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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 June 30, 2003.
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, 78730
AUSTIN, TEXAS (Zip Code)
(Address of Principal Executive Offices)
(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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No [x]
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 71,735,368
(Class) (Outstanding at August 8, 2003)
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2003
INDEX
PAGES
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets as of
June 30, 2003 and March 31, 2003......................................................3
Condensed Consolidated Statements of Operations and
Comprehensive Loss for Each of the Three-
Month Periods Ended June 30, 2003 and June 30, 2002...................................4
Condensed Consolidated Statements of Cash Flows
for Each of the Three-Month Periods
Ended June 30, 2003 and June 30, 2002.................................................5
Notes to Condensed Consolidated Financial Statements..................................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................................14
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........................27
Item 4. Controls and Procedures..............................................................28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................................29
Item 2. Changes in Securities and Use of Proceeds............................................29
Item 3. Defaults on Senior Securities........................................................29
Item 4. Submission of Matters to a Vote of Security Holders..................................29
Item 5. Other Matters........................................................................29
Item 6. Exhibits and Reports on Form 8-K.....................................................29
SIGNATURE .....................................................................................30
2
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(unaudited)
June 30, 2003 March 31, 2003
-------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents $ 8,667 $ 6,616
Trade receivables, net of allowance of $130
as of June 30, 2003 and March 31, 2003 805 1,218
Inventory 4,907 2,757
Prepaid and other current assets 1,344 1,495
--------------- -----------------
Total current assets 15,723 12,086
Property, plant and equipment, net 14,405 14,279
Intellectual property, net 9,427 9,789
--------------- -----------------
Total assets $ 39,555 $ 36,154
=============== =================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of long-term debt $ 852 $ 810
Accounts payable 3,173 3,511
Accrued expenses 2,634 2,013
Deferred revenue 1,452 14
Grant payable 1,797 1,715
-------------- ---------------
Total current liabilities 9,908 8,063
Long-term interest 7,483 6,744
Long-term debt, less current portion 5,725 5,623
Long-term debt to stockholder 33,419 33,242
--------------- -----------------
Total liabilities 56,535 53,672
--------------- -----------------
Commitments and contingencies
Stockholders' equity (deficit):
Preferred stock, $0.001 par value, authorized, issued and
outstanding 1,000 shares at June 30, 2003 8,577 -
Common stock, $0.001 par value, authorized: 100,000,000 shares,
issued and outstanding: 71,734,022 and 71,722,794 shares
at June 30, 2003 and March 31, 2003, respectively 72 72
Additional paid-in capital 367,762 366,518
Deferred compensation (212) (181)
Notes receivable from stockholder (4,953) (5,161)
Accumulated deficit (384,109) (374,604)
Accumulated other comprehensive loss (4,117) (4,162)
--------------- -----------------
Total stockholders' equity (deficit) (16,980) (17,518)
--------------- -----------------
Total liabilities and stockholders
equity (deficit) $ 39,555 $ 36,154
=============== =================
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands, except per share amounts)
(unaudited)
June 30, 2003 June 30, 2002
-------------------- -------------------
Revenue:
Licensing and royalty revenue $ 556 $ 1
Battery and system sales 1,075 508
-------------------- -------------------
Total revenues 1,631 509
Cost of sales: 3,818 2,522
-------------------- -------------------
Gross profit (loss) (2,187) (2,013)
Operating expenses:
Research and product development 2,056 2,798
Marketing 958 783
General and administrative 2,468 2,413
Depreciation and amortization 788 645
-------------------- -------------------
Total costs and expenses 6,270 6,639
-------------------- -------------------
Operating loss (8,457) (8,652)
Interest and other income 80 116
Interest expense (1,112) (1,123)
------------------ -----------------
Net loss (9,489) (9,659)
Preferred stock dividends accrued 16
Net loss available to common
stockholders $ (9,505) $ (9,659)
==================== ===================
Other comprehensive loss:
Net loss $ (9,489) $ (9,659)
Change in foreign currency
translation adjustments 45 60
-------------------- -------------------
Comprehensive loss $ (9,444) $ (9,599)
==================== ===================
Net loss per share $ (0.13) $ (0.19)
==================== ===================
Net loss per share available to
common stockholders $ (0.13) $ (0.19)
==================== ===================
Shares used in computing net
loss per share available
to common stockholders,
basic and diluted 71,728 51,488
==================== ===================
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three Months Three Months
Ended Ended
June 30, 2003 June 30, 2002
-------------- -------------
Cash flows from operating activities:
Net loss $ (9,489) $ (9,659)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 788 645
Compensation related to stock options 15 -
Accretion of debt discount 177 339
Interest income on shareholder note receivable (69) (69)
Beneficial conversion of preferred stock 17 -
Warrant accretion for preferred stock 52 -
Deferred compensation expense 250 -
Changes in operating assets and liabilities:
Trade receivables 413 (155)
Other current assets 172 415
Inventory (2,151) (1,277)
Accounts payable (359) 1,304
Accrued expenses and long-term interest 1,275 (316)
Deferred revenue 1,438 -
--------------- ---------------
Net cash used in operating activities (7,471) (8,773)
--------------- ---------------
Cash flows from investing activities:
Purchases of property, plant & equipment (62) (449)
Proceeds from investments --------------- ---------------
Net cash used in investing activities (62) (449)
--------------- ---------------
Cash flows from financing activities:
Proceeds of long-term debt 277 600
Other long-term debt (164) (207)
Proceeds from issuance of preferred stock,
net of issuance costs 9,458 -
Proceeds from issuance of common stock and warrants,
net of issuance costs - 15,150
--------------- ---------------
Net cash provided by financing activities 9,571 15,543
--------------- ---------------
Effect of foreign exchange rates on cash
and cash equivalents 13 124
--------------- ---------------
Increase (decrease) in cash and cash equivalents 2,051 6,445
Cash and cash equivalents, beginning of period 6,616 623
--------------- ---------------
Cash and cash equivalents, end of period $ 8,667 $ 7,068
=============== ===============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(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 June 30, 2003, its
consolidated results of operations for each of the three-month periods
ended June 30, 2003 and June 30, 2002, and the consolidated cash flows for
each of the three-month periods ended June 30, 2003 and June 30, 2002.
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, 2003. The results for the three-month
period ended June 30, 2003 are not necessarily indicative of the results to
be expected for the entire fiscal year ending March 31, 2004. The year-end
condensed consolidated balance sheet data as of March 31, 2003 was derived
from audited financial statements, but does not include all disclosures
required by generally accepted accounting principles.
