription agreements with seven employees to raise $506,040 capital in exchange for 253,020 shares of common stock (at par value $0.001) . The Company received fully payments by December 31, 2010. In January 2011, the Company and those employees entered into an agreement to cancel the subscription agreements entered in December 2010. The Company refunded subscription payment in full in January 2011.

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NOTE 9: COMMON STOCK WARRANTS

As of March 31, 2011 and December 31, 2010, there were 2,743,000 warrants with an exercise price of $1.60 per share outstanding and 658,320 warrants with an exercise price of $1.25 per share outstanding. No warrants were issued or cancelled during the three months ended March 31, 2010.

NOTE 10: DERIVATIVE LIABILITIES

The Company granted a total of 3,401,320 warrants in connection with their private placement in February 2010. Pursuant to the Subsequent Equity Sales section under warrant agreement the Company granted, if and whenever on or after the date of inception and through the earlier to occur of (i) eighteen months from the date hereof and (ii) date that there is an effective registration statement on file with the Securities and Exchange Commission covering the resale of all of the Warrant Stock and all of the shares of common stock issued in the offering, the Company issues or sells any shares of common stock or securities convertible into common stock for a consideration per share of common stock less than the then current Exercise Price, then, the Exercise Price shall be multiplied by a fraction. Because of the reset provision, the warrant agreement is considered not indexed to the Company’s stock and therefore the 3,401,320 warrants were determined to be a derivative liability under ASC 815-15 and ASC 815-20. The fair value of these warrants at the inception of the private placement was $1,218,744.

At March 31, 2011 and December 31, 2010, the derivative liability was valued at $717,875 and $1,141,118, respectively using the Multinomial Lattice models. The $423,243 change in fair value is reported in the Company’s consolidated statement of operations as a gain on derivatives. The warrants were valued with the following assumptions: at February 10, 2010 - annual volatility of 73%, term of 5 years, risk free rate of 2.39%, target exercise price of $2.50 for the $1.25 warrants and $3.00 for the $1.60 warrants; at December 31, 2010 - annual volatility of 50%, term of 4.11 years, risk free rate of 2.01%, target exercise price of $2.50 for the $1.25 warrants and $3.00 for the $1.60 warrants; at March 31, 2011- annual volatility of 48%, term of 3.87 years, risk free rate of 2.24%, target exercise price of $2.50 for the $1.25 warrants and $3.00 for the $1.60 warrants. The projected volatility is based on average volatility of 15 comparable companies over the previous years as the Company does not have sufficient trading history. The attributes of the comparable companies used in volatility analysis included 1) SIC 3600 (Electrical Equipment) and 3670 (Electronics), 2) Battery and power related products and services, 3) Market cap $38 million to $3.9 billion, 4) Global sales and operations, and 5) Annual revenues $73 million to 1.8 billion.

NOTE 15: REVENUE INFORMATION AND GEOGRAPHIC INFORMATION

    Three Months Ended March 31  
    2011     2010  
United States $  53,833   $  69,178  
Ukraine   -     32,439  
Sweden   -     67,517  
Korea   59,637     5,257  
Japan   -     1,712  
Australia   -     7,489  
Taiwan   12,212     31,654  
Hong Kong   49,332     238,157  
China   20,117,794     12,811,069  
Total $  20,292,808   $  13,264,472  

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NOTE 16: RECONCILIATION OF EARNINGS PER SHARE

    Three Months Ended March 31  
    2011     2010  
Numerator:            
Net income available to common stockholders $  3,385,972   $  (1,467,367 )
Denominator:            
Basic weighted-average shares outstanding   36,888,000     30,206,111  
Effect of dilutive securities:   -     1,104,203  
Diluted weighted-average shares outstanding   36,888,000     31,310,314  
Net income (loss) per share:            
Basic $  0.09   $  (0.05 )
Diluted $  0.09   $  (0.05 )

NOTE 17: SUBSEQUENT EVENT

On March 23, 2011, TMK Shenzhen entered into a credit agreement from DBS Bank (China) Limited Shenzhen Branch (“DBS”) to obtain a line of credit in the amount of RMB 10,000,000 (approximately $1,522,000) in the form of AR factoring. The loan bears interest at approximately 130% of the prevailing PRC prime rate (“prime rate”) at the time of the loan. Based on the loan agreement, each borrowing should be repaid within 165 days of invoice date. The agreement has not specified an expiration date. The loan proceeds of RMB 10,000,000 (approximately $1,522,000) were received in April, 2011.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Special Note Regarding Forward Looking Statements

