Back to GetFilings.com
UNITED STATES
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 December 31, 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,
AUSTIN, TEXAS 78730
(Address of Principal Executive Offices) (Zip Code)
(512) 527-2900
(Registrant's Telephone Number, Including Area Code)
----------------------------------------------------------------
Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes x No
Indicate 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 75,288,843
- -------------------------------- ---------------------------------
(Class) (Outstanding at February 6, 2004)
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2003
INDEX
PAGES
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets as of
December 31, 2003 and March 31, 2003..................................................3
Condensed Consolidated Statements of Operations and
Comprehensive Loss for Each of the Three-and Nine-
Month Periods Ended December 31, 2003 and December 31, 2002...........................4
Condensed Consolidated Statements of Cash Flows
for Each of the Nine-Month Periods
Ended December 31, 2003 and December 31, 2002.........................................5
Notes to Condensed Consolidated Financial Statements..................................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................................16
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........................33
Item 4. Controls and Procedures..............................................................33
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................................34
Item 2. Changes in Securities and Use of Proceeds............................................34
Item 3. Defaults on Senior Securities........................................................34
Item 4. Submission of Matters to a Vote of Security Holders..................................34
Item 5. Other Information....................................................................34
Item 6. Exhibits and Reports on Form 8-K.....................................................34
SIGNATURE .....................................................................................35
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(unaudited)
December 31, 2003 March 31, 2003
----------------- -----------------
ASSETS
Current assets:
Cash and cash equivalents $ 7,468 $ 6,616
Trade receivables, net of allowance of $130
as of December 31, 2003 and March 31, 2003 1,325 1,218
Inventory 2,491 2,757
Prepaid and other current assets 1,003 1,495
----------------- -----------------
Total current assets 12,287 12,086
Property, plant and equipment, net 8,058 14,279
Intellectual property, net 542 9,789
----------------- -----------------
Total assets $ 20,887 $ 36,154
================= =================
LIABILITIES, PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
Current liabilities:
Current portion of long-term debt $ 946 $ 810
Accounts payable 3,168 3,511
Accrued expenses 3,000 2,013
Deferred revenue 1,484 14
Grant payable - short term 1,753 1,715
----------------- -----------------
Total current liabilities 10,351 8,063
Grant payable - long term 3,036 -
Long-term interest 8,972 6,744
Long-term debt, less current portion 5,646 5,623
Long-term debt to stockholder 33,772 33,242
----------------- -----------------
Total liabilities 61,777 53,672
----------------- -----------------
Minority interest in joint venture 2,537 -
----------------- -----------------
Redeemable convertible preferred stock, $0.001 par value, 1,000 shares
authorized, issued, and outstanding at December 31, 2003,
liquidation value $10,000 8,845 -
----------------- -----------------
Commitments and contingencies
Stockholders' equity (deficit):
Common stock, $0.001 par value, authorized: 100,000,000 shares,
issued and outstanding: 74,906,078 and 71,722,794 shares
at December 31, 2003 and March 31, 2003, respectively 75 72
Additional paid-in capital 377,993 366,518
Deferred compensation (189) (181)
Notes receivable from stockholder (5,092) (5,161)
Accumulated deficit (420,955) (374,604)
Accumulated other comprehensive loss (4,104) (4,162)
----------------- -----------------
Total stockholders' deficit (52,272) (17,518)
----------------- -----------------
Total liabililities, preferred stock and stockholders' deficit $ 20,887 $ 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)
Three Months Ended December 31, Nine Months Ended December 31,
------------------------------- -------------------------------
2003 2002 2003 2002
-------------- --------------- -------------- --------------
Revenue:
Licensing and royalty revenue $ 81 $ 45 $ 706 $ 53
Battery and system sales 2,597 593 5,948 1,354
-------------- --------------- -------------- --------------
Total revenues 2,678 638 6,654 1,407
Cost of sales: 4,526 2,460 12,424 7,695
-------------- --------------- -------------- --------------
Gross profit (loss) (1,848) (1,822) (5,770) (6,288)
Operating expenses:
Research and product development 2,411 1,982 6,302 7,065
Marketing 1,218 749 3,474 2,101
General and administrative 3,128 2,468 8,269 7,611
Depreciation and amortization 286 662 1,844 1,959
Gain on disposal of assets (21) (20) (21) (20)
Restructuring charge 926 - 926 -
Contract settlement charge - - 3,046 -
Asset impairment charge - - 13,660 -
-------------- --------------- -------------- --------------
Total costs and expenses 7,948 5,841 37,500 18,716
-------------- --------------- -------------- --------------
Operating loss (9,796) (7,663) (43,270) (25,004)
Minority interest in joint venture 5 - 5 -
Cost of warrants (181) - (181) -
Interest and other income 99 87 264 284
Interest expense (1,027) (987) (3,052) (3,115)
-------------- --------------- -------------- --------------
Net loss (10,900) (8,563) (46,234) (27,835)
Dividends on preferred stock 50 - 116 -
Preferred stock accretion 156 - 363 -
-------------- --------------- -------------- --------------
Net loss available to common stockholders $ (11,106) $ (8,563) $ (46,713) $ (27,835)
============== =============== ============== ==============