2. LIQUIDITY AND CAPITAL RESOURCES:
At June 30, 2003, the Company's principal sources of liquidity were cash
and cash equivalents of $8.7 million and $24 million available under
financing commitments with Berg & Berg ($10 million remaining under Berg &
Berg's equity line of credit, $10 million under a new financing commitment
discussed in Note 4 and $4 million under a working capital commitment). As
described in Note 4, Financing, in the first quarter of fiscal 2004, the
Company consummated a private placement of preferred stock that resulted in
approximately $9.5 million of net proceeds. As a result of the Company's
success in arranging alternative financing in 2002 and 2003, Berg & Berg
has a contractual right to reduce or terminate its remaining $10 million
commitment under the equity line of credit. However, Berg & Berg has not
elected to reduce its commitment to date. The equity line of credit expires
on March 31, 2004 and the Company's right to draw on the line is limited to
$5 million per quarter and is further conditioned on Stephan Godevais
remaining as CEO. At June 30, 2003, the Company had commitments for capital
expenditures of approximately $82,000.
At the Company's current level of operations, it is using cash from
operations of approximately $6.0 to $9.5 million per quarter. The Company's
cash requirements may vary materially from those now planned because of
changes in its operations, including changes in OEM relationships, market
conditions, or joint venture and business opportunities. To sustain its
operations for a longer period of time than can be funded from operations
and its commitments from Berg & Berg, the Company may need to seek
additional financing.
The Company believes that its existing cash and cash equivalents,
anticipated cash flows from its operating activities and available
financing will be sufficient to fund its working capital and capital
expenditure needs through fiscal 2004. If the Company's working capital
requirements and capital expenditures are greater than it expects, it may
need to raise additional debt or equity financing in order to provide for
its operations. Additionally, if Berg & Berg does not provide the Company
additional funding under its commitments, 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.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
REVENUE RECOGNITION:
Revenues are generated from licensing fees and royalties per technology
license agreements and sales of products including batteries and battery
systems. Licensing fees are recognized as revenue upon completion of an
executed agreement and delivery of licensed information, if there are no
significant remaining vendor obligations and collection of the related
receivable is reasonably assured. Royalty revenues are recognized as
revenue upon receipt of cash payment from the licensee. Product sales are
recognized when the sale is complete, when all of the following criteria
are met: persuasive evidence of an arrangement exists, delivery has
occurred, seller's price to the buyer is fixed and determinable, and
collectibility is reasonably assured. Product shipments that are not
recognized as
6
revenue during the period shipped are recorded as deferred revenue and
reflected as a liability on the Company's balance sheet.
STOCK-BASED COMPENSATION:
The Company accounts for equity instruments issued to non-employees in
accordance with the provisions of SFAS No. 123 ("SFAS 123"), "Accounting
for Stock-Based Compensation," as amended by SFAS No. 148 ("SFAS 148"),
"Accounting for Stock-Based Compensation - Transition and Disclosure an
amendment of FASB Statement No. 123," and consensus of the Emerging Issues
Task Force number 96-18. The Company accounts for stock-based employee
compensation arrangements in accordance with the provisions of Accounting
Principles Board Opinion No. 25 ("APB No. 25"), "Accounting for Stock
Issued to Employees" and complies with the disclosure provisions of SFAS
123, as amended by SFAS 148. Accordingly, no compensation expense has been
recognized for the Company's stock plans. Had compensation expense for the
stock plans been determined based on the fair value at the grant date for
options granted in the first quarters of fiscal 2004 and 2003 consistent
with the provisions of SFAS 123, as amended by SFAS 148, the pro forma net
loss would have been reported as follows (in thousands):
Three Months Ended
June 30, 2003 June 30, 2002
-----------------------------
Net loss available to stockholders - as reported $ (9,505) $ (9,659)
Add: stock-based compensation expense, net of related taxes (1,382) (1,701)
------- -------
Net loss available to stockholders - pro forma (10,887) (11,360)
Net loss available to stockholders per share - as reported (0.13) (0.19)
Net loss available to stockholders per share, basic
and diluted - pro forma (0.15) (0.22)
The fair value of each option grant is estimated at the date of grant using
the Black-Scholes pricing model with the following weighted average
assumptions for grants in the first quarters of fiscal 2004 and 2003:
2004 2003
---------------------------
Risk-free Interest Rate 2.46% 2.85%
Expected Life 5.00 years 4.71 years
Volatility 109.82% 106.52%
Dividend Yield - -
RECENT ACCOUNTING PRONOUNCEMENTS:
In December 2002, SFAS 148 was issued, which amends SFAS 123, to provide
alternative methods of transition for a voluntary change to the fair value
based method of accounting for stock-based employee compensation. It also
amends the disclosure requirements of SFAS 123 to require prominent
disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect
of the method used on reported results. Certain disclosure requirements
under SFAS 148 became effective for the Company beginning December 15, 2002
and the Company has complied with those requirements. The remaining
disclosure requirements under SFAS 148 became effective for the Company in
the first quarter of fiscal 2004. These additional reporting requirements
did not have a material impact on its financial statements.
In April 2003, SFAS No. 149 ("SFAS 149"), "Amendments of Statement 133 on
Derivative Instruments and Hedging Activities", was issued, which amends
and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging
activities under FASB Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities". The Company will adopt SFAS 149
beginning its second quarter of fiscal year 2004 and does not expect this
adoption to have a significant impact on its financial statements.
In May 2003, SFAS No. 150 ("SFAS 150"), "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity", was
issued, which establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. The Company adopted SFAS 150 in its first quarter
of fiscal year 2004. The adoption did not have a material impact on its
financial statements.
7
In May 2003, FIN 46, "Consolidation of Variable Interest Entities", was
issued, which clarifies the application of Accounting Research Bulletin No.
51, "Consolidated Financial Statements", to certain entities in which
equity investors do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance
its activities without additional subordinated financial support from other
parties. The Company will adopt FIN 46 beginning its second quarter of
fiscal year 2004 and does not expect this adoption to have a significant
impact on its financial statements.
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 June 30 were as
follows:
2003 2002
------------------ -----------------
Common stock options
Beginning of period 8,923,000 6,426,000
Granted (expired) during the period (159,000) 729,000
------------------ -----------------
End of period 8,764,000 7,155,000
Warrants to purchase common stock 3,590,000 3,237,000
------------------ -----------------
Total 12,354,000 10,392,000
================== =================
4. FINANCING:
On June 10, 2003, Berg & Berg committed to provide the Company an
additional $10 million in fiscal 2004, increasing its total available
financing commitments to $24 million ($10 million remaining under Berg &
Berg's equity line of credit, $10 million under this new financing
commitment and $4 million under a working capital commitment). The new
commitment is conditioned upon negotiation and execution of definitive
documents and any necessary shareholder approval under the rules of the
NASDAQ SmallCap Market. This issuance will be on competitive terms, which
will be finalized as part of the definitive documents.
On June 2, 2003, the Company raised $10 million (net proceeds of $9.5
million) through the sale of Series C Convertible Preferred Stock and
warrants to purchase common stock. The preferred stock is convertible into
common stock at $4.25 per share, which represents an 11.3% premium over the
closing price of the Company's common stock on May 22, 2003. The preferred
stock is redeemable by the holder upon maturity and upon the occurrence of
certain triggering or default events. Net proceeds from the financing will
be used for working capital purposes.