In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as “believe,” “expect,” “anticipate,” “project,” “target,” “plan,” “optimistic,” “intend,” “aim,” “will” or similar expressions which are intended to identify forward-looking statements. Such statements include, among others, those concerning market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, including those identified in Item 1A “Risk Factors” in our annual report on Form 10-K for the fiscal year ended December 31, 2010, as well as assumptions, which, if they were to ever materialize or prove incorrect, could cause the results of the Company to differ materially from those expressed or implied by such forward-looking statements.

Readers are urged to carefully review and consider the various disclosures made by us in this report and our other filings with the SEC. These reports attempt to advise interested parties of the risks and factors that may affect our business, financial condition and results of operations and prospects. The forward-looking statements made in this report speak only as of the date hereof and we disclaim any obligation, except as required by law, to provide updates, revisions or amendments to any forward-looking statements to reflect changes in our expectations or future events.

Use of Terms

Except as otherwise indicated by the context, references in this report to:

  • “we,” “us,” “our,” or “the Company” are to combined business of China TMK Battery Systems Inc., a Nevada corporation, and its consolidated subsidiaries, Leading Asia, Good Wealth, TMK and Borou;

  • “Leading Asia” are to Leading Asia Pacific Investment Limited, a BVI company;

  • “Good Wealth” are to Good Wealth Capital Investment Limited, a Hong Kong company;

  • “TMK” are to Shenzhen TMK Power Industries Ltd., a PRC limited company;

  • “Borou” are to Shenzhen Borou Industrial Co., Ltd., a PRC limited company;

  • “BVI” are to the British Virgin Islands;

  • “Hong Kong” are to the Hong Kong Special Administrative Region of the People’s Republic of China;

  • “PRC,” “China,” and “Chinese,” are to the People’s Republic of China;

  • “SEC” are to the Securities and Exchange Commission;

  • “Securities Act” are to the Securities Act of 1933, as amended;

  • “Exchange Act” are to the Securities Exchange Act of 1934, as amended;

  • “Renminbi” and “RMB” are to the legal currency of China; and

  • “U.S. dollars,” “dollars” and “$” are to the legal currency of the United States.

Overview of our Business

Through our indirect Chinese subsidiary, TMK, we design, develop, manufacture and sell environmentally-friendly Ni-MH rechargeable batteries, which are commonly used to power applications such as, vacuum cleaners and other household electrical appliances; cordless power tools; medical devices; light electric vehicles, such as bicycles, electric vehicles and hybrid electric vehicles; light fittings, battery-operated toys, telecommunications, traffic control, and traffic lighting applications; and personal portable electronic devices, such as digital cameras, portable media players, portable gaming devices and PDAs.

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Historically, we have focused on the development of high-rate types SC, C, D, and F Ni-MH rechargeable batteries and have been engaged in the large-scale production of these products for over eight years. The target customers of these products are mainly factories that produce power tools, vacuum cleaners and other household electrical appliances, electric bicycles, battery-operated toys and medical devices and whose requirements for battery performance are higher-rate than those of the ordinary type AA and AAA batteries used for domestic purposes.

More recently, we have developed a working prototype of a hybrid electric vehicle battery pack and are producing sample cells for testing for an electric vehicle battery pack. To expand our business into the hybrid electric vehicle and electric vehicle markets, we plan to establish an advanced power battery research and development center, set up a battery-production base for small scale testing and production and establish a cooperation application demonstration point with 1-3 vehicle producers to lay a solid foundation for the approval of the project and for the support of the government. To date, we have entered into letters of intent with two automobile companies in China for the sale of our hybrid electric vehicle battery backs. We are also actively seeking opportunities to expand into the Lithium-Ion battery space. We have a lithium battery patent and some customers who are the purchasers of both nickel-metal hydride battery and Lithium-Ion battery. Therefore, we are searching for the potential acquiree to develop our production capacity to meet the demand of our customers and to grow our business, and have signed an MOU with one such company discussed under Item 1 “Business—Our Corporate History and Background—MOU with Hualian.” In addition, we have been actively seeking opportunities to design and distribute batteries for use in telecommunications, traffic control, and traffic lighting applications. We have developed working prototypes of both nickel-metal hydride battery and Lithium-Ion battery and sent to our customers for testing .