Net loss $ (10,900) $ (8,563) $ (46,234) $ (27,835)
Other comprehensive loss:
Change in foreign currency
translation adjustments 67 270 61 166
-------------- --------------- -------------- --------------
Comprehensive loss $ (10,833) $ (8,293) $ (46,173) $ (27,669)
============== =============== ============== ==============
Net loss per share available to
common stockholders $ (0.15) $ (0.14) $ (0.65) $ (0.50)
============== =============== ============== ==============
Shares used in computing net loss
per share available to common
stockholders, basic and diluted 73,515 62,864 72,335 55,383
============== =============== ============== ==============
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)
Nine Months Ended Nine Months Ended
December 31, 2003 December 31, 2002
------------------ ------------------
Cash flows from operating activities:
Net loss $ (46,234) $ (27,835)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 1,844 1,959
Asset impairment charge 13,660 -
Contract settlement charge 3,046 -
Restructuring charge 926 -
Cost of warrants 181 -
Accretion of debt discount and other 521 747
Interest income on stockholder note receivable 69 (208)
Deferred compensation expense 524 -
Changes in operating assets and liabilities:
Trade receivables (107) (135)
Other current assets 582 (679)
Inventory (429) (196)
Accounts payable (426) (529)
Accrued expenses and long-term interest 2,734 1,146
Deferred revenue 1,470 -
------------------ ------------------
Net cash used in operating activities (21,639) (25,730)
------------------ ------------------
Cash flows from investing activities:
Purchases of property, plant & equipment (1,765) (986)
Proceeds from sale of property, plant & equipment 2,685 -
------------------ ------------------
Net cash provided by (used in) investing activities 920 (986)
------------------ ------------------
Cash flows from financing activities:
Proceeds from long-term debt - 4,670
Payment of long-term debt (623) (750)
Dividends paid (66) -
Proceeds from issuance of preferred stock,
net of issuance costs 9,416 -
Proceeds from stock option exercises 180 -
Proceeds from issuance of common stock and warrants,
net of issuance costs 12,533 25,135
------------------ ------------------
Net cash provided by financing activities 21,440 29,055
------------------ ------------------
Effect of foreign exchange rates on cash
and cash equivalents 131 260
------------------ ------------------
Increase in cash and cash equivalents 852 2,599
Cash and cash equivalents, beginning of period 6,616 623
------------------ ------------------
Cash and cash equivalents, end of period $ 7,468 $ 3,222
================== ==================
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
December 31, 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 condensed consolidated balance sheets of Valence
Technology, Inc. and its subsidiaries (the "Company") as of December 31, 2003
and December 31, 2002, its condensed consolidated results of operations for each
of the three- and nine-month periods ended December 31, 2003 and December 31,
2002, and the condensed consolidated cash flows for each of the nine-month
periods ended December 31, 2003 and December 31, 2002. Because all 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 fiscal year ended March
31, 2003. The results for the nine-month period ended December 31, 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 December 31, 2003, the Company's principal sources of liquidity were cash and
cash equivalents of $7.5 million and $14 million available under financing
commitments with Berg & Berg Enterprises, LLC ("Berg & Berg"). On June 10, 2003,
Berg & Berg committed to provide the Company an additional $10 million in fiscal
2004, supplemented by an existing $4 million working capital commitment. The
Company expects that Berg & Berg will fund the $14 million commitments by
purchasing the Company's common stock from time to time as requested by the
Company at then-current market value. As described in Note 4, Financing, in the
first quarter of fiscal 2004, the Company completed a private placement of
preferred stock that resulted in approximately $9.4 million of net proceeds. At
December 31, 2003, the Company had commitments for capital expenditures of
approximately $189,000.
At the Company's current level of operations, it is using cash from operations
of approximately $6 to $9.5 million per quarter. 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 business
plan. 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. 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
finance 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 that case, the Company's ability to continue
its operations would depend on arranging for additional equity or debt
financing. There can be no assurance that the Company will receive additional
financing.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
REVENUE RECOGNITION:
Revenues are generated from sales of products including batteries and battery
systems, and from licensing fees and royalties per technology license
agreements. Product sales are recognized 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, including product shipments to resellers that are subject to
right of return, are recorded as deferred revenue and reflected as a liability
on the Company's balance sheet. 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 upon
receipt of cash from the licensee.
6
IMPAIRMENT OF LONG-LIVED ASSETS:
The Company performs a review of long-lived tangible and intangible assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of these
assets is measured by comparison of their carrying amounts to future
undiscounted cash flows that 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 value and is
recorded in the period the determination was made.
EXIT COSTS:
The Company recognizes liabilities for costs associated with exit or disposal
activities at fair value in the period during which the liability is incurred.
Costs associated with exit or disposal activities are included in restructuring
charges.
