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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 September 30, 2002
Or
[_] 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 0-20028
VALENCE TECHNOLOGY, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0214673
-------------------------------- --------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6504 Bridge Point Parkway, Austin, Texas 78730
---------------------------------------------------------
(Address of principal executive offices including zip
code)
(512) 527-2900
---------------------------------------------------------
(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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $0.001 par value 61,149,303 shares
------------------------------ ----------------------------------
(Class) (Outstanding at November 12, 2002)
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets as of
September 30, 2002 and March 31, 2002...............................3
Condensed Consolidated Statements of Operations and
Comprehensive Loss for the Three-
and Six-Month Periods Ended September 30, 2002 and 2001.............4
Condensed Consolidated Statements of Cash Flows
for the Six-Month Periods
Ended September 30, 2002 and 2001...................................5
Notes to Condensed Consolidated Financial Statements................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................12
Item 3. Quantitative and Qualitative Disclosures About Market Risk.........26
Item 4. Controls and Procedures............................................26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................27
Item 2. Changes in Securities and Use of Proceeds..........................27
Item 3. Defaults Upon Senior Securities....................................27
Item 4. Submission of Matters to a Vote of Security Holders................27
Item 5. Other Information..................................................27
Item 6. Exhibits and Reports on Form 8-K...................................27
SIGNATURES ...................................................................28
Certification of Principal Executive Officer..................................29
Certification of Principal Financial Officer..................................30
Exhibit Index.................................................................31
Page 2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
As of September 30, 2002 and March 31, 2002 (in
thousands, except share and per share amounts)
(unaudited)
September 30, March 31,
2002 2002
------------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 5,781 $ 623
Trade receivables, net of allowance of $253
and $312 as of September 30, 2002 and
March 31, 2002, respectively 216 362
Inventory, net 3,401 2,589
Prepaid and other current assets 880 1,552
------------- -----------
Total current assets 10,278 5,126
Property, plant and equipment, net 15,299 14,166
Intellectual property, net 10,514 11,239
------------- -----------
Total assets $ 36,091 $ 30,531
============= ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of long-term debt $ 702 $ 683
Accounts payable 3,155 2,548
Accrued expenses 1,966 2,632
Grant payable 1,700 1,553
Accrued payroll and benefits 754 561
------------- -----------
Total current liabilities 8,277 7,977
Long-term interest 5,126 3,778
Long-term debt, less current portion 6,001 5,884
Long-term debt to stockholder 30,818 28,755
------------- -----------
Total liabilities 50,222 46,394
------------- -----------
Commitments and contingencies
Stockholders' equity (deficit):
Common stock, $0.001 par value, authorized:
100,000,000 shares, issued and outstanding:
61,149,303 and 45,570,144 shares at September 30,
2002 and March 31, 2002, respectively 61 46
Additional paid-in capital 351,163 331,038
Notes receivable from stockholder (5,022) (5,990)
Accumulated deficit (355,975) (336,703)
Accumulated other comprehensive loss (4,358) (4,254)
------------- -----------
Total stockholders' equity (deficit) (14,131) (15,863)
------------- -----------
Total liabililities and stockholders
equity (deficit) $ 36,091 $ 30,531
============= ===========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
Page 3
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
LOSS For the Three and Six Month Periods Ended September 30, 2002
and 2001
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Six Months Ended
------------------------------ ------------------------------
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
Revenue:
Licensing and royalty revenue $ 7 $ 45 $ 8 $ 2,178
Battery and laminate sales 253 482 761 1,207
------------- ------------- ------------- -------------
Total revenues 260 527 769 3,385
Cost of sales: 2,713 1,534 5,235 4,336
------------- ------------- ------------- -------------
Gross profit (loss) (2,453) (1,007) (4,466) (951)
Operating expenses:
Research and product development 2,285 2,282 5,083 4,502
Marketing 569 651 1,352 1,084
General and administrative 2,730 3,163 5,143 6,763
Depreciation and amortization 652 2,463 1,297 4,853
------------- ------------- ------------- -------------
Total costs and expenses 6,236 8,559 12,875 17,202
------------- ------------- ------------- -------------
Operating loss (8,689) (9,566) (17,341) (18,153)
Loss on disposal of assets (147) (147)
Interest and other income 81 504 197 699
Interest expense (1,005) (898) (2,128) (1,647)
------------- ------------- ------------- -------------
Net loss (9,613) (10,107) (19,272) (19,248)
Net loss available to common
stockholders $ (9,613) $ (10,107) $ (19,272) $ (19,248)
============= ============= ============= =============
Other comprehensive loss:
Net loss $ (9,613) $ (10,107) $ (19,272) $ (19,248)
Change in foreign currency
translation adjustments (164) 831 (104) 648
------------- ------------- ------------- -------------
Comprehensive loss $ (9,777) $ (9,276) $ (19,376) $ (18,600)
============= ============= ============= =============
Net loss per share available to
common stockholders $ (0.19) $ (0.22) $ (0.37) $ (0.42)
============= ============= ============= =============
Shares used in computing net
loss per share available
to common stockholders,
basic and diluted 51,797 45,549 51,643 45,448
============= ============= ============= =============
The accompanying notes are an integral part of these
condensed consolidated financial statements.
Page 4
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS For the
Six Month Periods Ended September 30, 2002 and 2001
(in thousands)
(unaudited)
Six Months Six Months
Ended Ended
September 30, September 30,
2002 2001
------------- -------------
Cash flows from operating activities:
Net loss $ (19,272) $ (19,248)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 1,297 4,853
Accretion of debt discount 570 325
Interest income on shareholder note receivable (138) (139)
Write-off property and equipment 155
Compensation related to the issuance of stock options 198
Changes in operating assets and liabilities:
Trade receivables 286 3,225
Prepaid and other current assets 584 (216)
Inventory (811) 947
Accounts payable 515 (2,966)
Accrued expenses and long-term interest 689 803
Deferred revenue (2,500)
------------- ------------
Net cash used in operating activities (16,280) (14,563)
------------- ------------
Cash flows from investing activities:
Purchases of property, plant & equipment (809) (5,293)
Proceeds from investments 154
------------- ------------
Net cash used in investing activities (809) (5,139)
------------- ------------
Cash flows from financing activities:
Proceeds of long-term debt 2,600 16,986
Other long-term debt (469) (358)
Proceeds from issuance of common stock and warrants,
net of issuance costs 20,141 95
------------- ------------
Net cash provided by financing activities 22,272 16,723
------------- ------------
Effect of foreign exchange rates on cash
and cash equivalents (25) 148
------------- ------------
Increase (decrease) in cash and cash equivalents 5,158 (2,831)
Cash and cash equivalents, beginning of period 623 3,755
------------- ------------
Cash and cash equivalents, end of period $ 5,781 $ 924
============= ============
The accompanying notes are an integral part of these
condensed consolidated financial statements.
Page 5
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2002
(Unaudited)
1. INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
These interim condensed consolidated financial statements are unaudited
but reflect, in the opinion of management, all normal recurring
adjustments necessary to present fairly the financial position of
Valence Technology, Inc. and its subsidiaries (the "Company") as of
September 30, 2002, its consolidated results of operations for each of
the three and six-month periods ended September 30, 2002 and September
30, 2001, and the consolidated cash flows for each of the six-month
periods ended September 30, 2002 and September 30, 2001. Because all the
disclosures required by generally accepted accounting principles are not
included, these interim condensed consolidated financial statements
should be read in conjunction with the audited financial statements and
notes thereto in the Company's Annual Report on Form 10-K as of and for
the year ended March 31, 2002. The results for the three and six-month
periods ended September 30, 2002 are not necessarily indicative of the
results to be expected for the entire fiscal year ending March 31, 2003.
The year-end condensed consolidated balance sheet data as of March 31,
2002 was derived from audited financial statements, but does not include
all disclosures required by generally accepted accounting principles.
During fiscal 2002, the Company completed its transition from a research
and development-focused entity to a marketing and customer-focused
entity. In accomplishing its transition, the Company successfully
executed the following milestones: launch of its Saphion(TM) technology,
establishment of a sales pipeline including generation of initial
revenues, completion of its management team, and scale up of its
manufacturing operations in Northern Ireland. Accordingly, for financial
reporting purposes, the Company transitioned out of its development
stage status.
2. LIQUIDITY AND CAPITAL RESOURCES:
At the Company's current level of operations, it is using cash from
operations in the approximate amount of $6.0 million to $9.0 million per
quarter. However, the Company expects its cash requirements to increase,
by as much as $3.0 million, during the third quarter of fiscal 2003,
before resuming previous levels in the fourth quarter. This increase is
due to payments related to D&O insurance premium, restructuring charges
and previously committed capital expenditures for equipment in the
Company's Northern Ireland facility. The increase will be fully funded
by cash on hand and available capital from Berg & Berg Enterprises, LLC
("Berg & Berg"). In addition, at September 30, 2002 the Company had
commitments for capital expenditures of approximately $718,000.
At September 30, 2002, the Company's principal sources of liquidity were
cash and cash equivalents of $5.8 million, $2.1 million available under
a loan agreement with Berg & Berg and $25.0 million available under an
equity line of credit financing commitment with Berg & Berg. Currently,
the Company does not have material sales. Consequently, the Company is
dependent on Berg & Berg's continued willingness to fund its continued
operations. Under the equity line of financing commitment Berg & Berg
has the contractual right to reduce the remaining availability under the
line from $25 million to $8.5 million. Further, the commitment expires
on March 31, 2004 and Company's right to draw down on the line is
limited to $5 million per quarter and is further dependent upon meeting
certain operating conditions. Although the Company does not currently
satisfy all of these conditions, Berg & Berg has waived these conditions
for any draw down in the third and fourth quarters of fiscal 2003,
except for the condition that Stephan Godevais remain CEO. There can be
no assurance that the Company can meet these conditions in subsequent
quarters.
Assuming Berg & Berg continues to fund the operations of the Company at
the rate of $5 million per quarter, the Company expects to have
sufficient financing through the next twelve months to meet its working
capital, capital expenditure and investment requirements. However, if
Berg & Berg were to exercise its right to reduce the amounts under the
equity line of credit to $8.5 million or if the Company were not able to
satisfy the conditions to funding under that line in the first quarter
of fiscal 2004, the Company would exhaust its existing sources of
liquidity. In such a case, the Company's ability to continue its
operations would be dependent on arranging for additional equity or debt
financing, which, given the current equity and debt markets, could be
difficult to arrange.
Page 6
In addition, the Company has planned for an increase in sales, and if
the Company experiences sales in excess of its plan during this period,
its working capital needs would likely increase from that currently
anticipated. Therefore, the Company's may need to arrange for additional
equity or debt financing.
3. FINANCING:
On April 9, 2002, the Company sold 6.122 million shares in a new
issuance of common stock to a select group of institutional investors,
at a price of $2.70 per share. A.G. Edwards & Sons, Inc. and Wm Smith
Securities, Incorporated served as placement agents for the offering.
The Company raised net proceeds of approximately $15.2 million in the
transaction. Proceeds from the financing were used for working capital
purposes.
On September 30, 2002, the Company drew down $5.0 million from its
equity line of credit financing commitment from Berg & Berg and issued
approximately 9.5 million shares of the Company's common stock (See Note
2, Liquidity and Capital Resources).