We conduct all of our operations in Shenzhen City, China, in close proximity to China's electronics manufacturing base and its rapidly growing market. Our access to China's supply of low-cost skilled labor, raw materials, machinery and facilities enables us to price our products competitively in an increasingly price-sensitive market. In addition, we have automated key stages of our manufacturing process to be able to produce high-quality battery cells that consistently meet the stringent requirements of our customers.

First Quarter Financial Performance Highlights

The following are some financial highlights for the first quarter:

  • Revenue: Revenue increased $7.0 million, or 53%, to $20.3 million for the three months ended March 31, 2011, from $13.3 million for the same period in 2010.

  • Gross Profit: Gross profit increased $1.7 million, or 54%, to $4.9 million for the three months ended March 31, 2011, from $3.2 million for the same period in 2010.

  • Income from operations: Income from operations increased $2.9 million, or 318%, to $3.8 million for the three months ended March 31, 2011, from $0.9 million for the same period last year.

  • Fully diluted net income per share: Fully diluted net income per share was $0.09 for the three months ended March 31, 2011, as compared to fully diluted net loss per share of $0.05 for the same period last year.

Results of Operations

The following tables set forth key components of our results of operations for the periods indicated, both in dollars and as a percentage of sales revenue and key components of our revenue for the periods indicated in dollars.

Three Months Ended March 31, 2011 Compared to Three Months Ended March 31, 2010

The following table sets forth key components of our results of operations for the three months ended March 31, 2011 and 2010, both in dollars and as a percentage of our net revenues.

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    Three Months Ended  
    March 31,  
    2011     2010  
          As a           As a  
          percentage of           percentage  
    In Dollars     net revenues     In Dollars     of net revenues  
Revenues $  20,292,808         $  13,264,472        
Cost of Goods Sold   (15,426,800 )   (76 )%   (10,105,697 )   (76 )%
Gross Profit   4,866,008     24%     3,158,775     24%  
Operating Expenses   (1,031,107 )   (5 )%   (2,240,446 )   (17 )%
Operating Income   3,834,901     19%     918,329     7%  
Other Income (Expense)   123,633     1%     (2,027,521 )   (15 )%
Income Taxes   (572,562 )   (3 )%   (358,175 )   (3 )%
Net Income $  3,385,972     17%   $  (1,467,367 )   (11 )%

Revenues. We derive revenues from the sale of environmentally-friendly Ni-MH rechargeable batteries. We had revenues of $20.3 million for the three months ended March 31, 2011, an increase of $7.0 million, or 53%, compared to $13.3 million for the three months ended March 31, 2010. The increase was due to an increase of new customers, increased demand from existing customers, and increased production.

Cost of Goods Sold. Our cost of goods sold includes the direct costs of our raw materials as well as the cost of labor and overhead. In the three months ended March 31, 2011, our cost of goods sold increased by 53%, from $10.1 million to $15.4 million, compared to the 2010 period. The increase of cost of sales in the 2011 period is attributable to the increase of product sales.

Gross Profit and Gross Margin. Our gross profit is equal to the difference between our revenues and our cost of goods sold. During the three months ended March 31, 2011, the gross margin of our business was 24%, which is consistent with the 24% margin in the same period of 2010.

Selling Expenses. Our selling expenses consist primarily of compensation and benefits to our sales and marketing staff, sales commission, cost of advertising, promotion, business travel, after-sale support, transportation costs and other sales related costs. Our selling expenses increased $137,270, or 58%, to $371,988 in the three months ended March 31, 2011, from $234,718 in the same period in 2010. The increase is primarily due to an increase in sales compensation, including sales commission, as a result of the increased sales.