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 No. 96-18,
"Accounting for Equity Instruments with Variable Terms That Are Issued for
Consideration Other Than Employee Services Under FASB Statement No. 123,
Accounting for Stock-Based Compensation". 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. 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
third quarter and the first nine months 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 Nine Months Ended
December 31, December 31,
------------ ------------- ---------- ---------
2003 2002 2003 2002
------------ ------------- ---------- ---------
Net loss available to common stockholders
- as reported $ (11,106) $ (8,563) $(46,713) $(27,835)
Add: stock-based compensation
expense, net of related taxes (1,350) (1,701) (4,050) (5,104)
------- ------- ------- -------
Net loss available to common stockholders
- pro forma (12,456) (10,264) (50,763) (32,939)
Net loss available to common stockholders
per share - as reported (0.15) (0.14) (0.65) (0.50)
Net loss available to common stockholders
per share, basic and diluted - pro forma (0.17) (0.16) (0.70) (0.59)
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 nine months of fiscal 2004 and 2003:
2004 2003
--------- -----------
Risk-free interest rate 3.25% 2.46%
Expected life 5.00 years 5.00 years
Volatility 104.68% 109.82%
Dividend yield - -
7
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. 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 adopted SFAS 149 in its second quarter of fiscal year
2004. The adoption did not 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
of SFAS 150 required the Company's contract settlement with Invest Northern
Ireland (Note 9, Commitments and Contingencies), which is payable in shares of
the Company's restricted common stock, to be recorded as a liability.
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 adopted FIN 46 in its second quarter of fiscal year 2004, and its
adoption did not have a material 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 for the periods ended December 31 were as
follows:
Three Months Ended Nine Months Ended
December 31, December 31,
---------------------- -----------------------
2003 2002 2003 2002
---------- ----------- ----------- -----------
Shares reserved for conversion of Series C preferred stock 2,353,000 - 2,353,000 -
Common stock options 8,636,000 8,320,000 8,636,000 8,320,000
Warrants to purchase common stock 2,375,000 3,237,000 2,375,000 3,237,000
---------- ----------- ----------- -----------
Total 13,364,000 11,557,000 13,364,000 11,557,000
========== =========== =========== ===========
4. FINANCING:
On June 2, 2003, the Company raised $10 million (net proceeds of $9.4 million)
through the sale of Series C Redeemable 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 date at which the pricing was
finalized. The Company has the right to convert the preferred stock if the
average of the volume weighted average price of the Company's common stock
8
for a ten-day trading period is at or above $6.38 per share. The preferred stock
is redeemable by the holder at the maturity date of December 2, 2004, and upon
the occurrence of certain triggering or default events. Net proceeds from the
financing are being used for working capital purposes.
On June 10, 2003, Berg & Berg committed to provide the Company $10 million in
fiscal 2004, increasing its total available remaining financing commitments to
$14 million ($10 million under this new financing commitment and $4 million
under a working capital commitment). The Company expects that Berg & Berg will
fund the $14 million commitments by purchasing shares of common stock from time
to time as requested by the Company at the then-current market price.
On November 14, 2003, the Company agreed to extend the time period in which a
warrant holder is able to exercise its warrants. The warrant exercise period
originally ended on July 27, 2003, and has been extended to July 27, 2004. The
non-cash expense related to the exercise period extension of $181,000 was
determined using the Black-Scholes model, with risk free rate of 1.04%, expected
life of 0.75 years, and volatility of 69.88. A total of 202,842 shares may be
purchased at an average exercise price of approximately $4.26 per share.
On December 22, 2003, the Company drew down $5 million from its equity line of
credit with Berg & Berg. The proceeds will be used to fund corporate operating
needs and working capital. Under the terms of the equity line of credit, the
Company issued to Berg & Berg 1,525,506 shares of its restricted common stock at
a discount of 15% to the average closing price of common stock for the last five
days prior to the purchase date, or approximately $3.28 per share. Under Rule
144 of the Securities Act of 1933, as amended, these shares are restricted from
being traded by Berg & Berg for a period of one year from the date of issuance,
unless registered, and thereafter must be traded only in compliance with the
volume restrictions imposed by this rule.
5. INVENTORY:
Inventory consisted of the following (in thousands) at:
December 31, 2003 March 31, 2003
---------------- -----------------
Raw materials $ 214 $ 1,163
Work in process 580 1,385
Finished goods 1,697 209
---------------- -----------------
$ 2,491 $ 2,757
================ =================
6. PROPERTY, PLANT, AND EQUIPMENT:
On December 12, 2003, the Company closed the sale of its Henderson, Nevada
building and land with net book value of $2.664 million for net proceeds of
$2.685 million. A gain of $21,000 was recorded on the sale. The Company is
leasing the facility from month-to-month for $20,000 per month.
Property, plant, and equipment, net of accumulated depreciation and impairment,
consisted of the following (in thousands) at:
December 31, 2003 March 31, 2003
----------------- ----------------
Building and land $ 12,201 $ 14,573
Leasehold improvements 51 47
Machinery and equipment 13,510 10,287
Office and computer equipment 1,065 845
Construction in progress 1,418 2,725
----------------- ----------------
Total cost before impairment and depreciation 28,245 28,477
Less: accumulated depreciation (15,020) (14,198)
Less: impairment (5,167) -
----------------- ----------------
Total cost, net of depreciation and impairment $ 8,058 $ 14,279
================= ================
9
7. INTELLECTUAL PROPERTY:
Intellectual property consisting of stacked battery construction technology
acquired from Telcordia Technologies, Inc. in December 2000 is amortized over
five years. Intellectual property, net of accumulated amortization and
impairment, consisted of the following (in thousands) at:
December 31, 2003 March 31, 2003
----------------- -----------------
Intellectual property before impairment $ 13,602 $ 13,602
Less: accumulated amortization (4,567) (3,813)
Less: Impairment (8,493) -
----------------- -----------------
Intellectual property, net $ 542 $ 9,789
================= =================
Amortization expense on intellectual property at December 31, 2003 will be as
follows (in thousands):
Fiscal Year
--------------------
Remainder of 2004 $ 29
2005 114
2006 114
2007 114
2008 114
Thereafter 57
-----------
$ 542
===========
Amortization expense for the three-month period ended December 31, 2003 was
approximately $29,000. Amortization expense for the three-month period ended
December 31, 2002 was approximately $363,000. The amount charged to amortization
expense for the nine months ended December 31, 2003 was approximately $754,000
and for the nine months ended December 31, 2002 was approximately $1,087,000.