4. NET LOSS PER SHARE:
Net loss per share is computed by dividing the net loss available to
common stockholders by the weighted average shares of common stock
outstanding during the period. The dilutive effect of the options and
warrants to purchase common stock are excluded from the computation of
diluted net loss per share, since their effect is antidilutive. The
antidilutive instruments excluded from the diluted net loss per share
computation at September 30 were as follows:
Three Months Ended Six Months Ended
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
Common Stock Option
Beginning of period 7,130,000 6,859,000 6,426,000 4,398,000
Granted (expired) during the period 166,000 (51,000) 870,000 2,410,000
------------- ------------- ------------- -------------
End of period 7,296,000 6,808,000 7,296,000 6,808,000
Warrants to purchase common stock 3,237,000 1,834,000 3,237,000 1,834,000
------------- ------------- ------------- -------------
Total 10,533,000 8,642,000 10,533,000 8,642,000
============= ============= ============= =============
5. INVENTORY:
Inventory consisted of the following (in thousands) at:
September 30, March 31,
2002 2002
------------- -------------
Raw materials $2,006 $1,977
Work in process 909 591
Finished goods 486 21
------------- -------------
$3,401 $2,589
============= =============
6. INTELLECTUAL PROPERTY:
Intellectual property is amortized over 8 years. Intellectual property,
net of impairment, consisted of the following (in thousands) at:
September 30, March 31,
2002 2002
------------- -------------
Intellectual properties $13,602 $13,602
Less: accumulated
amortization (3,088) (2,363)
------------- -------------
Intellectual properties, net
of accumulated amortization $10,514 $11,239
============= =============
Page 7
Amortization expense on intellectual property at September 30, 2002 will
be as follows (in thousands):
Fiscal Year
-----------------
Remainder of 2003 $725
2004 1450
2005 1450
2006 1450
2007 1450
Thereafter 3,989
----------
$10,514
==========
Amortization expense for the three months ended September 30, 2002 and
September 30, 2001 was approximately $362,000, and $480,000,
respectively. The amounts charged to amortization expense for the six
months ended September 30, 2002 and September 30, 2001 were
approximately $725,000 and $960,000, respectively.
7. DEBT TO STOCKHOLDER:
September 30, March 31,
2002 2002
------------- -------------
(in thousands)
2001 Loan balance $17,929 $16,436
1998 Loan balance 14,950 14,950
Unaccreted debt discount (2,061) (2,631)
------------- ------------
Balance $30,818 $28,755
============= ============
In October 2001, the Company entered into a loan agreement ("2001 Loan")
with Berg & Berg. Under the terms of the agreement, Berg & Berg agreed
to advance the Company funds of up to $20 million between the date of
the agreement and September 30, 2003. Interest on the 2001 Loan accrues
at 8.0% per annum, payable from time to time, and all outstanding
amounts with respect to the loans are due and payable on September 30,
2005. As of September 30, 2002, a total of $19,036,000 had been drawn on
the 2001 Loan. On June 21, 2002, Berg & Berg agreed to reduce the
principal amount of the 2001 loan by $1,106,705, representing interest
due to the Company by Mr. Lev Dawson (See Note 9, Related Party
Transactions). The Company has the right to reborrow this $1,106,705 of
principal as needed. On November 8, 2002 the Company and Berg & Berg
amended an affirmative covenant in the agreement to acknowledge the
Nasdaq SmallCap Market as an acceptable market for the listing of the
Company's Common Stock. Borrowings on the 2001 Loan, net of the
repayment, as of September 30, 2002, were $17,929,000. In conjunction
with the 2001 Loan, Berg & Berg received a warrant to purchase 1,402,743
shares of the Company's common stock at the price of $3.208 per share.
The warrants were exercisable beginning on the date they were issued and
expire on August 30, 2005. The fair value assigned to these warrants,
totaling approximately $2,768,000, has been reflected as additional
consideration for the debt financing, recorded as a discount on the debt
and accreted as interest expense, amortized over the life of the loan.
The warrants were valued using the Black-Scholes valuation method using
the assumptions of a life of 47 months, 100% volatility, and a risk free
rate of 5.5%. As of September 30, 2002, a total of $707,000 has been
accreted and included as interest expense. The amounts charged to
interest expense on the outstanding balance of the loan for the three
and six-month periods ended September 30, 2002 were $331,000 and
$673,000, respectively.
In July 1998, the Company entered in to an amended loan agreement ("1998
Loan") with Berg & Berg which allows the Company to borrow, prepay and
re-borrow up to $10,000,000 principal under a promissory note on a
revolving basis. In November 2000, the 1998 Loan agreement was amended
to increase the maximum amount to $15,000,000. As of September 30, 2002,
the Company had an outstanding balance of $14,950,000 under the 1998
Loan agreement. The loan bears interest at one percent over lender's
borrowing rate (approximately 9.0% at September 30, 2002). Effective
December 31, 2001, the Company and the lender agreed to extend the
loan's maturity date from August 30, 2002 to September 30, 2005. On
November 8, 2002 the Company and Berg & Berg amended an affirmative
covenant in the agreement to acknowledge the Nasdaq SmallCap Market as
an acceptable market for the listing of the Company's Common Stock. As
of September 30, 2002, accrued interest on the loan totaled $4,080,000,
which is included in long-term interest. In fiscal 1999, the Company
issued warrants to purchase 594,031 shares of common stock to Berg &
Berg in conjunction with the 1998 Loan agreement, as amended. The
Page 8
warrants were valued using the Black Scholes valuation method and had an
average weighted fair value of approximately $3.63 per warrant at the
time of issuance. The fair value of these warrants, totaling
approximately $2,159,000, has been reflected as additional consideration
for the debt financing, recorded as a discount on the debt and accreted
as interest expense to be amortized over the life of the line of credit.
As of September 30, 2002, a total of $2,159,000 has been accreted. The
amounts charged to interest expense for the three-month periods ended
September 30, 2002 and September 30, 2001 were $339,000 for each period.
Interest expense for the six months ended September 30, 2002 and
September 30, 2001 was approximately $675,000 for each period.
8. COMMITMENTS AND CONTINGENCIES:
LITIGATION:
During fiscal 2002, the Company received notification that 23 former
employees of the Mallusk, Northern Ireland facility filed claims against
the Company in connection with the reduction in work force at the
facility in March 2001. The time period for filing such claims expired
July 6, 2001, although the Tribunal may accept late claims. The Company
has successfully settled 18 of the claims for a total of $12,000. The
Company is pursuing settlement of the final 5 claims and does not expect
the potential charge to be material.
GRANTS:
Resulting from the reduction of Northern Ireland manufacturing activity
at the end of the fiscal year ended March 31, 2001, the employment
levels specified by Northern Ireland Industrial Development Board, now
titled Invest Northern Ireland ("INI"), have not been maintained.
Consequently, the Company is in default of its agreement with the INI.
The INI is not seeking repayment and on the advice of counsel, on the
basis that successful negotiations will be concluded, the Company does
not believe that the INI will bring any legal action pursuant to the
Letter of Offer. The Company has begun discussions with the INI to end
the current agreement and enter into a new agreement more closely
aligned to current business conditions. Initial discussions with the INI
resulted in the INI releasing its potential clawback on $170,000 of
capital grants. Although it is unlikely, the INI could demand repayment
of a portion of the total amounts received, which include revenue grants
of $1.4 million and equipment grants of $13.3 million, net of the
$170,000 release. The Company's estimate of the maximum liability is
$1,700,000.
9. RELATED PARTY TRANSACTIONS:
In March 2002, the Company obtained $30 million of additional equity
financing commitment with Berg & Berg, an affiliate of Carl Berg, a
director and principal shareholder in the Company. The Company's
financing commitment with Berg & Berg enables it to access up to $5.0
million per quarter (but no more than $30.0 million in the aggregate) in
equity capital over the next two years. This commitment was approved by
stockholders at the Company's 2002 annual meeting held on August 27,
2002. In exchange for any amounts funded pursuant to this new agreement,
the Company will issue to Berg & Berg restricted common stock at 85% of
the average closing price of the Company's common stock over the five
trading days prior to the purchase date. The Company will agree to
register any shares it issues to Berg & Berg under this agreement. Berg
& Berg's obligation to fund the equity commitment is subject to
conditions including, but not limited to, the Company's achievement of
operating milestones. As of November 4, 2002, so long as Stephan
Godevais remains as CEO, Berg & Berg agreed to waive these conditions to
funding for the third and fourth fiscal quarters of 2003. In addition,
Berg & Berg has the option to reduce the commitment to the extent the
Company enters into a debt or equity financing arrangement with a third
party at any time during the term of the commitment. As a result of an
offering the Company completed in April 2002 and the draw down of $5.0
million of the commitment on September 30, 2002, Berg & Berg may elect
to reduce its remaining commitment to $8.5 million.
On January 1, 1998, the Company granted options to Mr. Dawson, the
Company's Chairman of the Board, Chief Executive Officer and President,
an incentive stock option to purchase 39,506 shares, which was granted
pursuant to the Company's 1990 Plan (the "1990 Plan"). Also, an option
to purchase 660,494 shares was granted pursuant to the Company's 1990
Plan and an option to purchase 300,000 shares was granted outside of any
equity plan of the Company, neither of which were incentive stock
options (the "Nonstatutory Options"). The exercise price of all three
options is $5.0625 per share, the fair market value on the date of the
grant. The Compensation Committee of the Company approved the early
exercise of the Nonstatutory Options on March 5, 1998. The options
permitted exercise by cash, shares, full recourse notes or non-recourse
notes secured by independent collateral. The
Page 9
Nonstatutory Options were exercised on March 5, 1998 with non-recourse
promissory notes in the amounts of $3,343,750 ("Dawson Note One") and
$1,518,750 ("Dawson Note Two") (collectively, the "Dawson Notes")
secured by the shares acquired upon exercise plus 842,650 shares
previously held by Mr. Dawson. Since the issuance date (the "Issuance
Date") of the Dawson Notes (March 5, 1998), the largest aggregate
amounts of indebtedness outstanding at any time under Dawson Note One
and Dawson Note Two were $4,119,383 and $1,871,046, respectively. As of
September 30, 2002, amounts of $3,453,476 and $1,568,588 were
outstanding under Dawson Note One and Dawson Note Two, respectively, and
under each of the Dawson Notes, interest from the Issuance Date accrues
on unpaid principal at the rate of 5.69% per annum, or at the maximum
rate permissible by law, whichever is less.
In accordance with the Dawson Notes, interest is payable annually in
arrears and had been unpaid until June 21, 2002. Accrued interest
through March 4, 2002, the last interest payment due date, totaled
$1,106,705. On June 21, 2002, the accrued interest was paid in full (See
Note 7, Debt to Stockholder). In addition, the stock price of the
Company's common stock has suffered a decline. Management believes that
this is a temporary decline and feels that the principal on the Dawson
Notes will be fully collectible. The amount of fair value that the
underlying stock represented at September 30, 2002 was $681,951.
10. GEOGRAPHIC INFORMATION:
The Company conducts its business in two geographic segments.