General and Administrative Expenses. Our general and administrative expenses consist primarily of compensation and benefits to our general management, finance and administrative staff, professional advisor fees and other expenses incurred in connection with general operations. General and administrative expenses decreased $1.4 million, or 77%, to $0.4 million in the three months ended March 31, 2011, from $1.8 million in the same period of 2010. The decrease was primarily due to $1.77 million of one-time merger costs incurred in the first quarter of 2010 in connection with our reverse acquisition. The one-time merger cost included approximately $0.9 million in consulting, legal, audit and transaction fees in connection with the reverse merger, and approximately $0.86 million in financial advisory consultation and service fees paid to our financial advisor in connection with the reverse merger and concurrent financing.

Research and Development Expenses. Our research and development expenses consist of the costs associated with research and development personnel and expense in research and development projects. Our research and development expenses increased $15,442, or 9%, to $180,686 in the three months ended March 31, 2011, from $165,244 million in the 2010 period, due to our increased investment in research and development personnel to fuel future growth.

Interest Expense. Interest expense increased $53,057, or 22%, to $294,964 in the three months ended March 31, 2011, from $241,907 in the 2010 period. The increase in interest expense is due to the fact we borrowed more bank loans in the three months ended March 31, 2011, compared to the same period in 2010. This is consistent with the increase in the balance of our bank loans outstanding at March 31, 2011, compared to March 31, 2010.

Change in Fair Value of Derivative Liability. We granted a total of 3,401,320 warrants in connection with our private placement in February 2010. Due to the reset provision included in our warrant agreements, warrants are classified as derivative liability. The gain from change in fair value of derivative liability for the three months ended March 31, 2011 represents the difference of fair value between December 31, 2010 and March 31, 2011. The loss from change in fair value of derivative liability for the three months ended March 31, 2010 represents the difference of fair value between February 10, 2010 (inception date) and March 31, 2010.

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Income before Income Taxes. Our income before income taxes increased by $5.0 million, or 457%, to $4.0 for the three months ended March 31, 2011, from loss before income taxes of $1.1 for the 2010 period. The increase is primarily due to the increased gross margin, decreased operating expenses due to one-time merger cost and increased gain from change in fair value of derivative liability.

Net Income. As a result of the foregoing factors, our net income was $3.4 million for the three months ended March 31, 2011, as compared to $1.5 million net loss for the three months ended March 31, 2010.

Liquidity and Capital Resources

As of March 31, 2011, we had cash and cash equivalents of $0.7 million. The following table summarizes the key cash flow metrics from our condensed consolidated statements of cash flows for the three months ended March 31, 2011 and 2010.

Cash Flow
(all amounts in U.S. dollars)

    Three Months Ended March 31,  
    2011     2010  
Net cash provided by (used in) operating activities $  1,117,977   $  (1,147,250 )
Net cash provided by (used in) investing activities   1,528,927     (5,874,237 )
Net cash provided by (used in) financing activities   (2,367,004 )   6,970,904  
Effect of exchange rate changes in cash and cash equivalent   21,827     154,354  
Net increase in cash and cash equivalents   301,727     103,771  
Cash and cash equivalents at beginning of the period   356,871     185,590  
Cash and cash equivalent at end of the period $  658,598   $  289,361  

Operating Activities

Net cash provided by operating activities was $1.1 million for the three months ended March 31, 2011, a significant improvement from $1.1 million net cash used in operating activities for the same period of 2010. Such an increase was primarily attributed to our increased net income.

Investing Activities

Net cash provided by investing activities was $1.5 million for the three months ended March 31, 2011, as compared to $5.9 million net cash used in investing activities for the same period of 2010. Such a decrease was primarily due to less capital expenditures and less cash deposit made for business acquisition for the three months ended March 31, 2011, compared with the same period in 2010. In addition, we received proceeds of $1.5 million from maturity of a 6-month certificate of deposit.

Financing Activities

Net cash used by financing activities was $2.4 million during the three months ended March 31, 2011, as compared to net cash provided by financing activities of $7.0 million during the same period of 2010. The decrease was mainly attributable to $8.3 million cash provided by stock issuance or stock subscription during the three months ended March 31, 2010, while there is no such activity in the three months ended March 31, 2011.