8. DEBT TO STOCKHOLDER:
(in thousands) December 31, 2003 March 31, 2003
----------------- --------------
2001 Loan balance $20,000 $20,000
1998 Loan balance 14,950 14,950
Unaccreted debt discount (1,178) (1,708)
----------------- --------------
Balance $33,772 $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
December 31, 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 December 31, 2003, accrued interest on the loan totaled $3.054
million, 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
million, has been reflected as additional consideration for the debt financing,
recorded as a discount on the debt and accreted as interest expense 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 December 31, 2003, a total of approximately $1.591
million 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 December 31, 2003 and December
10
31, 2002 were $404,000 and $392,000, respectively. The amounts charged to
interest expense on the outstanding balance of the loan for the nine-month
periods ended December 31, 2003 and December 31, 2002 were $1.217 million and
$1.065 million, respectively. Interest payments on the loan are currently being
deferred, and are recorded as long-term interest.
In July 1998, the Company entered into an amended loan agreement ("1998 Loan")
with Berg & Berg that allows the Company to borrow, prepay and re-borrow up to
$10 million principal under a promissory note on a revolving basis. In November
2000, the 1998 Loan agreement was amended to increase the maximum amount to $15
million. As of December 31, 2003, the Company had an outstanding balance of
$14.95 million under the 1998 Loan agreement. The loan bears interest at one
percent over the lender's borrowing rate (approximately 9.0% at December 31,
2003). Effective December 31, 2001, the Company and Berg & Berg 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 December 31, 2003, accrued
interest on the loan totaled $5.762 million, 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 million, 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 December 31, 2003, a
total of $2.159 million has been accreted. The amount charged to interest
expense for each of the three-month periods ended December 31, 2003 and December
31, 2002 was $335,000. The amount charged to interest expense for each of the
nine-month periods ended December 31, 2003 and December 31, 2002 was $1.010
million. Interest payments on the loan are currently being deferred, and are
recorded as long-term interest.
9. COMMITMENTS AND CONTINGENCIES:
WARRANTIES:
The Company has established a warranty reserve in connection with the sale of
N-Charge(TM) Power Systems covering a 12-month warranty period during which the
Company would provide a replacement unit to any customer returning a purchased
product because of a product performance issue. 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 December 31, 2003 is $357,000.
Product warranty liabilities for the nine months ended December 31, 2003 and the
year ended March 31, 2003 are as follows (in thousands):
December 31, 2003 March 31, 2003
----------------- -----------------
Beginning balance $ 123 $ 35
Less: claims (300) (26)
Less: returns (18) -
Plus: accruals 552 114
----------------- -----------------
Ending balance $ 357 $ 123
================= =================
11
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 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, on August 1, 2003 the Company reached
agreement with INI to terminate the Letter of Offer. Pursuant to this agreement,
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 one
year from the respective payment dates). The Company had previously accrued a
$1.7 million liability with respect to the INI claim, and accrued an additional
liability of approximately $3 million in its fiscal quarter ended September 30,
2003.
10. SERIES C REDEEMABLE CONVERTIBLE PREFERRED STOCK:
On June 2, 2003, the Company issued 1,000 shares of Series C Redeemable
Convertible Preferred stock ("Series C") and warrants to purchase the Company's
common stock for $10,000 per share, raising net proceeds of $9.416 million.
Holders of the Series C stock are entitled to receive dividends at an annual
rate of 2%, paid quarterly in cash or common stock. 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 preferred 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 $584,000,
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 a warrant to purchase 352,900 shares of the Company's common
stock. The warrant is exercisable at a purchase price of $5.00 per share and
expires in June 2008. The warrant was valued using the Black-Scholes valuation
model. The warrant was recorded to additional paid in capital at its relative
fair value to the Series C stock at $933,000. Accretion to the redemption value
of $10 million is being recorded over the eighteen-month period of the Series
C stock.
11. 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 December 31, 2003, the equity line was fully drawn. The
Company's financing commitment with Berg & Berg enabled it to access up to $5
million per quarter (but no more than $30 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 the amounts funded pursuant to this agreement, the
Company has issued 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.
On January 1, 1998, the Company granted options to Mr. Lev 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, the Company granted Mr. Dawson an
option to purchase 660,494 shares 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 December 31, 2003,
amounts of $3,501,000 and $1,591,000 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.
12
In accordance with the Dawson Notes, interest is payable annually in arrears and
has been paid through March 4, 2003.
12. GEOGRAPHIC INFORMATION:
The Company conducts its business in two geographic segments.