Long lived asset information by geographic area at September 30, 2002
and March 31, 2002 is as follows (in thousands):
September 30, 2002 March 31, 2002
------------------ --------------
United States $ 4,480 $ 4,609
International 10,819 9,557
------------------ --------------
Total $ 15,299 $ 14,166
================== ==============
Revenues by geographic area for the three and six-month periods ended
September 30, 2002 and September 30, 2001 are as follows (in thousands):
Three Months Ended Six Months Ended
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
United States $ 171 $ 363 $ 447 $ 1,570
International 89 164 322 1,815
------------- ------------- ------------- -------------
Total $ 260 $ 527 $ 769 $ 3,385
============= ============= ============= =============
11. JOINT VENTURE AGREEMENTS:
In June 2001, the Company and Hanil Telecom reached an agreement to
terminate their joint venture. As conditions of the termination, Shinhan
Bank transferred its payment guarantee obligations under a line of
credit from the Company to the Company's former joint venture partner
and the Company granted a license to an affiliate of Hanil Telecom. In
addition, the deferred revenue balance of $2.5 million was offset by
approximately $896,000 of accounts receivable and the remaining $1.6
million balance was recorded as license revenue to recognize the license
agreement.
Page 10
12. SUBSEQUENT EVENTS:
On November 4, 2002, the Company announced a reorganization in which its
worldwide workforce was downsized by 18% or 40 employees. The majority
of the reduction involved positions in Henderson, Nevada, which became
redundant with similar capabilities in the Company's Mallusk facility.
The Company also streamlined certain administrative and indirect labor
functions in its facilities in Austin, Texas and Mallusk, Northern
Ireland.
On November 12, 2002, the Company announced that it had signed an
agreement to establish a Chinese joint venture with Baoding Fengfan
Group Limited Liability Company ("Fengfan"). The commencement of this
venture is subject to standard Chinese government approval. The purpose
of the joint venture is to provide low cost manufacturing of the
Company's Saphion(TM) Lithium-ion batteries in China. Under the
agreement, the Company will contribute capital equipment and engineering
expertise. Fengfan will provide the cash required to fund the joint
venture for the first two years as well as the land and facility needed
for manufacturing operations.
13. RECENT ACCOUNTING PRONOUNCEMENTS:
In June 2001, SFAS No. 142 ("SFAS 142"), "Goodwill and Other Intangible
Assets," was issued, which requires, among other things, the
discontinuance of goodwill amortization. SFAS 142 also requires the
Company to complete a transitional goodwill impairment test six months
from the date of adoption. The Company adopted SFAS No. 142 on April 1,
2002. An assessment of the value of the Company's intellectual property
was performed during the quarter ended December 31, 2001 under SFAS No.
121. An impairment charge was deemed appropriate and recorded during the
quarter ended December 31, 2001, and the useful life of the Company's
intellectual property was reduced.
In August 2001, SFAS No. 144 ("SFAS 144"), "Accounting for the
Impairment or Disposal of Long-Lived Assets," was issued, which
addresses the financial accounting and reporting for the impairment of
long-lived assets. This statement supersedes SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of" and the accounting and reporting provisions of APB Opinion
No. 30, "Reporting the Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions," for the disposal of a
segment of a business. The Company adopted SFAS No. 144 on April 1,
2002. An impairment charge was deemed appropriate and recorded during
the quarter period ended December 31, 2001.
In April 2002, SFAS No. 145 ("SFAS 145"), "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections" was issued, which rescinds FASB Statement No.
4, "Reporting Gains and Losses from Extinguishment of Debt," and an
amendment of that Statement, FASB Statement No. 64, "Extinguishments
of Debt Made to Satisfy Sinking-Fund Requirements." The Statement also
rescinds FASB Statement No. 44, "Accounting for Intangible Assets of
Motor Carriers." The Statement amends FASB Statement No. 13,
"Accounting for Leases," to eliminate an inconsistency between the
required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects
that are similar to sale-leaseback transactions. The Company will
adopt SFAS No. 145 in April 2003 and does not expect this adoption to
have a material effect on the financial statements.
In June 2002, SFAS No. 146, "Accounting for Costs Associated with Exit
or Disposal Activities," was issued, which addresses financial
accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (EITF) Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in
a Restructuring)." The Company is required to adopt this standard in
January 2003.
Page 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This report contains statements that constitute "forward-looking statements"
within the meaning of Section 21E of the Securities Exchange Act of 1934,
Section 27A of the Securities Act of 1933 and the Private Securities Litigation
Reform Act of 1995. The words "expect," "estimate," "anticipate," "predict,"
"believe," and similar expressions and variations of such words are intended to
identify forward-looking statements. Such statements appear in a number of
places in this report and include statements regarding our intent, belief or
current expectations with respect to, among other things, the progress of our
research and development activities, trends affecting our liquidity position,
including, but not limited to, our access to additional equity or debt financing
and our rate of expenditures, our joint venture relationships, the status of the
development of our products and their anticipated performance and customer
acceptance and our business and liquidity strategies. We caution you not to put
undue reliance on such forward-looking statements. Such forward-looking
statements are not guarantees of our future performance and involve risks and
uncertainties. Our actual results may differ materially from those projected in
this report, for the reasons, among others, our limited available working
capital, uncertain market acceptance of our products, changing economic
conditions, risks inherent in establishing a new manufacturing capability, risks
in product and technology development, the effect of our accounting policies and
the other risks discussed below under the caption, "Risk Factors," and in our
Annual Report on Form 10-K filed with the Securities and Exchange Commission. We
undertake no obligation to publicly revise these forward-looking statements to
reflect events or circumstances that arise after the date of this report. In
addition to the risks and uncertainties discussed above, our other filings with
the Securities and Exchange Commission contain additional information concerning
risks and uncertainties that may cause actual results to differ materially from
those projected or suggested in our forward-looking statements. You should
carefully review the risk factors discussed below and in the other documents we
have filed with the Securities and Exchange Commission.
This Management's Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with the accompanying condensed
consolidated financial statements and notes thereto contained herein and our
consolidated financial statements and notes thereto contained in our Annual
Report on Form 10-K as of and for the year ended March 31, 2002. The results for
the three and six-month periods ended September 30, 2002 are not necessarily
indicative of the results to be expected for the entire fiscal year ending March
31, 2003.
OVERVIEW
Founded in 1989, our business has been driven primarily by our research and
development efforts, which have fostered our intellectual property position,
currently consisting of 722 issued and pending patents, including 254 patents
issued in the United States. Since our inception, we have been focused on
acquiring and developing our technology, developing our manufacturing
capabilities, recruiting personnel, establishing our sales channels and pipeline
and acquiring capital.
With the appointment of Stephan B. Godevais as our Chief Executive Officer and
President in May 2001, we initiated the transition of our business by broadening
our marketing and sales efforts to take advantage of our strengths in research
and development. With this strategic shift, our vision is to become a leader in
energy solutions by drawing on the numerous benefits of our latest battery
technology, the extensive experience of our management team and the significant
market opportunity available to us.
Historically, we focused our product development on the application of our
cobalt-oxide and manganese-oxide based lithium-ion technology to the mobile
communications market. Lithium-ion polymer batteries such as these are well
suited for applications including notebook computers, cellular telephones and
personal digital assistants, or PDAs, because they can be uniquely manufactured
as thin as one millimeter.
Recently, we unveiled our new lithium-ion technology, which utilizes a
phosphate-based cathode material. We have branded our phosphate-based
lithium-ion technology, Saphion(TM) technology, and believe that it addresses
the major weaknesses of existing oxide based lithium-ion alternatives while
offering a solution that is competitive in cost and performance. We believe
phosphate, in combination with different metals, enables greater energy density
than oxide technologies, whether cobalt or manganese. We believe that these
characteristics, along with the safety attributes of Saphion(TM) technology,
enable it to be designed into a wide variety of products in markets not served
by current lithium-ion solutions, including, among others, computers,
communications devices, consumer electronics, appliances, toys, vehicles and
uninterrupted power supply systems. Saphion(TM) technology will allow us to
offer solutions in the form of safer, environmentally friendly, lower-cost,
higher performance energy products which are becoming increasingly critical in
today's energy solutions market.
Page 12
Our business strategy is enhanced by the substantial and broad based experience
of our management team in the high technology industry. During the past year,
management successfully implemented and reached key milestones of our business
transition plan. We launched the Saphion(TM) technology and transitioned the
production of our Saphion(TM) polymer batteries from research and development to
our vertically integrated manufacturing facility in Northern Ireland. We
continue to ramp up production of high quality, large format Saphion(TM)
batteries for use in the N-Charge(TM) Power System, our first end-user product.
The N-Charge(TM) Power System is the first solution powered by Saphion(TM)
technology and is the first portable battery system designed to recharge and/or
run two mobile electronic devices simultaneously.
We have established the following objectives as our priorities for fiscal 2003:
o Sign additional Tier One customers for the N-Charge(TM) system.
o Launch new Saphion(TM)-based products to continue to demonstrate the
advantages and multiple applications for this technology.
o Sign an additional OEM agreement to build cylindrical and prismatic
Saphion(TM) products.
o Sign phosphate material and battery licensees by the end of the fiscal year.
Progress toward meeting these goals has been slowed by delays in signing Tier
One customers. In the current economic environment, many Tier One vendors have
reduced the resources available to qualify products beyond their core business.
With fewer people to evaluate and test products such as ours, the qualification
process is extended.
In August 2002, we announced that we had seen internal testing data that had
caused concerns regarding the reliability of the N-Charge product when stored
and not used for long periods of time. We anticipated that this issue would
cause a delay with potential customers in the process of qualifying the N-Charge
product. We have resumed our marketing efforts and sales activities via our
online store and indirect channel partners. We have not experienced any material
warranty claims related to this issue.
On September 26, 2002, we announced that we had validated our containment plan,
which resolves the technical issue discussed in the previous quarter. This
resolution has allowed us to continue the qualification process with leading
Tier One vendors. However, we expect that the previous forecast of strong
revenue growth for fiscal 2003 will likely shift by one to two quarters toward
the first half of fiscal 2004.
To limit the impact of this delay and shift in revenue growth on our cash flow,
we have taken the following actions:
o On November 4, 2002, we announced a reorganization in which our worldwide
workforce was downsized by 18% or 40 employees. The majority of the
reduction involved positions in Henderson, Nevada, which became redundant
with similar capabilities in our Mallusk facility. We also streamlined
certain administrative and indirect labor functions in our facilities in
Austin, Texas and Mallusk, Northern Ireland. The cost savings of this
reorganization is expected to be in the range of $500,000 to $750,000 per
quarter.
o With the objective of reducing the cost of the N-Charge(TM) product to lower
price points and drive demand, we have engaged a new contract manufacturer
and are planning to transfer part of our assembly process to Mexico.
Further, we are prepared to take additional cost-saving measures, if necessary,
to conserve our financial resources.
Separately, effective August 23, 2002, we transferred the listing of our common
stock to the Nasdaq SmallCap Market from the Nasdaq National Market.
RESULTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED SEPTEMBER 30, 2002 (SECOND QUARTER OF FISCAL
2003) AND SEPTEMBER 30, 2001 (SECOND QUARTER OF FISCAL 2002).