5. INVENTORY:
Inventory consisted of the following (in thousands) at:
June 30, 2003 March 31, 2003
----------------- -----------------
Raw Materials $ 674 $ 1,163
Work in Progress 1,522 1,385
Finished Goods 2,711 209
----------------- -----------------
$ 4,907 $ 2,757
================= =================
8
6. INTELLECTUAL PROPERTY:
Intellectual property is amortized over 8 years. Intellectual property,
consisted of the following (in thousands) at:
June 30, 2003 March 31, 2003
--------------- ---------------
Intellectual properties $13,602 $13,602
Less: accumulated
amortization (4,175) (3,813)
--------------- ---------------
Intellectual properties, net
of accumulated amortization 9,427 9,789
=============== ===============
Amortization expense on intellectual property at June 30, 2003 will be as
follows (in thousands):
Fiscal Year
------------------
Remainder of 2004 $1,088
2005 1,450
2006 1,450
2007 1,450
2008 1,450
Thereafter 2,539
---------
$9,427
=========
Amortization expense for the three months ended June 30, 2003 and June 30,
2002 was approximately $362,000, and $362,000, for each such three month
period.
7. DEBT TO STOCKHOLDER:
June 30, 2003 March 31, 2003
--------------- ----------------
(in thousands)
2001 Loan balance $20,000 $20,000
1998 Loan balance 14,950 14,950
Unaccreted debt discount (1,531) (1,708)
--------------- ----------------
Balance $33,419 $33,242
=============== ================
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. 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 June 30, 2003, accrued
interest on the loan totaled $2,242,000, which is included in long-term
interest. 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%. Through June 30, 2003, a total of $1,237,000 has been
accreted and included as interest expense. The amounts charged to interest
expense on the outstanding balance of the loan for the three-month periods
ended June 30, 2003 and June 30, 2002 were $404,000 and $342,000,
respectively.
In July 1998, the Company entered into 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
9
basis. In November 2000, the 1998 Loan agreement was amended to increase
the maximum amount to $15,000,000. As of June 30, 2003, 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 June 30, 2003). 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 June 30, 2003, accrued interest on the loan totaled
$5,087,000, 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
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 June 30,
2003, a total of $2,159,000 has been accreted. The amounts charged to
interest expense for the three-month periods ended June 30, 2003 and June
30, 2002 were $335,000 and $335,000, respectively.
8. COMMITMENTS AND CONTINGENCIES:
WARRANTIES:
The Company has established a warranty reserve in connection with the sale
of N-Charge(TM) Power Systems covering a warranty period ranging from 12 to
15 months during which time if a customer were to return the purchased
product due to a product performance issue, the Company would provide a
replacement unit. The Company has established its initial product warranty
reserves as 10% of N-Charge(TM) Power System sales. The Company will adjust
the percentage based on actual experience for future warranty provisions.
In addition, the Company has established a reserve for its 30 day right of
return policy under which a customer may return a purchased N-Charge(TM)
Power System. The Company has estimated its right of return liability as 5%
of the previous month's N-Charge(TM) Power System sales. The total warranty
liability as of June 30, 2003 is $197,000.
Product warranty liabilities at June 30, 2003 and March 31, 2003 are as
follows (in thousands):
June 30, 2003 March 31, 2003
----------------- -----------------
Beginning balance $ 123 -
Less: claims (37) (37)
Plus: accruals 111 160
----------------- -----------------
Ending Balance $ 197 123
================= =================
LITIGATION:
The Company is subject to various claims and litigation in the normal
course of business. In the opinion of management, all pending legal matters
are either covered by insurance or, if not insured, will not have a
material adverse impact on the Company's consolidated financial statements.
GRANTS:
Beginning in 1994, the Company has received employment and capital grants
from the Ireland Development Board, now known as Invest Northern Ireland,
or INI, for its Mallusk, Northern Ireland manufacturing facility. As a
result of the planned transition of manufacturing from the Mallusk facility
to China and other low cost manufacturing regions (see Note 12, Subsequent
Events) and the Company's desire to obtain unencumbered access to all of
its equipment for transfer to the Baoding Fengfan-Valence Battery Company
joint venture or for sale, the Company entered into negotiations with INI
to terminate the Letter of Offer, pursuant to which the INI would
unconditionally and irrevocably release the Company from all obligations,
liabilities, or claims under the Letter of Offer in exchange for $4.7
million of restricted common stock, payable in three installments over
three years (with an agreement by INI not to short the Company's common
stock at any time and not to trade the restricted common stock received for
at least
10
one year from the respective payment dates). The Company had previously
accrued a $1.7 million liability with respect to the INI claim. If the
settlement is consummated as contemplated, the Company would accrue an
additional liability of $3 million in its September 30, 2003 fiscal
quarter.
9. SERIES C REDEEMABLE CONVERTIBLE PREFERRED STOCK:
On June 2, 2003, the Company issued 1,000 shares of Series C Convertible
Preferred Stock ("Series C") and warrants to purchase the Company's common
stock for $10,000 per share, raising net proceeds of $9,458,000. Holders of
the Series C stock are entitled to receive dividends at an annual rate of
2%. The Series C stock is convertible to the Company's common stock at
$4.25 per share, which represents a premium of 11.3% over the closing price
of the Company's common stock on May 22, 2003, the date at which the
financial terms of the placement were set. The Company has the right to
force conversion of the Series C stock if the average of the volume
weighted average price of the Company's common stock for a ten consecutive
day trading period is at or above $6.38. The Series C stock matures on
December 2, 2004, unless converted to the Company's common stock prior to
that date. The costs of issuance of the Series C stock were $542,000,
consisting of investment banking and legal fees. These costs were deducted
from the gross proceeds.
In connection with the issue of the Series C stock, the Company issued to
the Series C holder warrants to purchase 352,900 shares of the Company's
common stock. The warrants are exercisable at a purchase price of $5.00 per
share and expire in June 2008. The warrants were valued at $1,029,000 using
the Black-Scholes valuation model and were recorded as a component of
common stock. The warrants were recorded at their relative fair value to
the Series C stock of 9%, or $933,199, and will accrete ratably over the
eighteen-month period of the Series C stock. Interest expense of $52,000
related to the warrant accretion was recognized in June 2003.
10. RELATED PARTY TRANSACTIONS:
In March 2002, the Company obtained a $30 million equity line of credit
with Berg & Berg, an affiliate of Carl Berg, a director and principal
shareholder in the Company. At June 30, 2003, there was $10.0 million
remaining on this equity line of credit. 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 two
years following the date of the commitment. 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 has agreed to register any
shares it issues to Berg & Berg under this commitment. As a result of the
Company's success in arranging alternative financing in 2002 and 2003, Berg
& Berg has a contractual right to reduce or terminate its remaining $10
million commitment under the equity line of credit. However, Berg & Berg
has not elected to reduce its commitment to date. The equity line of credit
expires on March 31, 2004 and the Company's right to draw on the line is
limited to $5 million per quarter and is further conditioned on Stephan
Godevais remaining as CEO.