Long lived asset information by geographic segment at December 31, 2003 and
March 31, 2003 is as follows (in thousands):
December 31, 2003 March 31, 2003
----------------- ----------------
United States $1,712 $4,930
International 6,888 19,138
----------------- ----------------
Total $8,600 $24,068
================= ================
Revenues by geographic segment for the three-month periods and nine-month
periods ended December 31, 2003 and December 31, 2002 are as follows (in
thousands):
Three Months Ended December 31, Nine Months Ended December 31,
--------------------------------- --------------------------------
2003 2002 2003 2002
---------------- ---------------- --------------- ---------------
United States $ 2,115 $ 305 $ 4,932 $ 752
International 563 333 1,722 655
---------------- ---------------- --------------- ---------------
Total $ 2,678 $ 638 $ 6,654 $ 1,407
================ ================ =============== ===============
13. JOINT VENTURE:
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(R) Lithium-ion batteries. Under
the terms of the joint venture agreement, the Company will contribute 51% of the
joint venture's registered capital, consisting of capital equipment, a
nonexclusive license to its technology, and engineering expertise. Fengfan will
contribute 49% of the joint venture's registered capital, consisting of the cash
required to fund the joint venture for the first two years, and also to acquire
the land and facility needed for manufacturing operations.
These interim consolidated financial statements include the consolidation of the
balance sheet, results of operations, and cash flows of the joint venture as of
December 31, 2003. Minority interest in the joint venture at December 31, 2003
is $2.5 million.
During the quarter ended December 31, 2003, Fengfan contributed approximately
$2.5 million in cash to the joint venture, while the Company began its
contribution of technology and engineering expertise. As of December 31, 2003,
the joint venture had initiated construction of its Baoding, China facility,
established its interim offices, and hired and trained staff. Net operating
expenses for the quarter ended December 31, 2003 were approximately $63,000. The
joint venture's assets at December 31,2003 included cash of approximately $1
million, which is exclusively for the joint venture's requirements, and
construction in progress of approximately $1.4 million.
13
14. FACILITY CLOSING:
On August 13, 2003, the Company announced successful qualification of its OEM
manufacturer in China, ATL, for Saphion(R) products. Additionally, the Company
announced its plans to transition manufacturing from its Northern Ireland
facility to China and other low-cost manufacturing regions. As of December 31,
2003, the Company had completed the transition of manufacturing to ATL and other
manufacturers. The Company anticipates that manufacturing equipment will begin
to move from Northern Ireland to its joint venture in China (Note 13) in its
fiscal quarter ending March 31, 2004. The Company estimates that the costs
related to its transition of manufacturing from its Northern Ireland facility
will range from $1.5 million to $2 million.
As of December 31, 2003, all production at the Northern Ireland facility had
ceased. Activities related to closing the facility and preparing equipment for
transition to the joint venture are expected to continue throughout the quarter
ending March 31, 2004. All inventory remaining at the conclusion of
manufacturing operations was determined to be obsolete and unusable by any of
the Company's battery manufacturing sources. Raw materials inventory
obsolescence expense of approximately $178,000 and work in process inventory
obsolescence expense of approximately $517,000 were recorded as restructuring
charges during the quarter ended December 31, 2003. Remaining payment
obligations for factory equipment operating leases that extended beyond December
31, 2003 were approximately $231,000. These lease payment obligations provide no
economic benefit to the Company, and contractual lease costs of approximately
$231,000 were recorded as restructuring charges during the quarter ended
December 31, 2003. When the Northern Ireland manufacturing transition was
initiated, an incentive payment plan was established for certain employees. The
employees earned the bonus, which was paid in January 2004, if they were in good
standing on December 31, 2003. The cost of this bonus plan was $352,000 and was
charged to general and administrative expense during the quarter ended December
31, 2003.
Liabilities related to restructuring at December 31, 2003 consisted of the
following (in thousands):
Inactive Employee
Obsolete Operating Retention
Inventory Leases Bonus
-------------- -------------- --------------
Beginning balance $ - $ - $ -
Costs incurred 695 231 352
-------------- -------------- --------------
Ending balance $ 695 $ 231 $ 352
============== ============== ==============
15. IMPAIRMENT CHARGE:
An impairment charge of approximately $13.7 million was recorded during the
fiscal quarter ended September 30, 2003. The charge was recorded pursuant to
FASB Statement No. 144, "Accounting for Impairment or Disposal of Long-Lived
Assets." During the second quarter of fiscal 2004 the Company completed
qualification of its OEM manufacturer in China, ATL, for Saphion(R) products. In
addition, the Company announced the formation of a manufacturing joint venture
in China with Fengfan Group, Ltd. The Company has transitioned all manufacturing
from its Northern Ireland facility to China and other low-cost manufacturing
regions as of December 31, 2003. The Northern Ireland facility has ceased
manufacturing operations as of the end of calendar 2003. The Company also
experienced progress on the development of cylindrical battery construction
technology and now expects greater emphasis on the licensing of cylindrical
technology to the detriment of the licensing of stacked technology (which was
the technology acquired from Telcordia in December 2000). As a result of these
developments, the Company determined that the future cash flows expected to be
generated from its Northern Ireland facility and stacked technology intellectual
property acquired in the Telcordia transaction in December 2000 did not exceed
their carrying value. This determination resulted in the net impairment charge
against property, plant, and equipment and intellectual property to record these
assets at their fair value. The Company determined that assets with a carrying
amount of approximately $19.5 million should be written down by approximately
$13.7 million to their fair value. Fair value was based on estimated future cash
flows to be generated by these assets, discounted at the Company's market rate
of interest of 8%.