BATTERY AND LAMINATE SALES. Revenue from battery and laminate sales totaled
$253,000 for the second quarter of fiscal 2003. For the corresponding period of
fiscal 2002, revenue from battery and laminate sales totaled $482,000. Revenue
from battery and laminate sales for the six-month period ended September 30,
2002 totaled $761,000 compared to $1.2 million during the corresponding period
during fiscal 2002. In December 2000, we completed the acquisition of technology
rights from Telcordia Technologies, Inc. and correspondingly completed a
strategic shift away from our battery and laminate sales
Page 13
pipeline to an emphasis on licensing and royalty revenue. Battery and laminate
sales in the first and second quarters of fiscal 2002 represented sales from the
customer pipeline established before the strategic shift. During the second half
of fiscal 2002, we implemented a balanced strategy leveraging revenue from both
licensing and battery and laminate products. Battery and laminate sales for the
first and second quarters of fiscal 2003 are initial results from the
re-establishment of our customer pipeline for battery and laminate products,
including the launch of the N-Charge(TM) Power System.
LICENSING AND ROYALTY REVENUE. No licensing revenue was recognized during the
second quarter of fiscal 2003 and royalty revenue totaled $7,000 for the period.
Licensing and royalty revenue totaled $45,000 for the second quarter of fiscal
2002, consisting entirely of royalties. For the six-month period ended September
30, 2002, licensing and royalty revenue totaled $8,000. For the six-month period
ended September 30, 2001, licensing and royalty revenue totaled $2.2 million, of
which $1.6 million related to the conversion of the Hanil Joint Venture to a
license agreement. We continue to pursue licensing for both our process and
chemistry patent portfolios.
COST OF SALES. Cost of sales consists primarily of expenses incurred to
manufacture battery, laminate, and Saphion(TM) products. Cost of sales totaled
$2.7 million and $1.5 million for the second quarter of fiscal 2003 and fiscal
2002, respectively. Cost of sales totaled $5.2 million and $4.3 million for the
six-month periods ended September 30, 2002 and September 30, 2001, respectively.
As previously announced, we experienced a delay during the second quarter of
fiscal 2003 in the commercialization of our N-Charge(TM) Power System due to a
technical issue. The increase in cost of sales from fiscal 2002 to fiscal 2003
is due to a write off of inventory necessary as a result of the resolution of
the technical issue as well as costs associated with the manufacturing of our
newly launched Saphion(TM) materials and N-Charge(TM) Power System. This
increase is partially offset by lower cost of sales due to the decrease in
battery and laminate sales and continued automation improvements in our Northern
Ireland manufacturing facility. We maintained a negative gross margin on our
sales in all periods due to insufficient production and sales volumes to
facilitate the coverage of our indirect and fixed cost of sales.
RESEARCH AND PRODUCT DEVELOPMENT. Research and product development expenses
consist primarily of personnel, equipment, and materials to support our battery
and product research and product development. Research and development expenses
totaled $2.3 million and $2.3 million for the second quarter of fiscal 2003 and
fiscal 2002, respectively and $5.1 million and $4.5 million for the six-month
periods ended September 30, 2002 and September 30, 2001, respectively. Although
there was no significant change in total research and development expenses
during the comparable second quarters, higher research and development costs
during the first half of fiscal 2003 were due to increased headcount and
development expense associated with the development of battery pack products
using our Saphion(TM) technology. This increase was partially offset by lower
research and development expenses at our Northern Ireland facility.
MARKETING. Marketing expenses consist primairly of costs related to sales and
marketing personnel, public relations and promotional materials. Marketing
expenses were $569,000 and $651,000 for the second quarter of fiscal years 2003
and 2002, respectively. Marketing expenses totalled $1.4 million and $1.1
million for the first half of fiscal 2003 and 2002, respectively. The increased
expenditures in the first half of fiscal 2003 are the result of our continued
focus in the areas of sales and marketing through additional sales personnel and
increased promotional activities. Marketing expenses during the second quarter
of fiscal 2003 were lower than expenses during the second quarter of 2002 due to
reorganzation costs.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of salaries and other related costs for finance, human resources,
accounting, information technology, legal and corporate related expenses.
General and administrative expenses were $2.7 million and $3.2 million for the
second quarter of fiscal 2003 and fiscal 2002, respectively, and $5.1 million
and $6.8 million for the first half of fiscal 2003 and fiscal 2002,
respectively. The decreases between comparable periods are pimarily due to
decreased recruiting, legal, severance and travel expenses in fiscal 2003. The
decrease is partially offset by increases to insurance and facility maintenance
expenses.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization totalled $652,000
and $2.5 million for the second quarter of fiscal 2003 and fiscal 2002,
respectively, and $1.3 million and $4.9 million for the six-month periods ended
September 2002 and 2001, respectively. The significant decrease in deprecation
and amortization expenses during fiscal 2003 resulted primarily from the impact
of an impairment of assets during the third quarter of fiscal 2002. This
decrease is partially offset by depreciation for capital assets acquired
subsequent to the third quarter of fiscal 2002.
INTEREST AND OTHER INCOME. Interest and other income was $81,000 for the second
quarter of fiscal 2003 as compared to $504,000 for the same period in fiscal
2002. Interest and other income was $197,000 for the six-month period ended
September 30, 2002 as compared to $699,000 for the same period in fiscal 2001.
Interest during fiscal 2002 related primarily
Page 14
to interest earned on investments acquired from West Coast Venture Capital in
Febuary 2001. These assets were transferred to Berg & Berg as a reduction of our
outstanding debt during the fourth quarter of fiscal 2002.
INTEREST EXPENSE. Interest expense was $1.0 million and $898,000 during the
quarters ended September 30, 2002 and September 30, 2001, respectively and $2.1
million and $1.6 million for the first half of fiscal 2003 and 2002,
respectively. This increase is a result of increased borrowings of long-term
debt.
LIQUIDITY AND CAPITAL RESOURCES
At our current level of operations, we are using cash from operations in the
approximate amount of $6.0 million to $9.0 million per quarter. However, we
expect our cash requirements to increase, by as much as $3.0 million, during the
third quarter of fiscal 2003, before resuming previous levels in the fourth
quarter. This increase is due to payments related to D&O insurance premium,
restructuring charges and previously committed capital expenditures for
equipment in our Northern Ireland facility. The increase will be fully funded by
cash on hand and available capital from Berg & Berg. In addition, at September
30, 2002 we had commitments for capital expenditures of approximately $718,000.
At September 30, 2002, our principal sources of liquidity were cash and cash
equivalents of $5.8 million, $2.1 million available under a loan agreement with
Berg & Berg and $25.0 million available under an equity line of credit financing
commitment with Berg & Berg. Currently, we do not have material sales.
Consequently, we are dependent on Berg & Berg's continued willingness to fund
our continued operations. Under the equity line of financing commitment Berg &
Berg has the contractual right to reduce the remaining availability under the
line from $25 million to $8.5 million. Further, the commitment expires on March
31, 2004 and our right to draw down on the line is limited to $5 million per
quarter and is further dependent upon meeting certain operating conditions.
Although we do not currently satisfy all of these conditions, Berg & Berg has
waived these conditions for any draw down in the third and fourth quarters of
fiscal 2003, except for the condition that Stephan Godevais remain CEO. There
can be no assurance that we can meet these conditions in subsequent quarters.
Assuming Berg & Berg continues to fund our operations at the rate of $5 million
per quarter, we expect that we will have sufficient financing through the next
twelve months to meet our working capital, capital expenditure and investment
requirements. However, if Berg & Berg were to exercise its right to reduce the
amounts under the equity line of credit to $8.5 million or if we were not able
to satisfy the conditions to funding under that line in the first quarter of
fiscal 2004, we would exhaust our existing sources of liquidity. In such a case,
our ability to continue our operations would be dependent on arranging for
additional equity or debt financing, which, given the current equity and debt
markets, could be difficult to arrange.
In addition, we have planned for an increase in sales, and if we experience
sales in excess of our plan during this period, our working capital needs would
likely increase from that currently anticipated. Therefore, we may need to
arrange for additional equity or debt financing.
We used net cash from operations for the first six months of fiscal 2003 and
2002 of $16.3 million and $14.6 million, respectively. The cash used in our
fiscal 2003 operating activities was primarily due to net loss, investments in
inventory and the add back of non-cash expenses, including depreciation and
amortization and accretion of debt discount. The increase in net operating cash
outflows was primarily due to a decrease in accounts receivable collections in
fiscal 2003 compared to fiscal 2002 as a result of lower sales activity in the
respective preceding fiscal quarters.
We used $809,000 and $5.1 million in investing activities for the first six
months of fiscal 2003 and 2002, respectively. The decrease is due to the
substantial completion of investments in equipment for our Northern Ireland
facility.
We obtained cash from financing activities of $22.3 million and $16.7 million
during the first six months of fiscal 2003 and 2002, respectively.
As a result of the above, we had a net increase in cash and cash equivalents of
$5.2 million during the first six months of fiscal 2003 and a net decrease of
cash of $2.8 million in the first six months of fiscal 2002.
As of September 30, 2002, our short-term and long-term debt obligations,
including long-term interest, were $702,000 and $41.9 million, respectively.
During fiscal 2002, we reached an agreement with Berg & Berg to extend the
maturity date of
Page 15
our loan agreement with a current loan balance of $14.95 million and accrued
interest of $4.1 million from August 30, 2002 to September 30, 2005.
During fiscal 1994, through our Dutch subsidiary, we signed an agreement or
Letter of Offer with the Northern Ireland Industrial Development Board now
titled Invest Northern Ireland ("INI"), to open an automated manufacturing plant
in Northern Ireland in exchange for capital and revenue grants from the INI. The
grants available under the agreement for an aggregate of up to (pound)25.6
million, generally became available over a five-year period through October 31,
2001. As a condition to receiving funding from the INI, the subsidiary must
maintain a minimum of (pound)12.0 million (approximately $18.7 million) in debt
or equity financing from us. As of September 30, 2002, we had received grants
aggregating (pound)9.4 million (approximately $14.7 million). The amount of the
grants available under the agreement depends primarily on the level of capital
expenditures that we make. Substantially all of the funding received under the
grants is repayable to the INI if the subsidiary is in default under the
agreement, which includes the permanent cessation of business in Northern
Ireland. Funding received under the grants to offset capital expenditures is
repayable if related equipment is sold, transferred or otherwise disposed of
during a four-year period after the date of grant. In addition, a portion of
funding received under the grants may also be repayable if the subsidiary fails
to maintain specified employment levels for the two-year period immediately
after the end of the five-year grant period. As a result of the reduction of
Northern Ireland business activity, specified employment levels have not been
maintained, but the INI is not seeking repayment and on the advice of counsel,
on the basis that successful negotiations will be concluded, we do not believe
that the INI will bring any legal action pursuant to the Letter of Offer. We
have begun discussions with the INI to end the current agreement and enter into
a new agreement more closely aligned to current business conditions. We may not
be able to meet the requirements necessary to retain grants under the INI
agreement. Although we believe it is unlikely, the INI could demand repayment of
a portion of the total amounts received, which include revenue grants of $1.4
million and equipment grants of $13.3 million.
Since inception, we have experienced significant losses and negative cash flow
from operations. We believe that our existing cash and cash equivalents,
anticipated cash flows from our operating activities and available financing
will be sufficient to fund our working capital and capital expenditure needs
through fiscal 2003. If our working capital requirements and capital
expenditures are greater than we expect, we may need to raise additional debt or
equity financing in order to provide for our operations. There can be no
assurance that additional debt or equity financing will be available on
acceptable terms or at all.