In February 10, 2010, we completed a private placement transaction with a group of accredited investors, pursuant to which we issued to the investors an aggregate of 5,486,000 shares of our common stock, for a purchase price of $1.25 per share, and warrants to purchase up to 2,743,000 shares of our common stock. The warrants have a term of 5 years, bear an exercise price of $1.60 per share, as adjusted from time to time pursuant to anti-dilution and other customary provisions, and are exercisable by investors at any time after the closing date. As a result of this private placement, we raised $6,857,500 in gross proceeds, which left us with $5,392,151 in net proceeds after the deduction of offering expenses in the amount of $1,465,349.

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On March 27, 2010, we issued an aggregate of 2,717,000 shares of common stock, for a purchase price of $0.001 per share (par value), to multiple employees for proceeds of $3,396,250.

Loan Commitments

As of March 31, 2011, the amount, maturity date and term of each of our bank loans were as follows:

          Interest              
Bank   Amount*     Rate     Maturity Date     Duration  
China Construction Bank Shenzhen Branch $ 2,283,000 5.67% January 3, 2012 3 Years
Bank of China Shenzhen Branch 6,088,000 5.95% August 13, 2012 3 Years
DBS Bank 1,357,751 7.02% November 20, 2012 3 Years
Bank of Shanghai Shenzhen Branch 7,610,000 5.508% June 28, 2013 3 Years
Industrial Bank Co. Ltd.   1,369,800     6.116%     May 22, 2011     6 months  
                         
Total $  18,708,551                    

_____________
* Calculated based on the exchange rate of $1 = RMB 6.5703

On October 20, 2010, TMK Shenzhen obtained a three-month loan in the amount of RMB 8,000,000 (or approximately $1,209,920) from Shenzhen Development Bank bearing interest at approximately 4.86% with maturity date on January 19, 2011. The loan was fully repaid in January 2011.

On November 22, 2010, Borou obtained a six-month term loan in the amount of RMB 9,000,000 (or approximately $1,361,160) from Industrial Bank Co., Ltd. bearing interest at 6.116% with maturity date on May 22, 2011. The loan is guaranteed by Mr. Wu, Henian, Mr. Tu, Jun, Mr. Wu, Jie and Shenzhen Shenhang Guarantee Company. This loan is borrowed under a line of credit in the amount of RMB 10,000,000 (approximately $1,512,400) that is available from November 19, 2010 to November 19, 2011.

On November 16, 2009, TMK Shenzhen obtained a three-year term loan from DBS Bank (China) Limited Shenzhen Branch (“DBS”) in the amount of RMB 15,300,000 (approximately $2,237,778) bearing interest at approximately 130% of the prevailing PRC prime rate (“prime rate”) at the time of the loan (approximately 7.02% per annum) paid monthly. The loan can only be used for equipment purchase (RMB 11,318,500) and working capital purpose (RMB 3,981,500). DBS requires the Company to deposit RMB 3,000,000 (approximately $438,780) as security (was refunded to the Company during 2010). Based on the agreement, DBS has right to request the Company to repay the outstanding balance immediately if the Company does not meet any of the following: (a) the Company should provide audited financial within six months of year-end; (b) the Company cannot pledge its account receivables to any other third parties without DBS permission; (c) the Company's account receivable settlements (cash collections) should be maintained at RMB 40,000,000 (approximately $5,850,400) annually and RMB 10,000,000 (approximately $1,462,600) quarterly. The Company did not violate any of the above covenants as of and for the three months ended March 31, 2011.

On December 30, 2008, TMK Shenzhen obtained a three-year term loan from China Construction Bank Shenzhen Branch (“CCB”) in the amount of RMB 30,000,000 (approximately $4,400,698) bearing interest at approximately 105% of the prevailing prime rate at the time of the loan (approximately 5.67% per annum and subject to adjustment every 12 months) paid monthly. Pursuant to the loan agreement, the principal needs to be made at a fixed amount of RMB 1,000,000 (approximately $146,260) starting from the 13th month until maturity date. In the event the Company defaults on the loan, the interest rate will be increased to 150% of the prime rate. In addition, the loan should be used for working capital purpose only. If violated, the interest rate will be increased to 200% of the prime rate and the penalty will be computed at 11.34% of violated amount. The terms of the loan also called for a deposit of RMB 1,800,000 to Shenzhen General Chamber of Commerce (SGCC) to secure the loan until the term loan is repaid in full. During 2010, the Company made addition deposit of RMB 600,000 to SGCC as requested by CCB. The loan with CCB is personally guaranteed by Mr. Wang, Zongfu and Mr. Huang, Junbiao and secured by the Company’s property with fair value of RMB 3,000,000 (approximately $440,070) and the Company's equipment with fair value of RMB 20,030,700 (approximately $2,938,302). The Company did not violate any of the above covenants as of and for the three months ended March 31, 2011.