14
16. SUBSEQUENT EVENT:
On January 22, 2004, the holder of Series C Redeemable Convertible Preferred
Stock converted 139 of its 1,000 shares with principal amount of $1.39 million,
including accrued and unpaid dividends, to 327,453 shares of the Company's
common stock at the conversion price of $4.25 per share.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Report contains statements that constitute "forward-looking
statements" within the meaning of Section 21e of the Securities Exchange Act of
1934, as amended, and Section 27a of the Securities Act of 1933, as amended. The
words "expect", "estimate", "anticipate", "predict", "believe" and similar
expressions and variations thereof are intended to identify forward-looking
statements. These statements appear in a number of places in this Report and
include statements regarding the intent, belief or current expectations of
Valence Technology, Inc. ("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, (c)
trends affecting our manufacturing capabilities, (d) trends affecting the
commercial acceptability of our products, and (e) our business and growth
strategies. You are cautioned not to put undue reliance on forward-looking
statements. 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
Securities and Exchange Commission, to which we refer in this Report as the
Commission. We undertake no obligation to publicly revise these forward-looking
statements to reflect events or circumstances that arise after the date hereof.
The results for the three-and nine-month periods ended December 31, 2003 are not
necessarily indicative of the results to be expected for the entire fiscal year
ending March 31, 2004.
BUSINESS OVERVIEW
At Valence Technology, Inc., our vision is to become the world leader in
energy solutions by enabling our customers to differentiate their products. Our
current objective is to offer the safest, most environmentally friendly and
energy-dense Lithium-ion battery solutions with the best price-to-performance
ratio on the market. The driving force behind the introduction of Lithium-ion
technology to the market was consumer demand for high-energy, small battery
solutions to power portable electronic devices. The battery industry,
consequently, focused on high-energy solutions at the expense of safety.
Saphion(R) technology, a phosphate based cathode material, addresses the need
for a safe Lithium-ion solution, especially in large-format applications.
Valence is the leader in the development and commercialization of Saphion(R)
technology.
Founded in 1989 as a research and development company, we currently possess
an extensive library of international patents. Prior to 2000, our efforts were
focused primarily on developing and acquiring battery technologies. During 2001,
with the addition of Stephan Godevais as Chairman and Chief Executive Officer
and recruitment of additional executive management talent, we developed and
initiated the implementation of a business plan to capitalize on the significant
market opportunity for safe, high-performance energy storage systems (which we
estimate will be in excess of $20 billion by 2010) by productizing and
commercializing our technological innovations.
Our business plan and strategy focus on the generation of revenue from a
combination of product sales and licensing activities, while minimizing
manufacturing cost through a manufacturing plan that utilizes internal
capabilities and partnerships with contract manufacturers. We plan to capitalize
on our Saphion(R) technology through our existing and new solutions that
differentiate our own products and end-users' products in both the large format
and small format markets. In addition, we are planning to expand the fields of
use of our Saphion(R) technology through the licensing of our intellectual
property related to our battery chemistries and manufacturing processes.
To date, we have achieved the following successes in implementing our
business plan:
o Proven the feasibility of our technology;
o Launched new Saphion(R) technology based products, including our
N-Charge(TM) Power System and our K-Charge(TM) Power System,
which meet market needs of a large customer base;
o Demonstrated capability for high volume production; and
o Continued to build our brand awareness in multiple channels.
Our financial results through the third quarter for fiscal 2004 are
consistent with our expected progress in our business plan. Most significantly,
revenue grew by over 370% as
16
compared to year-to-date revenues through the third fiscal quarter in the prior
year to $6.7 million. Additionally, we achieved improvement of our negative
gross margin and expanded our development and channel launch of Saphion(R) based
products. We continued our efforts to transition our manufacturing to low-cost
regions, and subsequently incurred initial costs associated with the
establishment of our joint venture in China, as well as non-recurring expenses
related to the discontinuation of our manufacturing facility in Northern
Ireland. We will continue to evaluate our progress in the coming quarters based
upon the following measures: revenue growth, gross margin improvement,
conversion of fixed manufacturing costs to variable manufacturing costs, and
overhead cost management in order to generate positive cash flows from operating
activities.
Valence's business headquarters is located in Austin, Texas, our research
and development center is in Henderson, Nevada, and our European sales and OEM
manufacturing support center is in Mallusk, Northern Ireland.
PRODUCTS
In February 2002, we unveiled our Saphion(R) technology, a Lithium-ion
technology that 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(R)
technology addresses the major weaknesses of the 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(R) technology
is able to offer unrivaled safety, comparable energy density, superior rate
capability, exceptional cycle life, and unmatched service life when compared to
traditional Lithium-ion technologies. Therefore, we have initiated the use of
Lithium-ion outside its historic applications into products such as back-up
power systems, vehicles, and power tools, among others, and believe that we can
greatly broaden these applications.