On January 1, 1998, the Company granted options to Mr. Dawson, the
Company's then 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 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. As of June
30, 2003, amounts of $3,405,532 and $1,547,753 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 paid through March 4, 2003.
11
11. GEOGRAPHIC INFORMATION:
The Company conducts its business in two geographic segments.
Long lived asset information by geographic area at June 30, 2003 and March
31, 2003 is as follows (in thousands):
June 30, 2003 March 31, 2003
-------------- -----------------
United States $4,770 $4,930
International 19,062 19,138
-------------- -----------------
Total $23,832 $24,068
============== =================
Revenues by geographic area for the three-month periods ended June 30,
2002 and June 30, 2001 are as follows (in thousands):
June 30, 2003 June 30, 2002
-------------- ----------------
United States $ 912 $ 276
International 719 233
-------------- ----------------
Total $ 1,631 $ 509
============== ================
12. SUBSEQUENT EVENTS:
On July 9, 2003, Boading Fengfan-Valence Battery Company, a joint venture
between the Company and Fengfan Group, Ltd. ("Fengfan") was formed. On July
21, 2003, the Company announced that the joint venture had been granted a
business license for operations in China. 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 terms of the joint venture
agreement, the Company will contribute capital equipment, technology 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.
On August 13, 2003, the Company announced its successful qualification of
its OEM manufacturer in China, ATL, for Saphion products. Additionally, the
Company announced its plans to transition manufacturing from its Northern
Ireland facility to China and other low-cost manufacturing regions. The
Company expects the transition to be completed by the end of calendar 2003.
The Company estimates that the costs related to its transfer of
manufacturing from its Northern Ireland facility will range from $1.2
million to $3 million.
As a result of the planned transfer of manufacturing from the Northern
Ireland facility to China and other low-cost manufacturing regions, the
Company expects to incur an impairment charge on the long lived assets of
the facility per FASB Statement No. 144 "Accounting for Impairment or
Disposal of Long-Lived Assets". Additionally, subsequent to the first
fiscal quarter of 2004, the Company experienced progress on the development
of its cylindrical battery construction technology and expects greater
emphasis on the licensing of its cylindrical technology. As a result of
these developments, the Company estimates that the future cash flows
expected to be generated from its Northern Ireland facility and
intellectual property acquired in the Telcordia transaction in December
2000 will not exceed their carrying value, which will result in an
impairment charge to be recorded during the second fiscal quarter of 2004
against property, plant, and equipment and intellectual property. The
Company estimates that assets with a carrying amount of approximately $20.0
million will be written down by approximately between $13 million and $15
million to their fair value. Fair value will be based on estimated future
cash flows to be generated by these assets, discounted at the Company's
market rate of interest.
The Company has received employment and capital grants from the Ireland
Development Board, now known as Invest Northern Ireland, or INI, for its
Mallusk, Northern Ireland facility. As a result of the planned transition
of manufacturing from the Mallusk facility to China and other low cost
manufacturing regions and the Company's desire to obtain unencumbered
access to all of its equipment for transfer to the Baoding Fengfan-Valence
Battery Company joint venture or for sale, the Company entered into
negotiations with INI to terminate the Letter of Offer, pursuant to which
the INI would unconditionally and irrevocably release the Company from all
obligations,
12
liabilities, or claims under the Letter of Offer in exchange for $4.7
million of restricted common stock, payable in three installments over
three years.
13
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 EXCHANGE ACT AND SECTION 27A OF THE
SECURITIES ACT. THE WORDS "EXPECT", "ESTIMATE", "ANTICIPATE", "PREDICT",
"BELIEVE" AND SIMILAR EXPRESSIONS AND VARIATIONS THEREOF ARE INTENDED TO
IDENTIFY FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS APPEAR IN A NUMBER OF
PLACES IN THIS FILING AND INCLUDE STATEMENTS REGARDING THE INTENT, BELIEF OR
CURRENT EXPECTATIONS OF VALENCE TECHNOLOGY, INC. (THE "COMPANY," "VALENCE,"
"WE," OR "US"), OUR DIRECTORS OR OFFICERS WITH RESPECT TO, AMONG OTHER THINGS
(A) TRENDS AFFECTING OUR FINANCIAL CONDITION OR RESULTS OF OPERATIONS, (B) OUR
PRODUCT DEVELOPMENT STRATEGIES, TRENDS AFFECTING OUR MANUFACTURING CAPABILITIES
AND TRENDS AFFECTING THE COMMERCIAL ACCEPTABILITY OF OUR PRODUCTS, AND (C) OUR
BUSINESS AND GROWTH STRATEGIES. OUR STOCKHOLDERS ARE CAUTIONED NOT TO PUT UNDUE
RELIANCE ON SUCH FORWARD-LOOKING STATEMENTS. SUCH FORWARD-LOOKING STATEMENTS ARE
NOT GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE PROJECTED IN THIS REPORT, FOR
THE REASONS, AMONG OTHERS, DISCUSSED IN THE SECTIONS -- "MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS", AND "RISK
FACTORS." THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR
FINANCIAL STATEMENTS AND RELATED NOTES, WHICH ARE PART OF THIS REPORT OR
INCORPORATED BY REFERENCE TO OUR REPORTS FILED WITH THE COMMISSION. WE UNDERTAKE
NO OBLIGATION TO PUBLICLY REVISE THESE FORWARD-LOOKING STATEMENTS TO REFLECT
EVENTS OR CIRCUMSTANCES THAT ARISE AFTER THE DATE HEREOF.
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, 2003. THE RESULTS FOR
THE THREE-MONTH PERIOD ENDED JUNE 30, 2003 ARE NOT NECESSARILY INDICATIVE OF THE
RESULTS TO BE EXPECTED FOR THE ENTIRE FISCAL YEAR ENDING MARCH 31, 2004.
BUSINESS AND BUSINESS STRATEGY
We were founded in 1989. From 1989 through 2000, our efforts were focused
on developing and acquiring our battery technologies. 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, which
has fostered an extensive and worldwide portfolio of issued and pending patents.
With this strategic shift, our vision is to become a leader in energy storage
systems 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.
In February 2002, we unveiled our Saphion(TM) technology, a lithium-ion
technology which utilizes a phosphate-based cathode material. Traditional
lithium-ion technology utilizes an oxide-based cathode material, which has
limited its adoption to small applications such as notebook computers, cellular
phones and personal digital assistants (PDAs). We believe that Saphion(TM)
technology addresses the major weaknesses of this existing technology while
offering a solution that is competitive in cost and performance. We believe that
by incorporating a phosphate-based cathode material, our Saphion(TM) technology
is able to offer greater thermal and electrochemical stability than traditional
lithium-ion technologies.
Our business strategy incorporates a balance of system sales and licensing
and a manufacturing plan that leverages internal capabilities and partnerships
with contract manufacturers. We plan to capitalize on our Saphion(TM) technology
by designing solutions that differentiate end-users' products in both the large
format and small format markets. In addition, we will seek to expand the fields
of use of our Saphion(TM) technology through the licensing of our intellectual
property related to our battery chemistries and manufacturing processes.