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On June 22, 2010, TMK Shenzhen obtained a three-year term loan from Shanghai Bank Shenzhen Branch (“SHB”) in the amount of RMB 50,000,000 (approximately $7,562,000) bearing interest at 5.508% annually with maturity date on June 28, 2013. Pursuant to the loan agreement, the principal needs to be paid at a fixed amount of RMB 2,000,000 (approximately $320,480) starting from the 13th month until maturity date. In the event the Company defaults on the loan, the interest rate will be increased to 150% of the prime rate. In addition, the loan should be used for the purchase of production materials only. If violated, the interest rate will be increased to 200% of the prime rate. The agreement also requires that during the 12-month period after signing of the loan agreement, the Company needs to generate international sales of no less than RMB 50 million (approximately $7,562,000) and domestic sales of no less than RMB 100 million (approximately $15,124,000). The loan is guaranteed by Dongguan Yikang Metal Material Company’s properties and Mr. Wu, Henian’s personal property. The Company did not violate any of the above covenants as of and for the three months ended March 31, 2011.

On August 05, 2009, Borou obtained a three-year term loan from Bank of China Shenzhen Branch (“BOC”) in the amount of RMB 40,000,000 (approximately $5,850,400) bearing interest at approximately 110% of the prevailing prime rate at the time of the loan (approximately 5.94% per annum) paid monthly. Pursuant to the loan agreement, the loan can only be used for working capital purposes (RMB 20,000,000) and fixed asset purchases (RMB 20,000,000). If violated, a penalty will be charged 100% interest rate on the violated amount. The loan is guaranteed by TMK Shenzhen and secured by Mr. Wu Henian, Mr. Huang Junbiao, and Mr. Wang Zongfu's ownerships in TMK Shenzhen. In addition, the loan is secured by property owned by Deli Investment Limited Co. with fair value of RMB 20,000,000 (approximately $2,925,200) and one of Borou's properties with fair value of RMB 20,000,000 (approximately $2,925,200). Based on the loan agreement, BOC also has the right to request the Company to repay the outstanding balance immediately if Borou does not meet any of the following: (a) Borou cannot distribute any bonus or dividend if it incurs an after-tax loss, or its pretax net income is not significant enough to pay for its prior year loss. Any pretax net income should be used to pay off principal and interests; (b) Borou should pay off the bank before it pays off borrowing from its shareholders and other debt; (c) Fixed asset purchase loans can only be used for equipment purchases. The proceeds will be sent to the equipment vendor directly. Any new equipment purchased under the loan should be added to bank collateral 30 days after a payment is made; (d) Prior to loan payoff date, Borou should maintain monthly purchase settlements of not less than RMB 8,000,000 (approximately $1,170,080) with the bank (note purchase settlements are accounted for as the total of each cash-in and cash-out transaction amounts). Borou did not violate any of the above covenants as of and for the three months ended March 31, 2011. In accordance with the loan agreement, Borou also agreed to pay RMB 1,200,000 of bank charge in three years with annual bank charge of RMB 400,000 made prior to August 30th of each year.

On March 23, 2011, TMK Shenzhen entered into a credit agreement from DBS Bank (China) Limited Shenzhen Branch (“DBS”) to obtain a line of credit in the amount of RMB 10,000,000 (approximately $1,522,000) in the form of AR factoring. The loan bears interest at approximately 130% of the prevailing PRC prime rate (“prime rate”) at the time of the loan. Based on the loan agreement, each borrowing should be repaid within 165 days of invoice date. The agreement has not specified an expiration date. The loan proceeds of RMB 10,000,000 (approximately $1,522,000) were received in April, 2011.

Obligations under Material Contracts

Except with respect to the loan obligations disclosed above, we have no obligations to pay cash or deliver cash to any other party.