RISK FACTORS
CAUTIONARY STATEMENTS AND RISK FACTORS
SEVERAL OF THE MATTERS DISCUSSED IN THIS REPORT CONTAIN FORWARD-LOOKING
STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. FACTORS ASSOCIATED WITH THE
FORWARD-LOOKING STATEMENTS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER FROM THOSE
PROJECTED OR FORECASTED IN THIS REPORT ARE INCLUDED IN THE STATEMENTS BELOW. IN
ADDITION TO OTHER INFORMATION CONTAINED IN THIS REPORT, YOU SHOULD CAREFULLY
CONSIDER THE FOLLOWING CAUTIONARY STATEMENTS AND RISK FACTORS.
RISKS RELATED TO OUR BUSINESS
WE MAY HAVE A NEED FOR ADDITIONAL FINANCING.
We may need to raise additional capital. If we cannot obtain additional
financing on reasonable terms, or at all, we may not be able to execute our
business strategy as planned and our results of operations would suffer. At our
current level of operations, we are using cash from operations in the
approximate amount of $6.0 million to $9.0 million per quarter. However, we
expect our cash requirements to increase, by as much as $3.0 million, during the
third quarter of fiscal 2003, before resuming previous levels in the fourth
quarter. This increase is due to payments related to D&O insurance premium,
restructuring charges and previously committed capital expenditures for
equipment in our Northern Ireland facility. The increase will be fully funded by
cash on hand and available capital from Berg & Berg. In addition, at September
30, 2002 we had commitments for capital expenditures of approximately $718,000.
At September 30, 2002, our principal sources of liquidity were cash and cash
equivalents of $5.8 million, $2.1 million available under a loan agreement with
Berg & Berg and $25.0 million available under an equity line of credit financing
commitment with Berg & Berg. Currently, we do not have material sales.
Consequently, we are dependent on Berg & Berg's continued willingness to fund
our continued operations. Under the equity line of financing commitment Berg &
Berg has the contractual right to reduce the remaining availability under the
line from $25 million to $8.5 million. Further, the commitment expires on March
31, 2004 and our right to draw down on the line is limited to $5 million
per quarter and is
Page 16
further dependent upon meeting certain operating conditions. Although we do not
currently satisfy all of these conditions, Berg & Berg has waived these
conditions for any draw down in the third and fourth quarters of fiscal 2003,
except for the condition that Stephan Godevais remain CEO. There can be no
assurance that we can meet these conditions in subsequent quarters.
Assuming Berg & Berg continues to fund our operations at the rate of $5 million
per quarter, we expect that we will have sufficient financing through the next
twelve months to meet our working capital, capital expenditure and investment
requirements. However, if Berg & Berg were to exercise its right to reduce the
amounts under the equity line of credit to $8.5 million or if we were not able
to satisfy the conditions to funding under that line in the first quarter of
fiscal 2004, we would exhaust our existing sources of liquidity. In such a case,
our ability to continue our operations would be dependent on arranging for
additional equity or debt financing, which, given the current equity and debt
markets, could be difficult to arrange.
In addition, we have planned for an increase in sales, and if we experience
sales in excess of our plan during this period, our working capital needs would
likely increase from that currently anticipated. Therefore, we may need to
arrange for additional equity or debt financing.
ALL OF OUR ASSETS ARE PLEDGED AS COLLATERAL UNDER OUR LOAN AGREEMENTS. OUR
FAILURE TO MEET THE OBLIGATIONS UNDER OUR LOAN AGREEMENTS COULD RESULT IN
FORECLOSURE OF OUR ASSETS.
All of our assets are pledged as collateral under various loan agreements. If we
fail to meet our obligations pursuant to these loan agreements, our lenders may
declare all amounts borrowed from them to be due and payable together with
accrued and unpaid interest. If we are unable to repay our debt, these lenders
could proceed against our assets.
WE HAVE A HISTORY OF LOSSES, HAVE AN ACCUMULATED DEFICIT AND MAY NEVER ACHIEVE
OR SUSTAIN SIGNIFICANT REVENUES OR PROFITABILITY.
We have incurred operating losses each year since inception in 1989 and had an
accumulated deficit of $356.0 million as of September 30, 2002. We have working
capital of $2.0 million as of September 30, 2002, and have sustained recurring
losses related primarily to the research and development and marketing of our
products. We expect to continue to incur operating losses and negative cash
flows through fiscal 2003, as we begin to build inventory, increase our
marketing efforts and continue our product development. We may never achieve or
sustain significant revenues or profitability in the future.
OUR BUSINESS MAY BE ADVERSELY AFFECTED IF OUR SAPHION(TM) TECHNOLOGY BATTERIES
ARE NOT COMMERCIALLY ACCEPTED.
We are researching and developing batteries based upon phosphate chemistry. Our
batteries are designed and manufactured as components for other companies and
end-user customers. Our success is dependent on the acceptance of our batteries
and the products using our batteries in their markets. We may have technical
issues that arise that may affect the acceptance of our products by our
customers. Market acceptance may also depend on a variety of other factors,
including educating the target market regarding the benefits of our products.
Market acceptance and market share are also affected by the timing of market
introduction of competitive products. If we or our customers are unable to gain
any significant market acceptance for Saphion(TM) technology based batteries,
our business will be adversely affected. It is too early to determine if
Saphion(TM) technology based batteries will achieve significant market
acceptance.
IF WE ARE UNABLE TO DEVELOP, MANUFACTURE AND MARKET PRODUCTS THAT GAIN WIDE
CUSTOMER ACCEPTANCE, OUR BUSINESS MAY BE ADVERSELY AFFECTED.
The process of developing our products is complex and uncertain, and failure to
anticipate customers' changing needs and to develop products that receive
widespread customer acceptance could significantly harm our results of
operations. We must make long-term investments and commit significant resources
before knowing whether our predictions will eventually result in products that
the market will accept. After a product is developed, we must be able to
manufacture sufficient volumes quickly and at low costs. To accomplish this, we
must accurately forecast volumes, mix of products and configurations that meet
customer requirements, and we may not succeed.
Page 17
FAILURE TO DEVELOP SALES CHANNELS FOR OUR CURRENT AND FUTURE END-USER PRODUCTS
WOULD SIGNIFICANTLY IMPACT OUR FUTURE REVENUE AND PROFITABILITY.
We introduced the N-Charge(TM) Power System, our first end-user product in
February 2002. We must develop reliable sales channels for distribution of our
N-Charge(TM) product and any future end-user products. If our N-Charge(TM)
product is not commercially accepted, our results of operations will be
adversely affected. In addition, failure to develop effective sales channels
will significantly impact our future revenue and profitability.
OUR FAILURE TO DEVELOP PARTNERSHIPS WITH OTHER BATTERY MANUFACTURERS WILL LIMIT
OUR ABILITY TO WIDELY INTRODUCE OUR PHOSPHATE CHEMISTRY TECHNOLOGY INTO THE
MARKETPLACE AND COULD SIGNIFICANTLY IMPACT OUR SALES AND PROFITABILITY IN FUTURE
PERIODS.
To successfully implement our business strategy of broadly disseminating the
Saphion(TM) technology, we intend to develop relationships with manufacturers of
lithium-ion batteries using stacked polymer technology as well as cylindrical
battery manufacturers. Our failure to develop these relationships will limit our
ability to widely introduce our phosphate chemistry technology into the
marketplace and could significantly impact our sales and profitability in future
periods.
WE HAVE FORMED RELATIONSHIPS WITH THREE OF THE WORLD'S LEADING PERSONAL COMPUTER
VENDORS. THESE RELATIONSHIPS MAY NOT ALL RESULT IN SALES OR PROFITABILITY.
We have entered into a Memorandum of Understanding with each of Acer Inc. and
Wistron Corporation for the development of devices using our technology.
Additionally, we have entered into a relationship with Hewlett-Packard Company
in which our N-Charge(TM) product will be featured in Hewlett-Packard's
Education Solutions Portfolio product bundle. Subsequently, Hewlett Packard
placed an initial purchase order and we shipped the N-Charge(TM) product to
Hewlett Packard in the first quarter of fiscal 2003. Wistron has also placed an
initial order and we began shipment of Saphion Lithium-ion batteries to Wistron
in November 2002. Neither the Memoranda of Understanding with Acer or Wistron
nor the relationship with Hewlett-Packard requires those companies to make any
financial commitments to us and may not lead to additional purchase orders. As a
result of the foregoing, these relationships may not result in significant sales
of products incorporating our Saphion(TM) technology, including sales of our
N-Charge(TM) product. If these relationships result in additional sales, we
cannot assure you that they will be profitable. If these relationships do not
lead to significant purchase orders, our future revenues and profitability may
be materially adversely affected.
BECAUSE OUR BATTERIES ARE INTENDED PRIMARILY TO BE INCORPORATED INTO OTHER
PRODUCTS, WE WILL NEED TO RELY ON OEMS TO COMMERCIALIZE OUR PRODUCTS. WE MAY NOT
OBTAIN ADEQUATE ASSISTANCE FROM THESE THIRD PARTIES TO SUCCESSFULLY
COMMERCIALIZE OUR PRODUCTS.
Our business strategy contemplates that we will be required to rely heavily on
assistance from OEMs to gain market acceptance for our products. We therefore
will need to identify acceptable OEMs and enter into agreements with them. Once
we identify acceptable OEMs and enter into agreements with them, we will need to
meet these companies' requirements by developing and introducing new products
and enhanced, or modified, versions of our existing products on a timely basis.
OEMs often require unique configurations or custom designs for batteries, which
must be developed and integrated into their product well before the product is
launched. This development process not only requires substantial lead-time
between the commencement of design efforts for a customized battery system and
the commencement of volume shipments of the battery system to the customer, but
also requires the cooperation and assistance of the OEMs for purposes of
determining the battery requirements for each specific application. We may have
technical issues that arise that may affect the acceptance of our products by
OEMs. If we are unable to design, develop and introduce products that meet OEMs'
requirements, we may lose opportunities to enter into additional purchase orders
and our reputation may be damaged. As a result, we may not receive adequate
assistance from OEMs or battery pack assemblers to successfully commercialize
our products, which could impair our profitability.
FAILURE TO IMPLEMENT AN EFFECTIVE LICENSING BUSINESS STRATEGY COULD ADVERSELY
AFFECT OUR REVENUE, CASH FLOW AND PROFITABILITY.
In December 2000, we acquired the intellectual property assets of Telcordia
Technologies, Inc. As a result of the acquisition of these intellectual property
assets and the internal development of our Saphion(TM) technology, we
significantly increased the role of licensing in oUR business strategy. We have
not entered into any licensing agreements for our Saphion(TM) technology. Our
future operating results could be affected by a variety of factors including:
Page 18
o our ability to secure and maintain significant customers of our
proprietary technology;
o the extent to which our future licensees successfully incorporate our
technology into their products;
o the acceptance of new or enhanced versions of our technology;
o the rate that our licensees manufacture and distribute their products to
OEMs; and
o our ability to secure one-time license fees and ongoing royalties for
our technology from licensees.