We introduced our first product based on our Saphion(TM) technology, the
N-Charge(TM) Power System, in February 2002. The N-Charge(TM) Power System is a
rechargeable battery system that provides supplemental battery power for a wide
variety of portable electronic devices. Since the introduction of the
N-Charge(TM) Power System, we have focused our efforts on marketing the
N-Charge(TM) Power System to top tier companies in an effort to validate our
Saphion(TM) technology. We have successfully developed various channels for the
sale and distribution of the N-Charge(TM)system, including resellers, Tier One
companies, and national retailers. In February 2003, we introduced our first
large format energy storage system powered by our Saphion(TM) technology, the
K-Charge(TM) Power System (previously announced as the Pure Po4wer Pack). The
K-Charge(TM) Power System is engineered specifically for large format
applications such as those required by the telecommunications, industrial,
vehicular and utility markets. It is currently in a prototype stage and is being
offered to customers for evaluation and customization for specific product
requirements.
Currently, our battery products are offered in a stacked, polymer
construction. Our research and development efforts are focused on a new
generation of our Saphion(TM) technology which, in addition to expected enhanced
performance
14
characteristics, will provide us the ability to manufacture batteries using the
technology in a cylindrical construction, which we believe will greatly increase
its potential in the marketplace.
Historically, our polymer batteries have been primarily manufactured at our
manufacturing facility in Northern Ireland. We have an OEM arrangement with a
Chinese manufacturing facility and have utilized the OEM manufacturer's
capabilities for certain cobalt-oxide based products over the last several
quarters. In August 2003, we announced the qualification of our polymer OEM to
manufacture our Saphion(TM) products. In July 2003, we announced the grant of a
Chinese business license for our manufacturing joint venture in China with
Fengfan Group, Ltd. ("Fengfan"). Under the terms of the joint venture agreement,
we will contribute capital equipment, technology 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.
We intend to transition manufacturing from our Northern Ireland facility to
China and other low-cost manufacturing regions during the remainder of fiscal
2004. We will maintain a presence in Northern Ireland to manage European sales
and marketing activities and support our contract manufacturing partnerships and
joint venture company.
BASIS OF PRESENTATION, CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our consolidated financial statements in conformity with generally
accepted accounting principles in the U.S. Our accounting policies are described
in Note 3 of the Notes to Consolidated Financial Statements included in "Part 1
- -- Financial Information, Item 1 - Financial Statements". The preparation of our
financial statements requires us to make estimates and assumptions that affect
reported amounts. We believe our most critical accounting policies and estimates
relate to revenue recognition and impairment of long-lived assets.
REVENUE RECOGNITION: Revenues are generated from licensing fees and royalties
per technology license agreements and sales of products including batteries and
battery systems. Licensing fees are recognized as revenue upon completion of an
executed agreement and delivery of licensed information, if there are no
significant remaining obligations and collection of the related receivable is
reasonably assured. Royalty revenues are recognized as revenue upon receipt of
cash payment from the licensee. Product sales are recognized when the sale is
complete, when all of the following criteria are met: persuasive evidence of an
arrangement exists, delivery has occurred, seller's price to the buyer is fixed
and determinable, and collectibility is reasonably assured. Product shipments
that are not recognized as revenue during the period shipped are recorded as
deferred revenue and reflected as a liability on our balance sheet.
IMPAIRMENT OF LONG-LIVED ASSETS: SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," requires us to review long-lived tangible and
intangible assets for impairment whenever events or changes in circumstances
indicate the carrying amount of an asset may not be recoverable. Recoverability
of these assets is measured by comparison of its carrying amount to future
undiscounted cash flows the assets are expected to generate. If long-lived
assets are considered to be impaired, the impairment to be recognized equals the
amount by which the carrying value of the assets exceeds its fair market value
and is recorded in the period the determination was made. See Note 12,
Subsequent Events, regarding potential impairment of tangible and intangible
assets.
15
RESULTS OF OPERATIONS
THREE MONTH PERIODS ENDED JUNE 30, 2003 (FIRST QUARTER OF FISCAL 2004) AND JUNE
20, 2002 (FIRST QUARTER OF FISCAL 2003)
REVENUE. The following table summarizes revenue (in thousands) by type for the
first quarter of fiscal 2004 and fiscal 2003:
THREE MONTHS THREE MONTHS
ENDED ENDED PERCENTAGE
JUNE 30, 2003 JUNE 30, 2002 CHANGE
--------------- -------------- ---------------
Battery and system sales $1,075 $508 112%
--------------- -------------- ---------------
Licensing and royalty
revenue 556 1 55,500%
--------------- -------------- ---------------
Total revenues $1,631 $509 220%
--------------- -------------- ---------------
BATTERY AND SYSTEM SALES: Revenue from battery and system sales totaled $1.1
million and $508,000 for the first quarter of fiscal 2004 and 2003,
respectively. The $567,000 or 112% increase in battery and system sales was
primarily due to establishment of retail and reseller channels for our
N-Charge(TM) Power system product as well as increased volumes achieved through
our on-line store. Total product shipments for the first quarter of fiscal 2004
totaled $2.4 million representing an increase of approximately 400% over the
corresponding period in fiscal 2003 volumes. Product shipments that are not
recognized as revenue during the period shipped are recorded as deferred revenue
and reflected as a liability on the balance sheet. Shipments for which there
exists a potential right of return are accordingly recorded as deferred revenue
until sold through the respective sale channel.
LICENSING AND ROYALTY REVENUE: Licensing and royalty revenues relate to revenue
from licensing agreements for technology developed in-house and acquired from
Telcordia Technologies, Inc. in December 2000. Licensing and royalty revenue
totaled $556,000 for the first quarter of fiscal 2004 and was related to
royalties and license payments from Amperex Technology Limited. No licensing
revenue was recognized during the first quarter of fiscal 2003 and royalty
revenue totaled $1,000. We continue to pursue licensing of both our process and
chemistry patent portfolios.
COST OF SALES. Cost of sales consists primarily of expenses incurred to
manufacture battery and system products. Costs of sales totaled $3.8 million and
$2.5 million for the first quarter of fiscal 2004 and 2003, respectively. The
increase in cost of sales was largely due to increased product sales.
Additionally, we incurred higher temporary labor and overtime expenses in the
first quarter of fiscal 2004 to meet initial shipment deadlines for new
channels. We maintained a negative gross margin on our sales in both periods due
to insufficient production and sales volumes to facilitate the coverage of our
indirect and fixed costs. We expect cost of sales to continue decrease as a
percentage of sales as production and product sales volumes continue to increase
and as we continue to implement lower cost OEM manufacturing.
RESEARCH AND PRODUCT DEVELOPMENT. Research and product development expenses
consist primarily of personnel, equipment and materials to support our battery
and product research and development. Research and product development expenses
totaled $2.1 million and $2.8 million for the first fiscal quarters of 2004 and
2003, respectively. The $0.7 million or 26% decrease in research and development
expenses was primarily due to a reduction in headcount and related costs as a
result of our reorganization which took place in the third quarter of fiscal
2003. The decrease was partially offset by increased chemical and other
development expenses associated with continued our Saphion(TM) product family
development.