Critical Accounting Policies

There have been no changes in our critical accounting policies from those under Item 7. “Management's Discussion and Analysis of Results of Operations and Financial Condition” in our annual report on Form 10-K for the fiscal year ended December 31, 2010.

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Inflation

Inflation and changing prices have not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future. However, our management will closely monitor price changes in our industry and continually maintain effective cost controls in operations.

Off Balance Sheet Arrangements

We do not have any off balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity or capital expenditures or capital resources that is material to an investor in our securities.

Seasonality

Our operating results and operating cash flows historically have not been subject to seasonal variations. This pattern may change, however, as a result of new market opportunities or new product introduction.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable.

ITEM 4. CONTROLS AND PROCEDURES.

Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

As required by Rule 13a-15(e), our management has carried out an evaluation, with the participation and under the supervision of our Chief Executive Officer, Mr. Xiangjun Liu, and our Chief Financial Officer, Mr. Jin Hu, of the effectiveness of the design and operation of our disclosure controls and procedures, as of March 31, 2011. Based upon, and as of the date of this evaluation, Mr. Liu and Mr. Chang, determined that, as of March 31, 2011, because of the material weaknesses described in Item 9A “Controls and Procedures” on our Annual Report on Form 10-K for the fiscal year ended December 31, 2010, which we are still in the process of remediating as of March 31, 2011, our disclosure controls and procedures were not effective. Investors are directed to Item 9A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 for a description of these weaknesses.

Changes in Internal Controls over Financial Reporting

We regularly review our system of internal control over financial reporting and make changes to our processes and systems to improve controls and increase efficiency, while ensuring that we maintain an effective internal control environment. Changes may include such activities as implementing new, more efficient systems, consolidating activities, and migrating processes.

During its evaluation of the effectiveness of internal control over financial reporting as of March 31, 2011, the management concluded that: (1) we lacked an audit committee within our board to oversee the financial reporting pursuant to U.S. GAAP and the SEC’s rules and regulations; and (2) our accounting staff lacked sufficient accounting skills and experience necessary to fulfill our public reporting obligations according to U.S. GAAP and the SEC’s rules and regulations.

As of March 31, 2011, our management is still in the process of implementing remediation procedures to improve internal controls over financial reporting. We have already taken measures to remediate these material weaknesses by seeking additional financial reporting and accounting staff members with relevant accounting experience, skills and knowledge in the preparation of financial statements in accordance with of U.S. GAAP and financial reporting disclosure requirements under SEC rules. We are also in the process of implementing a rigorous process for collecting and reviewing information required for the preparation of the financial statements to meet our public accounting obligations according to U.S. GAAP and the SEC’s rules and regulations with the support from the board and additional personnel experienced in U.S. GAAP and the SEC’s rules to be hired. Management remains committed to improving its internal control over financial reporting and will continue to work to put effective controls in place.

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Other than the foregoing changes, there were no changes in our internal controls over financial reporting during period covered by this report that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

PART II
OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

From time to time, we may become involved in various lawsuits and legal proceedings, which arise, in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these, or other matters, may arise from time to time that may harm our business. We are currently not aware of any such legal proceedings or claims that we believe will have a material adverse affect on our business, financial condition or operating results.

ITEM 1A. RISK FACTORS.

There are no material changes from the risk factors previously disclosed under “Risk Factors” in our Registration Statement on Form 10, filed on February 14, 2011.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. (REMOVED AND RESERVED).

ITEM 5. OTHER INFORMATION.

We have no information to disclose that was required to be in a report on Form 8-K during the period covered by this report, but was not reported. There have been no material changes to the procedures by which security holders may recommend nominees to our board of directors.

ITEM 6. EXHIBITS.

The following exhibits are filed as part of this report or incorporated by reference:

Exhibit No.   Description
31.1

Certifications of Principal Executive Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

Certifications of Principal Financial Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1

Certifications of Principal Executive Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

Certifications of Principal Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: May 16, 2011 CHINA TMK BATTERY SYSTEMS INC.
     
  By: /s/ Xiangjun Liu                                 
    Xiangjun Liu, Chief Executive Officer
    (Principal Executive Officer)
     
  By: /s/ Jin Hu                                             
    Jin Hu, Chief Financial Officer
    (Principal Financial Officer and Principal
    Accounting Officer)