Our future success will also depend on our ability to execute our licensing
operations simultaneously with our other business activities. If we fail to
substantially expand our licensing activities while maintaining our other
business activities, our results of operations and financial condition will be
adversely affected.
FAILURE TO OBTAIN INTERNATIONAL REGULATORY APPROVAL FOR COMMERCIAL SHIPMENTS OF
PHOSPHATE MATERIAL WOULD CAUSE DELAYS IN THE PRODUCTION RAMP PLAN FOR OUR
BATTERY TECHNOLOGY AND RESULT IN DELAYS OR LOSSES OF REVENUES ASSOCIATED WITH
THAT PLAN.
We currently are shipping phosphate material from our facility in Henderson,
Nevada to our manufacturing facility in Mallusk, Northern Ireland as research
and development material. We must receive regulatory approval from the
appropriate international regulatory entities to ship commercial quantities of
the material. Failure to obtain the appropriate regulatory approvals
internationally would cause delays in the production ramp plan for our battery
technology and result in delays or losses of revenue associated with that plan.
OUR FAILURE TO COST-EFFECTIVELY MANUFACTURE BATTERIES IN COMMERCIAL QUANTITIES,
WHICH SATISFY OUR CUSTOMERS' PRODUCT SPECIFICATIONS, COULD DAMAGE OUR CUSTOMER
RELATIONSHIPS AND RESULT IN SIGNIFICANT LOST BUSINESS OPPORTUNITIES FOR US.
To be successful, we must cost-effectively manufacture commercial quantities of
our batteries that meet customer specifications. To facilitate commercialization
of our products, we will need to reduce our manufacturing costs, which includes
substantially raising and maintaining battery yields of commercial quality in a
cost-effective manner. If we fail to substantially increase yields in our
manufacturing process and reduce unit-manufacturing costs, we will not be able
to offer our batteries at a competitive price, and we will lose our current
customers and fail to attract future customers.
FAILURE TO SCALE UP OUR MANUFACTURING FACILITY WILL HARM OUR CUSTOMER RELATIONS
AND THREATEN FUTURE PROFITS.
We have begun to manufacture batteries on a commercial scale to fulfill purchase
orders and we are able to produce sufficient quantities of batteries for
short-term needs. We continue to install, de-bug and qualify equipment in our
manufacturing facility. If we fail to develop and efficiently operate a large
scale manufacturing facility capable of cost-effectively producing significant
quantities of batteries according to customer specifications, our ability to
serve the needs of our customers will be harmed and our future sales and profits
will be threatened.
OUR PATENT APPLICATIONS MAY NOT RESULT IN ISSUED PATENTS.
Patent applications in the United States are maintained in secrecy until the
patents issue or are published. Since publication of discoveries in the
scientific or patent literature tends to lag behind actual discoveries by
several months, we cannot be certain that we were the first creator of
inventions covered by pending patent applications or the first to file patent
applications on such inventions. We also cannot be certain that our pending
patent applications will result in issued patents or that any of our issued
patents will afford protection against a competitor. In addition, patent
applications filed in foreign countries are subject to laws, rules and
procedures which differ from those of the United States, and thus we cannot be
certain that foreign patent applications related to issued United States patents
will issue. Furthermore, if these patent applications issue, some foreign
countries provide significantly less effective patent enforcement than the
United States.
The status of patents involves complex legal and factual questions and the
breadth of claims allowed is uncertain. Accordingly, we cannot be certain that
patent applications we file will result in patents being issued, or that our
patents and any patents that may be issued to us in the future will afford
protection against competitors with similar technology. In addition, patents
issued to us may be infringed upon or designed around by others and others may
obtain patents that we need to license or design around, either of which would
increase costs and may adversely affect our operations.
Page 19
IF WE CANNOT PROTECT OR ENFORCE OUR EXISTING INTELLECTUAL PROPERTY RIGHTS OR IF
OUR PENDING PATENT APPLICATIONS DO NOT RESULT IN ISSUED PATENTS, WE MAY LOSE THE
ADVANTAGES OF OUR RESEARCH AND MANUFACTURING SYSTEMS.
Our ability to compete successfully will depend on whether we can protect our
existing proprietary technology and manufacturing processes. We rely on a
combination of patent and trade secret protection, non-disclosure agreements and
cross-licensing agreements. These measures may not be adequate to safeguard the
proprietary technology underlying our batteries. Employees, consultants, and
others who participate in the development of our products may breach their
non-disclosure agreements with us, and we may not have adequate remedies in the
event of their breaches. In addition, our competitors may be able to develop
products that are equal or superior to our products without infringing on any of
our intellectual property rights. Moreover, we may not be able to effectively
protect our intellectual property rights outside of the United States.
We have established a program for intellectual property documentation and
protection in order to safeguard our technology base. We intend to vigorously
pursue enforcement and defense of our patents and our other proprietary rights.
We could incur significant expenses in preserving our proprietary rights, and
these costs could harm our financial condition. We also are attempting to expand
our intellectual property rights through our applications for new patents. We
cannot be certain that our pending patent applications will result in issued
patents or that our issued patents will afford us protection against a
competitor. Our inability to protect our existing proprietary technologies or to
develop new proprietary technologies may substantially impair our financial
condition and results of operations.
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS BROUGHT AGAINST US COULD BE
TIME-CONSUMING AND EXPENSIVE TO DEFEND, AND IF ANY OF OUR PRODUCTS OR PROCESSES
ARE FOUND TO BE INFRINGING, WE MAY NOT BE ABLE TO PROCURE LICENSES TO USE
PATENTS NECESSARY TO OUR BUSINESS AT REASONABLE TERMS, IF AT ALL.
In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights. While we currently are
not engaged in any intellectual property litigation or proceedings, we may
become involved in these proceedings in the future. In the future we may be
subject to claims or inquiries regarding our alleged unauthorized use of a third
party's intellectual property. An adverse outcome in litigation could force us
to do one or more of the following:
o stop selling, incorporating or using our products that use the
challenged intellectual property;
o pay significant damages to third parties;
o obtain from the owners of the infringed intellectual property right a
license to sell or use the relevant technology, which license may not be
available on reasonable terms, or at all; or
o redesign those products or manufacturing processes that use the
infringed technology, which may be economically or technologically
infeasible.
Whether or not an intellectual property litigation claim is valid, the cost of
responding to it, in terms of legal fees and expenses and the diversion of
management resources, could be expensive and harm our business.
OUR ABILITY TO MANUFACTURE LARGE VOLUMES OF BATTERIES IS LIMITED AND MAY PREVENT
US FROM FULFILLING ORDERS.
We are actively soliciting additional purchase orders. We have qualified
additional automated equipment at our facility in Mallusk, Northern Ireland
which will provide us with sufficient capacity to assemble batteries in high
volumes. We may need additional low cost, quick lead-time equipment or contract
manufacturing support to fulfill large volume orders. If we cannot rapidly
increase our production capabilities to make sufficient quantities of
commercially acceptable batteries, we may not be able to fulfill purchase orders
in a timely manner, if at all. In addition, we may not be able to procure
additional purchase orders, which could cause us to lose existing and future
customers, purchase orders, revenue and profits.
IF OUR BATTERIES FAIL TO PERFORM AS EXPECTED, WE COULD LOSE EXISTING AND FUTURE
BUSINESS, AND OUR LONG-TERM ABILITY TO MARKET AND SELL OUR BATTERIES COULD BE
HARMED.
If we manufacture our batteries in commercial quantities and they fail to
perform as expected, our reputation could be severely damaged, and we could lose
existing or potential future business. Even if the performance failure is
corrected, this performance failure might have the long-term effect of harming
our ability to market and sell our batteries.
Page 20
WE DEPEND ON A SMALL NUMBER OF CUSTOMERS FOR OUR REVENUES, AND OUR RESULTS OF
OPERATIONS AND FINANCIAL CONDITION COULD BE HARMED IF WE WERE TO LOSE THE
BUSINESS OF ANY ONE OF THEM.
To date, our existing purchase orders in commercial quantities are from a
limited number of customers. We anticipate that sales of our products to a
limited number of key customers will continue to account for a significant
portion of our total revenues. We do not have long-term agreements with any of
our customers and do not expect to enter into any long-term agreements in the
near future. As a result, we face the substantial risk that one or more of the
following events could occur:
o reduction, delay or cancellation of orders from a customer;
o development by a customer of other sources of supply;
o selection by a customer of devices manufactured by one of our
competitors for inclusion in future product generations;
o loss of a customer or a disruption in our sales and distribution
channels; or
o failure of a customer to make timely payment of our invoices.
If we were to lose one or more customers, or if we were to lose revenues due to
a customer's inability or refusal to continue to purchase our batteries, our
business, results of operations and financial condition could be harmed.
THE FACT THAT WE DEPEND ON A SOLE SOURCE SUPPLIER OR A LIMITED NUMBER OF
SUPPLIERS FOR KEY RAW MATERIALS MIGHT DELAY OUR PRODUCTION OF BATTERIES.
We depend on a sole source supplier or a limited number of suppliers for certain
key raw materials used in manufacturing and developing our batteries. We
generally purchase raw materials pursuant to purchase orders placed from time to
time and have no long-term contracts or other guaranteed supply arrangements
with our sole or limited source suppliers. As a result, our suppliers may not be
able to meet our requirements relative to specifications and volumes for key raw
materials, and we may not be able to locate alternative sources of supply at an
acceptable cost. We have in the past experienced delays in product development
due to the delivery of nonconforming raw materials from our suppliers, and if in
the future we are unable to obtain high quality raw materials in sufficient
quantities on competitive pricing terms and on a timely basis, it may delay
battery production, impede our ability to fulfill existing or future purchase
orders and harm our reputation and profitability.
WE HAVE FOUR KEY EXECUTIVES. THE LOSS OF A SINGLE EXECUTIVE OR THE FAILURE TO
HIRE AND INTEGRATE CAPABLE NEW EXECUTIVES COULD HARM OUR BUSINESS.
Other than our written employment agreement with Stephan B. Godevais, our
President and Chief Executive Officer, we do not have written employment
contracts and do not have key man life insurance policies with respect to any of
our key members of management. Without qualified executives, we face the risk
that we will not be able to effectively run our business on a day-to-day basis
or execute our long-term business plan.
OUR REVENUE FROM LICENSE FEES AND ROYALTIES WILL DEPEND SIGNIFICANTLY ON THE
SUCCESS OF OUR LICENSEES AND THE MARKET DEMAND FOR THEIR PRODUCTS.
We expect to generate income from license fees as well as ongoing royalties
based on sales by licensees that design, manufacture and sell batteries
incorporating our technology. License fees will be nonrefundable and may be paid
in one or more installments. Ongoing royalties will be nonrefundable and
generally based on a percentage of the selling price of the batteries that
incorporate our technology sold by the licensee. Because we expect to derive a
portion of our future revenues from royalties on shipments by our licensees, our
future success depends upon the ability of our licensees to develop and
introduce high volume batteries that achieve and sustain market acceptance. If
our licensees are not successful or the demand for lithium-ion polymer
batteries, Saphion(TM) technology batteries or devices utilizing these batteries
does not increase, our revenues and profitability will be adversely affected. In
addition, our license fee revenues depend on our ability to gain additional
licensees within existing and new markets. A reduction in the demand for
lithium-ion polymer batteries, Saphion(TM) technology batteries, our loss of key
existing licensees or our failure to gain additional licensees could have a
material adverse effect on our business.