MARKETING. Marketing expenses consist primarily of costs related to sales and
marketing personnel, public relations and promotional materials. Marketing
expenses were $958,000 and $783,000 for the first quarter of fiscal 2004 and
2003, respectively. The $175,000 or 22% increase in marketing expenses during
fiscal 2004 was due to increased staffing and promotions to support expansion of
channels to sell our N-Charge(TM) power system and Saphion(TM) products. The
increase was partially offset by reorganization expenses incurred during the
first quarter of fiscal 2003.
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 totaled $2.5 million and $2.4 million the
first fiscal quarter of 2004 and 2003, respectively. The $0.1 million or 2%
increase in general and administrative expenses is related to costs related to
establishing a joint venture and for professional services in support of finance
and investor relations, offset by lower legal expenses and facilities costs.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses were
$788,000 and $645,000 million for the first fiscal quarter of 2004 and 2003,
respectively. The $143,000 or 22% increase in depreciation resulted primarily
from placement of installed machinery into service at our Northern Ireland
manufacturing facility in late fiscal 2003.
16
INTEREST AND OTHER INCOME. Interest and other income totaled $80,000 and
$116,000 first fiscal quarter of 2004 and 2003, respectively.
INTEREST EXPENSE. Interest expenses relate to mortgages on our Northern Ireland
facility as well as interest on our long-term debt to shareholder. Interest
expense was $1.1 million for fiscal quarters ended June 30, 2003 and June 30,
2002.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2003, our principal sources of liquidity were cash and cash
equivalents of $8.7 million, $24 million available under financing commitments
with Berg & Berg ($10 million remaining under Berg & Berg's equity line of
credit, $10 million under a new financing commitment discussed below and $4
million under a working capital commitment).
Our current forecasts project that these sources of liquidity will be
sufficient to allow us to execute on our current business plan without the need
for additional financing. Our current business plan contemplates that we will
realize increases in cash flow from the sale of our Henderson, Nevada and
Mallusk, Northern Ireland facilities, projected increases in product sales and
licensing revenue and further cash benefits from continued reductions in our
administrative and manufacturing costs, while maintaining capital expenditures
and expenditures for research and development at levels consistent with those
incurred in during fiscal 2003. However, our cash requirements may vary
materially from those now planned because of changes in our operations,
including changes in OEM relationships, market conditions, or joint venture and
business opportunities. If we are unable to realize our business plan or if our
cash requirements increase materially from those currently projected, we would
require additional debt or equity financing. There can be no assurance that we
could obtain the additional financing on reasonable terms, if at all.
On June 2, 2003 we raised net proceeds of approximately $9.5 million
through the sale of one thousand shares of newly issued Series C Preferred Stock
to an unaffiliated investor. The Series C Preferred Stock matures December 2,
2004 and carries a 2% annual dividend, paid quarterly in cash or shares of
common stock. On the maturity date, we will redeem for cash any unconverted
shares of the Series C Preferred Stock at their stated value plus any accrued
and unpaid dividends. Our current business plan contemplates conversion of all
shares of Series C Preferred Stock prior to their maturity date. If the Series C
Preferred Stock shares have not been converted by the maturity date, we may need
to raise additional debt or equity financing to facilitate any required
redemption. There can be no assurance that we could obtain the additional
financing on reasonable terms, if at all.
Currently, we do not have material sales to meet our operating needs.
Consequently, we are dependent on Berg & Berg's continued willingness to fund
our continued operations. As a result of our success in arranging alternative
financing in 2002 and 2003, Berg & Berg has a contractual right to reduce or
terminate its remaining $10 million commitment under the equity line of credit.
Berg & Berg has not elected to reduce its commitment to date. The equity line of
credit expires on March 31, 2004 and our right to draw down on the line is
limited to $5 million per quarter and is further conditioned on Stephan Godevais
remaining as CEO.
The additional $10.0 million funding commitment obtained from Berg & Berg
in June 2003 is subject to completion of definitive documentation and any
required stockholder approval.
At June 30, 2003, we had commitments for capital expenditures for the next
12 months of approximately $82,000 relating to the installation of specified
manufacturing equipment, which was included in accounts payable and accrued
expenses at June 30, 2003. We may require additional capital expenditures in
order to meet greater demand levels for our products than are currently
anticipated.
We used net cash from operations for the first quarter of fiscal 2004 and
2003 of $7.8 million and $8.8 million, respectively. The cash used for the first
quarter of our fiscal 2004 operating activities was due primarily to inventory
related working capital requirements, net loss and the add back of non-cash
expenses, including depreciation and amortization, accretion of debt discount,
and compensation related to issuance of stock options. The decrease in first
quarter fiscal 2004 operating cash requirements was due to lower net working
capital requirements.
We used $62,000 and $449,000 in investing activities during the first
quarter of fiscal 2004 and 2003, respectively. The decrease in first quarter
fiscal 2004 investing activities was due to the substantial completion of our
Northern Ireland facility.
We obtained cash from financing activities of $9.9 million and $15.5
million during the first quarter of fiscal 2004 and 2003, respectively.
17
As a result of the above, we had a net increase in cash and cash
equivalents of $2.1 million and $6.4 million in the first fiscal quarter of 2004
and 2003, respectively.
As of June 30, 2003, our short term and long-term debt obligations,
including long term interest, were $852,000 and $46.6 million, respectively.
During fiscal 2002, we reached an agreement with Berg & Berg to extend the
maturity date of our loan agreement with the loan balance of $14.95 million and
accrued interest of $4.8 million from August 30, 2002 to September 30, 2005.
Beginning in 1994, we have received employment and capital grants from the
Ireland Development Board, now known as Invest Northern Ireland, or INI, for our
Mallusk, Northern Ireland facility. As a result of the closing of the Mallusk
facility and our desire to obtain unencumbered access to all of our equipment
for transfer to our manufacturing joint venture with Fengfan or for sale, we
entered into negotiations with INI to terminate the Letter of Offer pursuant to
which the INI would unconditionally and irrevocably release the Company from all
obligations, liabilities, or claims under the Letter of Offer in exchange for
$4.7 million of restricted common stock, payable in three installments over
three years.
INFLATION
Historically, our operations have not been materially affected by
inflation. However, our operations may be affected by inflation in the future.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2002, SFAS No. 148 ("SFAS 148"), "Accounting for Stock-Based
Compensation - Transition and Disclosure an amendment of FASB Statement No.
123", was issued, which amends SFAS Statement No. 123 ("SFAS 123"), "Accounting
for Stock-Based Compensation," to provide alternative methods of transition for
a voluntary change to the fair value based method of accounting for stock-based
employee compensation. It also amends the disclosure requirements of SFAS 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. Certain disclosure requirements
under SFAS 148 became effective for us beginning December 15, 2002 and we have
complied with those requirements. The remaining disclosure requirements under
SFAS No. 148 became effective for us in the first quarter of fiscal 2004. The
additional reporting requirements did not have a material impact on our
financial statements.