We introduced our first product based on our Saphion(R) 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 and have been successful
in marketing the N-Charge(TM) Power System to national retailers, top tier
computer companies and resellers in an effort to validate our Saphion(R)
technology. In February 2003, we introduced our first large-format energy
storage system powered by our Saphion(R) technology, the K-Charge(TM) Power
System. 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.
Our battery products utilize both industry-standard cylindrical cells as
well as our patented stacked, polymer construction. Our research and development
efforts are focused on the next generation of our Saphion(R) technology to
provide enhanced performance characteristics and to optimize our cylindrical
cells for the applications we intend to serve. We believe we will greatly
increase our potential in the marketplace with the cylindrical construction.
SUPPLY CHAIN
Our approach to the supply chain for our products is to utilize contract
manufacturing partnerships and OEM relationships to achieve low costs and
greater flexibility. Historically, our polymer batteries have primarily been
manufactured at our 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 OEM to
manufacture our Saphion(R) products. In July 2003, we announced the grant of a
Chinese business license for our manufacturing joint venture in China with
Fengfan Group, Ltd. The purpose of the joint venture is to provide low-cost
manufacturing and product development. Under the terms of the joint venture
agreement, we will contribute capital equipment, a nonexclusive license to our
technology, and engineering expertise. Fengfan will provide the cash required to
fund the joint venture for the first two years and also to acquire the land and
facility needed for manufacturing operations. We completed the transition of
manufacturing from our Northern Ireland facility to China and other low-cost
manufacturing regions during calendar 2003. We maintain a presence in Northern
Ireland to manage European sales and marketing activities, and to 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 United States. Our accounting policies are
described in Note 3 of the Notes to Condensed Consolidated Financial Statements
included in "Part I -- 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, impairment of
long-lived assets, and exit costs.
17
REVENUE RECOGNITION: Revenues are generated from sales of products including
batteries and battery systems, and licensing fees and royalties per technology
license agreements. Product sales are recognized 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. Our revenue recognition is affected by
specific terms of end-user customer and reseller agreements that may include
right of return, stock balancing, acceptance, price rebates, and other terms
that require us to make reasonable estimates under each of the four revenue
recognition criteria. We defer recognition of revenue for partial or all
invoiced amounts for all transactions that have these or similar terms.
Estimates of deferred revenues are determined by the specific sales agreements
and our experience with similar agreements' terms, and while not typically
variable, may require modifications from time to time if unexpected events
occur. 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. 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 upon receipt of cash payment
from the licensee.
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 that the carrying amount of an asset may not be recoverable.
Recoverability of these assets is measured by comparison of their carrying
amounts to future undiscounted cash flows that 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 value and is recorded in the period the determination was made.
By their nature, future cash flows are estimates requiring informed judgment.
Our analysis of potential impairment of long-lived assets is subject to
estimates of future cash flows. If we experience actual results materially
different from estimates, then the carrying values of assets may have been
materially different from actual value. Our practice is to evaluate carrying
values against future cash flows estimated from our business plan, and if the
plan changes, or if results indicate that cash flows are different from plan,
the impairment analysis is revised to match the updated plan. See Notes to
Condensed Consolidated Financial Statements, Note 15, Impairment Charge,
regarding impairment of tangible and intangible assets.
EXIT COSTS: SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities", requires us to recognize liabilities for costs associated with exit
or disposal activities at fair value in the period during which the liability is
incurred. Estimates of liabilities related to exit or disposal activities may
include lease termination costs, compensation of staff, inventory obsolescence,
costs to prepare assets for disposal or sale, and other one-time expenses. We
record these costs based on actual agreements in place and on reasonable
estimates made at the balance sheet date. Some agreements may be revised, or
actual results may be different from costs reasonably estimated at the
incurrence of the liability. In these cases, additional costs or reduced costs
are recorded in the period incurred, and differences are disclosed in footnotes
to financial statements. Costs associated with exit or disposal activities are
included in restructuring charges. See Notes to Condensed Consolidated Financial
Statements, Note 14, Facility Closing, regarding costs of closing our Northern
Ireland facility.
18
RESULTS OF OPERATIONS
The following table summarizes the results of our operations for the three and
nine months ended December 31, 2003 (Third Quarter of Fiscal 2004) and December
31, 2002 (Third Quarter of Fiscal 2003):
Three Months Ended Nine Months Ended
------------------------------------ -----------------------------------------
December 31, 2003 December 31, 2002 December 31, 2003 December 31, 2002
----------------- ------------------ ------------------- ----------------------
% of % of % of % of
(Dollars in thousands) Dollars Revenue Dollars Revenue Dollars Revenue Dollars Revenue
Licensing and royalty revenue $ 81 3% $ 45 7% $ 706 11% $ 53 4%
Battery and system sales 2,597% 97% 593 93% 5,948 89% 1,345 96%
---------- ------ --------- ------- ---------- -------- ----------- ---------
Total revenues 2,678 100% 638 100% 6,654 100% 1,398 100%
Gross profit (loss) (1,848) (69%) (1,822) (286%) (5,770) (87%) (6,288) (450%)
Operating expenses 7,969 298% 5,861 919% 37,521 564% 18,736 1340%
Operating loss (9,817) (367%) (7,683) (1204%) (43,291) (651%) (25,024) (1790%)
---------- ------ --------- ------- ---------- -------- ----------- ---------
Net loss $(10,900) (407%) $(8,563) (1342%) $(46,234) (695%) $ (27,835) (1991%)
========== ====== ========= ======= ========== ======== =========== =========
REVENUE GROWTH AND GROSS MARGIN IMPROVEMENT
BATTERY AND SYSTEM SALES: Battery and system sales increased by $2.004 million,
or 338%, to $2.597 million for the quarter ended December 31, 2003 from $593,000
for the quarter ended December 31, 2002. Revenue from battery and system sales
increased by $4.603 million, or 342%, to $5.948 million for the first nine
months of fiscal 2004 from $1.345 million for the first nine months of fiscal
2003. Increases in battery and system sales were primarily the result of
establishing and growing our retail and reseller channels for our N-Charge(TM)
Power System product. Total product shipments for the first nine months of
fiscal 2004 totaled $7.4 million representing an increase of approximately 447%
over the corresponding period in fiscal 2003. Product shipments to resellers
that are subject to right of return are recorded on the balance sheet as
deferred revenue. We had $1.484 million in deferred revenue on our balance sheet
at December 31, 2003.