THERE IS A POTENTIAL SALES-CHANNEL CONFLICT BETWEEN OUR FUTURE TECHNOLOGY
LICENSEES AND US.
The acquisition of the Telcordia Technologies, Inc.'s intellectual property
assets and our Saphion(TM) technology licensing strategy has added significant
diversity to our overall business structure and our opportunities. We recognize
that there is
Page 21
potential for a conflict among our sales channels and those of our future
technology licensees. Although our manufacturing and marketing business
generally is complementary to our licensing business, sales-channel conflicts
may arise. If these potential conflicts do materialize, we may not be able to
mitigate the effect of a conflict that, if not resolved, may impact our results
of operations.
OUR OXIDE-BASED BATTERIES, WHICH NOW COMPRISE A SMALL PORTION OF OUR AVAILABLE
PRODUCTS, CONTAIN POTENTIALLY DANGEROUS MATERIALS, WHICH COULD EXPOSE US TO
PRODUCT LIABILITY CLAIMS.
In the event of a short circuit or other physical damage to an oxide based
battery, a reaction may result with excess heat or a gas being generated and
released. If the heat or gas is not properly released, the battery may be
flammable or potentially explosive. We could, therefore, be exposed to possible
product liability litigation. In addition, our batteries incorporate potentially
dangerous materials, including lithium. It is possible that these materials may
require special handling or that safety problems may develop in the future. We
are aware that if the amounts of active materials in our batteries are not
properly balanced and if the charge/discharge system is not properly managed, a
dangerous situation may result. Battery pack assemblers using batteries
incorporating technology similar to ours include special safety circuitry within
the battery to prevent such a dangerous condition. We expect that our customers
will have to use a similar type of circuitry in connection with their use of our
oxide-based products.
ACCIDENTS AT OUR FACILITIES COULD DELAY PRODUCTION AND ADVERSELY AFFECT OUR
OPERATIONS.
An accident in our facilities could occur. Any accident, whether due to the
production of our batteries or otherwise resulting from our facilities'
operations, could result in significant manufacturing delays or claims for
damages resulting from personal or property injuries, which would adversely
affect our operations and financial condition.
WE DEPEND UPON THE CONTINUED OPERATION OF OUR NORTHERN IRELAND FACILITY.
OPERATIONAL PROBLEMS AT THIS FACILITY COULD HARM OUR BUSINESS.
Our revenues are dependent upon the continued operation of our manufacturing
facility in Northern Ireland. The operation of a manufacturing plant involves
many risks, including potential damage from fire or natural disasters. In
addition, we have obtained permits to conduct our business as currently operated
at the facility. If the facility were destroyed and rebuilt, there is a
possibility that these permits would not remain effective at the current
location, and we may not be able to obtain similar permits to operate at another
location. The occurrence of these or any other operational problems at our
Northern Ireland facility may harm our business.
WE EXPECT TO SELL A SIGNIFICANT PORTION OF OUR PRODUCTS TO AND DERIVE A
SIGNIFICANT PORTION OF OUR LICENSING REVENUES FROM CUSTOMERS LOCATED OUTSIDE THE
UNITED STATES. FOREIGN GOVERNMENT REGULATIONS, CURRENCY FLUCTUATIONS AND
INCREASED COSTS ASSOCIATED WITH INTERNATIONAL SALES COULD MAKE OUR PRODUCTS AND
LICENSES UNAFFORDABLE IN FOREIGN MARKETS, WHICH WOULD REDUCE OUR FUTURE
PROFITABILITY.
We expect that international sales of our products and licenses, as well as
licensing royalties, will represent an increasingly significant portion of our
sales. International business can be subject to many inherent risks that are
difficult or impossible for us to predict or control, including:
o changes in foreign government regulations and technical standards,
including additional regulation of rechargeable batteries or technology
or the transport of lithium and phosphate, which may reduce or eliminate
our ability to sell or license in certain markets;
o foreign governments may impose tariffs, quotas and taxes on our
batteries or our import of technology into their countries;
o requirements or preferences of foreign nations for domestic products
could reduce demand for our batteries and our technology;
o fluctuations in currency exchange rates relative to the United States
dollar could make our batteries and our technology unaffordable to
foreign purchasers and licensees or more expensive compared to those of
foreign manufacturers and licensors;
o longer payment cycles typically associated with international sales and
potential difficulties in collecting accounts receivable may reduce the
future profitability of foreign sales and royalties;
o import and export licensing requirements in Northern Ireland or other
countries where we intend to conduct business may reduce or eliminate
our ability to sell or license in certain markets; and
Page 22
o political and economic instability in Northern Ireland or other
countries where we intend to conduct business may reduce the demand for
our batteries and our technology or our ability to market our batteries
and our technology in those countries.
These risks may increase our costs of doing business internationally and reduce
our sales and royalties or future profitability.
WE MAY NEED TO EXPAND OUR EMPLOYEE BASE AND OPERATIONS IN ORDER TO EFFECTIVELY
DISTRIBUTE OUR PRODUCTS COMMERCIALLY, WHICH MAY STRAIN OUR MANAGEMENT AND
RESOURCES AND COULD HARM OUR BUSINESS.
To implement our growth strategy successfully, we will have to increase our
staff, primarily with personnel in sales, marketing, and product support
capabilities, as well as third party and direct distribution channels. However,
we face the risk that we may not be able to attract new employees to
sufficiently increase our staff or product support capabilities, or that we will
not be successful in our sales and marketing efforts. Failure in any of these
areas could impair our ability to execute our plans for growth and adversely
affect our future profitability.
COMPETITION FOR PERSONNEL, IN PARTICULAR FOR PRODUCT DEVELOPMENT AND PRODUCT
IMPLEMENTATION PERSONNEL, IS INTENSE, AND WE MAY HAVE DIFFICULTY ATTRACTING THE
PERSONNEL NECESSARY TO EFFECTIVELY OPERATE OUR BUSINESS.
We believe that our future success will depend in large part on our ability to
attract and retain highly skilled technical, managerial and marketing personnel
who are familiar with and experienced in the battery industry, as well as
skilled personnel to operate our facility in Northern Ireland. If we cannot
attract and retain experienced sales and marketing executives, we may not
achieve the visibility in the marketplace that we need to obtain purchase
orders, which would have the result of lowering our sales and earnings. We
compete in the market for personnel against numerous companies, including
larger, more established competitors with significantly greater financial
resources than us. We cannot be certain that we will be successful in attracting
and retaining the skilled personnel necessary to operate our business
effectively in the future.
THE LIMITED NUMBER OF SKILLED WORKERS IN NORTHERN IRELAND COULD AFFECT THE
SUCCESS OF OUR IMPROVEMENTS IN THE MANUFACTURING FACILITY.
We may need to hire and train additional manufacturing workers. The availability
of skilled workers in Northern Ireland is limited because of a relatively low
unemployment rate. As a result, we face the risk that we may not:
o hire and train the new manufacturing workers necessary for the ramp-up
of our Mallusk, Northern Ireland manufacturing facility;
o develop improved processes;
o implement multiple production lines; or
o efficiently operate the Mallusk facility.
Our failure to efficiently automate our production on a timely basis, if at all,
could damage our reputation and relationships with future and existing
customers, cause us to lose business and potentially prevent us from
establishing the commercial viability of our products.
POLITICAL INSTABILITY IN NORTHERN IRELAND COULD INTERRUPT MANUFACTURING OF OUR
BATTERIES AND END-USER PRODUCTS AT OUR NORTHERN IRELAND FACILITY AND CAUSE US TO
LOSE SALES AND MARKETING OPPORTUNITIES.
Northern Ireland has experienced significant social and political unrest in the
past and we cannot assure you that these instabilities will not continue in the
future. Any political instability in Northern Ireland could temporarily or
permanently interrupt our manufacturing of batteries and end-user products at
our facility in Mallusk, Northern Ireland. Any delays could also cause us to
lose sales and marketing opportunities, as potential customers would find other
vendors to meet their needs.
RISKS ASSOCIATED WITH OUR INDUSTRY
IF COMPETING TECHNOLOGIES THAT OUTPERFORM OUR BATTERIES WERE DEVELOPED AND
SUCCESSFULLY INTRODUCED, THEN OUR PRODUCTS MIGHT NOT BE ABLE TO COMPETE
EFFECTIVELY IN OUR TARGETED MARKET SEGMENTS.
Rapid and ongoing changes in technology and product standards could quickly
render our products less competitive, or even obsolete. Other companies are
seeking to enhance traditional battery technologies, such as lead acid and
nickel cadmium or
Page 23
have recently introduced or are developing batteries based on nickel
metal-hydride, liquid lithium-ion and other emerging and potential technologies.
These competitors are engaged in significant development work on these various
battery systems, and we believe that much of this effort is focused on achieving
higher energy densities for low power applications such as portable electronics.
One or more new, higher energy rechargeable battery technologies could be
introduced which could be directly competitive with, or superior to, our
technology. The capabilities of many of these competing technologies have
improved over the past several years. Competing technologies that outperform our
batteries could be developed and successfully introduced, and as a result, there
is a risk that our products may not be able to compete effectively in our
targeted market segments.
We have invested in research and development of next-generation technology in
energy solutions. If we are not successful in developing and commercially
exploiting new energy solutions based on new materials, or we experience delays
in the development and exploitation of new energy solutions, compared to our
competitors, our future growth and revenues will be adversely affected.
OUR PRINCIPAL COMPETITORS HAVE GREATER FINANCIAL AND MARKETING RESOURCES THAN WE
DO AND THEY MAY THEREFORE DEVELOP BATTERIES SIMILAR OR SUPERIOR TO OURS OR
OTHERWISE COMPETE MORE SUCCESSFULLY THAN WE DO.
Competition in the rechargeable battery industry is intense. The industry
consists of major domestic and international companies, most of which have
financial, technical, marketing, sales, manufacturing, distribution and other
resources substantially greater than ours. There is a risk that other companies
may develop batteries similar or superior to ours. In addition, many of these
companies have name recognition, established positions in the market, and
long-standing relationships with OEMs and other customers. We believe that our
primary competitors are existing suppliers of liquid lithium-ion, competing
polymer and, in some cases, nickel metal-hydride batteries. These suppliers
include Sanyo, Matsushita Industrial Co., Ltd. (Panasonic), Sony, Toshiba, SAFT
and Electrovaya. All of these companies are very large and have substantial
resources and market presence. We expect that we will compete against
manufacturers of other types of batteries in our targeted application segments,
which include laptops, cellular telephones and personal digital assistant
products, on the basis of performance, size and shape, cost and ease of
recycling. There is also a risk that we may not be able to compete successfully
against manufacturers of other types of batteries in any of our targeted
applications.
LAWS REGULATING THE MANUFACTURE OR TRANSPORT OF BATTERIES MAY BE ENACTED WHICH
COULD RESULT IN A DELAY IN THE PRODUCTION OF OUR BATTERIES OR THE IMPOSITION OF
ADDITIONAL COSTS THAT WOULD HARM OUR ABILITY TO BE PROFITABLE.