In April 2003, SFAS No. 149 ("SFAS 149"), "Amendments of Statement 133 on
Derivative Instruments and Hedging Activities", was issued, which amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under FASB
Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities". We will adopt SFAS 149 beginning our second quarter of fiscal year
2004 and do not expect this adoption to have a significant impact on our
financial statements.
In May 2003, SFAS No. 150 ("SFAS 150"), "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity", was issued,
which establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. We
adopted SFAS 150 beginning our first quarter of fiscal year 2004. The adoption
did not have a material impact on our financial statements.
In May 2003, FIN 46, "Consolidation of Variable Interest Entities", was
issued, which clarifies the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements", to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. We will
adopt FIN 46 beginning our second quarter of fiscal year 2004 and do not expect
this adoption to have a significant impact on our financial statements.
18
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
EXECUTION OF OUR BUSINESS PLAN WITH OUR CURRENT AVAILABLE CAPITAL.
At June 30, 2003, our principal sources of liquidity were cash and cash
equivalents of $8.7 million and $10.0 million available under an equity line
financing commitment (subject to conditions discussed below), a $4 million
working capital commitment from Berg & Berg, and an additional $10.0 million
funding commitment, for which the terms will be negotiated at a later date, from
Berg & Berg Enterprises, LLC, an entity controlled by Carl E. Berg, a director
and principal stockholder of ours.
Our current forecasts project that these sources of liquidity will be sufficient
to allow us to execute on our current business plan without the need for
additional financing. Our current business plan contemplates that we will
realize increases in cash flow from the sale of our Henderson, Nevada facility,
projected increases in product sales and licensing revenue and further cash
benefits from continued reductions in our administrative and manufacturing
costs, while maintaining capital expenditures and expenditures for research and
development at levels consistent with those incurred in 2003. However, our cash
requirements may vary materially from those now planned because of changes in
our operations, including changes in OEM relationships, market conditions, or
joint venture and business opportunities., If we are unable to realize on our
business plan or if our cash requirements increase materially from those
currently projected, we would require additional debt or equity financing. There
can be no assurance that we could obtain the additional financing on reasonable
terms, if at all.
On June 2, 2003 we raised net proceeds of approximately $9.6 million through the
sale of one thousand shares of newly issued Series C Preferred Stock to The
Riverview Group, LLC. The Series C Preferred Stock matures December 2, 2004 and
carries a 2% annual dividend, paid quarterly in cash or shares of common stock.
On the maturity date, we will redeem for cash any unconverted shares of the
Series C Preferred Stock at their stated value plus any accrued and unpaid
dividends. We may also be required to redeem for cash any unconverted shares
prior to the maturity date upon the occurrence of certain default events. If the
Series C Preferred Stock shares have not been converted by the maturity date (or
we are required to redeem the shares prior to the maturity date), we may need to
raise additional debt or equity financing to facilitate any required redemption.
There can be no assurance that we could obtain the additional financing on
reasonable terms, if at all.
Currently, we do not have material sales to meet our operating needs.
Consequently, we are dependent on Berg & Berg's continued willingness to fund
our continued operations. Pursuant to the terms of the equity line financing
commitment, as a result of the offerings we completed in April 2002 and June
2003, Berg & Berg may elect to reduce or eliminate its remaining commitment of
$10 million. Berg & Berg has not elected to reduce its commitment to date.
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 conditioned on
Stephan Godevais remaining as CEO.
The additional $10.0 million funding commitment obtained in June 2003 is subject
to completion of definitive documentation and any required stockholder approval.
OUR WORKING CAPITAL REQUIREMENTS MAY INCREASE BEYOND THOSE CURRENTLY
ANTICIPATED.
We have planned for an increase in sales and, if we experience sales in excess
of our plan, our working capital needs and capital expenditures would likely
increase from that currently anticipated. Our ability to meet this additional
customer demand would be dependent on our ability to arrange for additional
equity or debt financing since it is likely that cash flow from sales is likely
to lag behind these increased working capital requirements. If our working
capital needs increase from that currently anticipated and we do not receive
additional financing from Berg & Berg, we may need to arrange for additional
equity or debt financing.
19
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 $400.4 million as of June 30, 2003. We have working
capital of $5.8 million as of June 30, 2003, and have sustained recurring losses
related primarily to the research and development and marketing of our products
combined with the lack of material sales. We expect to continue to incur
operating losses and negative cash flows during fiscal 2004, 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 WILL 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 WILL 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.
OUR PATENT APPLICATIONS MAY NOT RESULT IN ISSUED PATENTS, WHICH WOULD HAVE A
MATERIAL ADVERSE EFFECT ON OUR ABILITY TO COMMERCIALLY EXPLOIT OUR PRODUCTS.
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.
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.
20
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 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
and/or prismatic 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.
IN ADDITION TO OUR OWN PRODUCT LINES, OUR BATTERIES ARE INTENDED TO BE
INCORPORATED INTO OTHER PRODUCTS. WE WILL NEED TO RELY ON OEMS TO COMMERCIALIZE
THESE PRODUCTS.
Our business strategy contemplates that we will be required to rely 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
21
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 WILL ADVERSELY
AFFECT OUR REVENUE, CASH FLOW AND PROFITABILITY.
As a result of the intellectual property assets we have acquired and internally
developed, such as 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:
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.
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 potential for a conflict among our sales channels and those of our
future technology licensees. 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 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 at our internal manufacturing site and reduce costs
through the effective utilization of OEM partners. We have recently entered into
a manufacturing OEM relationship with a Chinese manufacturing facility. In
addition, we have recently formed a manufacturing joint venture in China. This
is part of our strategic plan to transition during the remainder of fiscal 2004
all of our high volume manufacturing to China and other low cost manufacturing
areas. We have completed the qualification of the OEM manufacturer but have not
yet ordered or received product in commercial quantities. The joint venture will
need to construct a manufacturing facility (using, in part, the technology and
equipment contributed by us) before it is able to manufacture batteries. In the
interim, we are closing our Northern Ireland manufacturing facility because of
its high cost of manufacturing. We expect to have sufficient inventory on hand
at the time of closure to meet our anticipated customer demand for the immediate
future. However, if our OEM partner is unable to manufacture product in
commercial quantities on a timely and efficient basis and/or manufacturing joint
venture suffers delays in constructing its facility, or fails to timely and
efficiently manufacture product, we could lose our current customers and fail to
attract future customers.
OUR ABILITY TO MANUFACTURE LARGE VOLUMES OF BATTERIES IS LIMITED AND MAY PREVENT
US FROM FULFILLING ORDERS.
We have been manufacturing batteries on a commercial scale to fulfill purchase
orders and we are able to produce sufficient quantities of batteries to supply
our current customer demands. We are actively soliciting additional purchase
orders. 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.
22
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. This performance failure might have the
long-term effect of harming our ability to market and sell our batteries.
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. During fiscal 2003, revenue from two customers,
Alliant Techsystems Inc. and Pabion Corporation, Ltd., each comprised more than
10% of total revenues. During fiscal 2002, revenue from four customers, Hanil
Joint Venture, Amperex Technology Limited, Alliant Techsystems Inc., and Samsung
Corporation, each comprised more than 10% of total revenues. For fiscal 2001,
revenue from four customers Alliant Techsystems Inc., MicroEnergy Technologies
Inc., Moltech Corporation, and Qualcomm, each comprised more than 10% of total
revenues. 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 ANY OF WHICH COULD HARM OUR BUSINESS.
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. We do not have key man life insurance policies with respect to
any of our key members of management.
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
23
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.
Until we successfully transition our manufacturing operations to China and other
low cost manufacturing areas, 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
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.
24
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. 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.
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 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. Most 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.
25
LAWS REGULATING THE MANUFACTURE OR TRANSPORTATION 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. 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. 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. The transportation of lithium and lithium ion batteries is
regulated both internationally and domestically. Under recently revised United
Nations recommendations and as adopted by the International Air Transport
Association (IATA), our N-Charge(TM) system currently falls within the level
such that it is no longer exempt and now requires a class 9 designation for
transportation. The revised United Nations recommendations are not U.S. law
until such time as they are incorporated into the DOT Hazardous Material
Regulations. However, DOT has proposed new regulations harmonizing with the UN
guidelines. At present it is not known if or when the proposed regulations would
be adopted by the US. While we fall under the equivalency levels for the US and
comply with all safety packaging requirements worldwide, future DOT or IATA
regulations or enforcement policies could impose costly transportation
requirements. In addition, compliance with any new DOT and IATA approval process
could require significant time and resources from our technical staff and if
redesign were necessary, could delay the introduction of new products.
GENERAL RISKS ASSOCIATED WITH STOCK OWNERSHIP
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 August 8, 2003, our officers, directors and their affiliates as a group
beneficially owned approximately 34.2% of our outstanding common stock. Carl
Berg, one of our directors, beneficially owns approximately 31.3% of our
outstanding common stock. 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.
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. Among other requirements, Nasdaq requires the minimum
bid price of a company's registered shares to be $1.00. On August 8, 2003, the
closing sale price of our common stock was $2.98. If we are not able to maintain
the requirements for continued listing on the NASDAQ SmallCap Market, it could
have a materially adverse effect on the price and liquidity of our common stock.
OUR STOCK PRICE IS VOLATILE, WHICH COULD RESULT IN A LOSS OF YOUR INVESTMENT.
26
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 71,734,022 shares of common stock as of
June 30, 2003. In addition, at June 30, 2003, we had 5,161,629 shares of our
common stock reserved for issuance under outstanding options and warrants, and
7,325,425 additional shares reserved for issuance under our stock option plans.
In connection with the potential conversion of the Series C Convertible
Preferred Stock issued on June 2, 2003, we expect that we may need to issue up
to 2,352,942 shares of our common stock (based on a conversion price of $4.25)
and up to 352,900 shares in upon exercise of the related warrant issued on June
2, 2003.
WE DO NOT INTEND TO PAY DIVIDENDS ON COMMON STOCK 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 on common stock. 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 June 30,
2003. 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 adjustable rates based on the Bank of England base rate plus 1.5%
and 1.75% (5.25% and 5.5%, respectively at June 30, 2003). 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%
27
above the lenders borrowing rate (9% at June 30, 2003) 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.
2004 2005 2006 2007 2008 THEREAFTER TOTAL
---------- ---------- ---------- ---------- ---------- ---------- ----------
(dollars in thousands)
Liabilities:
Fixed rate debt: -- -- 20,000 -- -- -- 20,000
Variable rate debt 635 890 15,893 1,000 1,060 2,048 21,526
---------- ---------- ---------- ---------- ---------- ---------- ----------
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
We conducted an evaluation, under the supervision and with the participation of
our Chief Executive Officer and Principal Financial Officer, of the
effectiveness of our disclosure controls and procedures as of the end of the
first fiscal quarter. Based on this evaluation, our Chief Executive Officer and
Principal Financial Officer concluded that our disclosure controls and
procedures are effective in timely alerting them to material information
required to be included in our periodic reports with the Commission.
In accordance with the Commission's requirements, our Chief Executive Officer
and Principal Financial Officer note that there were no 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
During the last fiscal quarter, there have been no changes in our internal
control over financial reporting that has materially affected or is reasonably
likely to materially affect our internal control over financial reporting.
Our management, including our Chief Executive Officer and Principal Financial
Officer, does not expect that our disclosure controls or our internal controls
will prevent all error and all fraud. A control system, no matter how well
conceived and operated, can provide only reasonable, not absolute, assurance
that the objectives of the control system are met. Further, the design of a
control system must reflect the fact that there are resource constraints, and
the benefits of controls must be considered relative to their costs. Because of
the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within our systems have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty and that
breakdowns can occur because of simple errors or mistakes. Additionally,
controls can be circumvented by the individual acts of some persons, by
collusion of two or more people or by management override of the controls. The
design of any system of controls also is based in part upon certain assumptions
about the likelihood of future events, and we cannot assure you that any design
will succeed in achieving its stated goals under all potential future
conditions; over time, controls may become inadequate because of changes in
conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be detected.
28
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are subject to various claims and litigation in the normal course of
business. In our opinion, all pending legal matters are either covered by
insurance or, if not insured, will not have a material adverse impact on our
consolidated financial statements.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On June 2, 2003, we sold 1,000 shares of our Series C Convertible Preferred
Stock and warrants to purchase 352,900 shares of our common stock at an
aggregate purchase price of $10 million to The Riverview Group, LLC, 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
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31 Rule 13a-14/15d-14(a) Certifications
32 Section 1350 Certifications
(b) Reports on Form 8-K:
(1) Report on Form 8-K, filed April 2, 2003, disclosing under Item 5 that
on March 31, 2003 we sold 2,973,589 shares of our restricted common stock to
Berg & Berg Enterprises, LLC.
(2) Report on Form 8-K, filed May 30, 2003, disclosing under Item 5 and 7
our press releases issued on May 13, 2003, May 14, 2003, May 19, 2003, and May
29, 2003.
(3) Report on Form 8-K, filed June 3, 2003, reporting under Item 5 and 7
the private placement by us of 1,000 shares of our Series C Convertible
Preferred Stock and warrants to purchase 352,900 shares of common stock.
(4) Report on Form 8-K, filed June 11, 2003, reporting under Item 5 and 7
the waiver of conditions of equity line of credit from Berg & Berg Enterprises,
LLC, dated May 30, 2003 and the Commitment Letter from Berg & Berg Enterprises,
LLC, dated June 9, 2003.
29
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: August 14, 2003 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)
30
EXHIBIT INDEX
EXHIBIT NO.
31. Rule 13a-14 and 15d-14(a) Certifications
32. Section 1350 Certifications
31