At the present time, international, federal, state or local law does not
directly regulate the storage, use and disposal of the component parts of our
batteries or the transport of our batteries. However, laws and regulations may
be enacted in the future which could impose environmental, health and safety
controls on the storage, use, and disposal of certain chemicals and metals used
in the manufacture of lithium polymer batteries as well as regulations governing
the transport of our batteries. Satisfying any future laws or regulations could
require significant time and resources from our technical staff and possible
redesign which may result in substantial expenditures and delays in the
production of our product, all of which could harm our business and reduce our
future profitability.
GENERAL RISKS ASSOCIATED WITH STOCK OWNERSHIP
AT ANY GIVEN TIME WE MIGHT NOT MEET THE CONTINUED LISTING REQUIREMENTS OF THE
NASDAQ SMALLCAP MARKET.
Given the volatility of our stock and trends in the stock market in general, at
any given time we might not meet the continued listing requirements of the
Nasdaq SmallCap Market. On September 26, 2002, we received notice from NASDAQ
that we had 180 days, or until March 25, 2003, to regain compliance with the
minimum bid price requirement ($1.00). We can regain compliance if, at anytime
before March 25, 2003, the bid price of our common stock closes at $1.00 per
share or more for a minimum of 10 consecutive trading days. On November 12,
2002, the closing sale price of our common stock was $0.90. Recent progress in
operations have generated a positive trend, but we cannot guarantee that this
positive movement will continue. Therefore, if we do not regain compliance with
the minimum bid price requirement (or if following regaining compliance our
stock again drops below $1.00 for an extended period of time) or we do not meet
any of the other requirements for continued listing, it could have a materially
adverse effect on the price and liquidity of our common stock.
Page 24
CORPORATE INSIDERS OR THEIR AFFILIATES WILL BE ABLE TO EXERCISE SIGNIFICANT
CONTROL OVER MATTERS REQUIRING STOCKHOLDER APPROVAL THAT MIGHT NOT BE IN THE
BEST INTERESTS OF OUR STOCKHOLDERS AS A WHOLE.
As of November 12, 2002, our officers, directors and their affiliates as a group
beneficially owned approximately 22.7% of our outstanding common stock. Carl
Berg, one of our directors, owns a substantial portion of that amount. As a
result, these stockholders will be able to exercise significant control over all
matters requiring stockholder approval, including the election of directors and
the approval of significant corporate transactions, which could delay or prevent
someone from acquiring or merging with us. The interest of our officers and
directors, when acting in their capacity as stockholders, may lead them to:
o vote for the election of directors who agree with the incumbent
officers' or directors' preferred corporate policy; or
o oppose or support significant corporate transactions when these
transactions further their interests as incumbent officers or directors,
even if these interests diverge from their interests as stockholders per
se and thus from the interests of other stockholders.
SOME PROVISIONS OF OUR CHARTER DOCUMENTS MAY MAKE TAKEOVER ATTEMPTS DIFFICULT,
WHICH COULD DEPRESS THE PRICE OF OUR STOCK AND LIMIT THE PRICE POTENTIAL
ACQUIRERS MAY BE WILLING TO PAY FOR OUR COMMON STOCK.
Our board of directors has the authority, without any action by the
stockholders, to issue additional shares of our preferred stock, which shares
may be given superior voting, liquidation, distribution and other rights as
compared to those of our common stock. The rights of the holders of our capital
stock will be subject to, and may be adversely affected by, the rights of the
holders of any preferred stock that may be issued in the future. The issuance of
additional shares of preferred stock could have the effect of making it more
difficult for a third party to acquire a majority of our outstanding voting
stock. These provisions may have the effect of delaying, deferring or preventing
a change in control, may discourage bids for our common stock at a premium over
its market price and may decrease the market price, and infringe upon the voting
and other rights of the holders, of our common stock.
OUR STOCK PRICE IS VOLATILE.
The market price of the shares of our common stock has been and is likely to
continue to be highly volatile. Factors that may have a significant effect on
the market price of our common stock include the following:
o fluctuation in our operating results;
o announcements of technological innovations or new commercial products by
us or our competitors;
o failure to achieve operating results projected by securities analysts;
o governmental regulation;
o developments in our patent or other proprietary rights or our
competitors' developments;
o our relationships with current or future collaborative partners; and
o other factors and events beyond our control.
In addition, the stock market in general has experienced extreme volatility that
often has been unrelated to the operating performance of particular companies.
These broad market and industry fluctuations may adversely affect the trading
price of our common stock, regardless of our actual operating performance.
As a result of this potential stock price volatility, investors may be unable to
sell their shares of our common stock at or above the cost of their purchase
prices. In addition, companies that have experienced volatility in the market
price of their stock have been the object of securities class action litigation.
If we were the subject of securities class action litigation, this could result
in substantial costs, a diversion of our management's attention and resources
and harm to our business and financial condition.
FUTURE SALES OF CURRENTLY OUTSTANDING SHARES COULD ADVERSELY AFFECT OUR STOCK
PRICE.
The market price of our common stock could drop as a result of sales of a large
number of shares in the market or in response to the perception that these sales
could occur. In addition these sales might make it more difficult for us to sell
equity or equity-related securities in the future at a time and price that we
deem appropriate. We had outstanding 61,149,303 shares of common stock as of
September 30, 2002. In addition, at September 30, 2002, we had 5,461,629 shares
of our common stock reserved for issuance under outstanding options and
warrants, and 7,422,049 additional shares reserved for issuance under our stock
option plans.
Page 25
SALES OF SHARES ELIGIBLE FOR FUTURE SALE COULD IMPAIR OUR STOCK PRICE.
Sales of a substantial number of shares of common stock in the public market, or
the perception that sales could occur, could adversely affect the market price
for our common stock. These factors could also make it more difficult to raise
funds through future offerings of common stock.
WE DO NOT INTEND TO PAY DIVIDENDS AND THEREFORE STOCKHOLDERS WILL ONLY BE ABLE
TO RECOVER THEIR INVESTMENT IN OUR COMMON STOCK, IF AT ALL, BY SELLING THE
SHARES OF OUR STOCK THAT THEY HOLD.
Some investors favor companies that pay dividends. We have never declared or
paid any cash dividends on our common stock. We currently intend to retain any
future earnings for funding growth and we do not anticipate paying cash
dividends on our common stock in the foreseeable future. Because we may not pay
dividends, a return on an investment in our stock likely depends on the ability
to sell our stock at a profit.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We considered the provisions of Financial Reporting Release No. 48 "Disclosures
of Accounting Policies for Derivative Financial Instruments and Derivative
Commodity Instruments, and Disclosures of Quantitative and Qualitative
Information about Market Risk Inherent in Derivative Commodity Instruments." We
had no holdings of derivative financial or commodity instruments at September
30, 2002. However, we are exposed to financial market risks, including changes
in foreign currency exchange rates and interest rates.
We have long-term debt, in the form of two building mortgages, which bear
interest at a adjustable rates based on the Bank of England base rate plus 1.5%
and 1.75% (5.5% and 5.75%, respectively at September 30, 2002). We also have
long-term debt in the form of two loans, which mature in September 2005, to a
stockholder. The first loan has an adjustable rate of interest at 1% above the
lenders borrowing rate (9% at September 30, 2002) and the second loan has a
fixed interest rate of 8%. The table below presents principal amounts by fiscal
year for our long-term debt.
2003 2004 2005 2006 2007 THEREAFTER TOTAL
------ ------ ------ ------ ------ ---------- -------
(dollars in thousands)
Liabilities:
Fixed rate debt: -- -- -- 17,929 -- -- 17,929
Variable rate debt 325 828 875 15,874 978 2,773 21,653
Based on borrowing rates currently available to us for loans with similar terms,
the carrying value of its debt obligations approximates fair value.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period prior to the date of this report, we carried out an
evaluation under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, of
the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13a-14(c) and 15(d)-14(c) of the Securities Exchange
Act of 1934. Based upon that evaluation, our principal executive officer and our
principal financial officer concluded that our disclosure controls and
procedures are effective in timely alerting them to material information
relating to us required to be included in this quarterly report on Form 10-Q.
There have been no significant changes in our internal controls or in other
factors, which could significantly affect internal controls subsequent to the
date that we carried out our evaluation.
Page 26
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On September 30, 2002, we sold 9,457,159 shares of our restricted common stock
at an aggregate price of $5.0 million to Berg & Berg, an affiliate of Carl Berg,
a director and principal stockholder, in a private placement transaction exempt
from registration pursuant to Section 4(2) of the Securities Act of 1933, as
amended.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a)(b)(c) On August 27, 2002, we held an annual meeting of our stockholders
for the fiscal year ended March 31, 2002. Our stockholders voted on the
following matters at the annual meeting:
(i) The following individuals were elected as our directors for terms expiring
at our 2003 annual meeting of stockholders (there were no votes against or
broker non-votes):
NOMINEE VOTES IN FAVOR VOTES ABSTAINED
- ------------------- -------------- ---------------
Carl E. Berg 48,583,410 975,863
Stephan B. Godevais 48,050,425 1,508,848
Bert C. Roberts, Jr. 48,553,670 1,005,603
Alan F. Shugart 48,566,873 992,400
(ii) Approval of the $30 million financing commitment we entered into with Berg
& Berg Enterprises, LLC. There were no broker non-votes.
VOTES IN FAVOR VOTES AGAINST VOTES ABSTAINED
-------------- ------------- ---------------
47,859,284 1,582,174 117,815
(iii) Approval of an amendment to our 2000 Stock Incentive Plan to increase the
number of shares of our common stock reserved for issuance under that plan by
500,000. There were no broker non-votes.
VOTES IN FAVOR VOTES AGAINST VOTES ABSTAINED
-------------- ------------- ---------------
40,287,625 9,091,711 179,937
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Waiver to Berg & Berg financing commitment, dated November 4,
2002.
10.2 Amendment to loan agreements with Berg & Berg, dated November 8,
2002.
99.1 Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
(b) Reports on Form 8-K:
(1) Report on Form 8-K, filed August 22, 2002, reporting under Item 5
reporting that commencing August 23, 2002, our common stock would be trading on
the Nasdaq SmallCap market.
Page 27
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
VALENCE TECHNOLOGY, INC.
Date: November 13, 2002 By: /s/ Stephan B. Godevais
-------------------------------------
Stephan B. Godevais
President, Chief Executive Officer
and Chairman of the Board
By: /s/ Kevin W. Mischnick
-------------------------------------
Kevin W. Mischnick
Vice President of Finance (Principal
Financial and Accounting Officer)
Page 28
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
OF VALENCE TECHNOLOGY, INC.
I, Stephan B. Godevais, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Valence Technology,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002 /S/ STEPHAN B. GODEVAIS
----------------------------------------
Stephan B. Godevais, Principal Executive
Officer
Page 29
CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER
OF VALENCE TECHNOLOGY, INC.
I, Kevin W. Mischnick , certify that:
1. I have reviewed this quarterly report on Form 10-Q of Valence Technology,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002 /S/ KEVIN W. MISCHNICK
---------------------------------------
Kevin W. Mischnick, Principal Financial
Officer
Page 30
EXHIBIT INDEX
EXHIBIT NO.
10.1 Waiver to Berg & Berg financing commitment, dated November 4,
2002.
10.2 Amendment to loan agreements with Berg & Berg, dated November 8,
2002.
99.1 Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
Page 31