LICENSING AND ROYALTY REVENUE: Licensing and royalty revenues relate to revenue
from licensing agreements for our technology. Licensing and royalty revenue
totaled $81,000 and $706,000 for the three- and nine-month periods ended
December 31, 2003, respectively, and was primarily related to license fees and
royalties payments from Amperex Technology Limited. Licensing and royalty
revenue totaled $45,000 and $53,000 for the three- and nine-month periods ended
December 2002, respectively. We continue to pursue licensing of both our process
and chemistry patent portfolios.
GROSS MARGIN (LOSS): Gross margin (loss) as a percentage of revenue was (69%)
for the third fiscal quarter of 2004 as compared to (286%) in the third fiscal
quarter of 2003. Although improving, we maintained a negative gross margin on
our sales in all periods because of insufficient production and sales volumes to
facilitate the coverage of our indirect and fixed factory costs, primarily from
continued operations of our Northern Ireland manufacturing facility. We expect
cost of sales to continue to decrease as a percentage of sales as production
volumes continue to increase, and as we implement lower cost OEM manufacturing,
complete our transition of manufacturing to China, and focus on the launch of
higher margin potential channels and products.
19
OPERATING EXPENSES AND OVERHEAD COST MANAGEMENT
The following table summarizes operating expenses for the three and nine months
ended December 31, 2003 (Third Quarter of Fiscal 2004) and December 31, 2002
(Third Quarter of Fiscal 2003):
Three Months Ended December 31, Nine Months Ended December 31,
-------------------------------------- ------------------------------------------
Increase Increase
(Dollars in thousands) 2003 2002 (Decrease) %Change 2003 2002 Decrease %Change
-------- --------- --------- --------- ---------- ----------- ---------- -------
Research and product development $2,411 $1,982 $ 429 22% $ 6,302 $ 7,065 $ (763) (11%)
Marketing 1,218 749 469 63% 3,474 2,101 1,373 65%
General and administrative 3,128 2,468 660 27% 8,269 7,611 658 9%
Depreciation and amortization 286 662 (376) (57%) 1,844 1,959 (115) (6%)
Restructuring charge 926 - 926 - 926 - 926 -
Contract settlement charge - - - - 3,046 - 3,046 -
Asset impairment charge - - - - 13,660 - 13,660 -
-------- --------- --------- --------- ---------- ----------- ---------- -------
Total operating expenses $7,969 $5,861 $2,108 36% $37,521 $18,736 $ 18,785 100%
======== ========= ========= ========= ========== =========== ========== ========
Percentage of revenue 298% 919% 564% 1340%
During the third fiscal quarter of 2004, operating expenses were 298% of sales
as compared to 919% in the same quarter last year. The decrease is a result of
increased revenues and improved focus on expense management.
RESEARCH AND PRODUCT DEVELOPMENT. Research and product development expenses
consist primarily of personnel, equipment and materials to support our efforts
to develop battery chemistry and products, as well as to improve our
manufacturing processes. Research and product development expenses increased by
$429,000, or 22%, to $2.411 million for the third quarter of fiscal 2004 from
$1.982 million for the third quarter of fiscal 2003. Research and product
development expenses decreased by $763,000, or 11%, to $6.302 million for the
nine months ended December 31, 2003 from $7.065 million for the nine months
ended December 31, 2002. The quarter-to-quarter increase in research and
development expenses is related to new product launch costs for prototypes,
testing and tooling. Fiscal year to date research and development expenses
decreased over the prior year primarily because headcount and related costs were
reduced in our reorganization that took place in the third quarter of fiscal
2003, offset by increases in the current quarter.
MARKETING. Marketing expenses consist primarily of costs related to sales and
marketing personnel, public relations and promotional materials. Marketing
expenses totaled $1.218 million and $749,000 for the third quarters of fiscal
2004 and 2003, respectively. Marketing expenses totaled $3.474 million and
$2.101 million for the first nine months of fiscal 2004 and 2003, respectively.
Increases were the result of increased staffing, advertising, and promotions to
support brand awareness and expansion of channels to sell our N-Charge(TM) Power
System and other Saphion(R) products. We expect marketing expenses to continue
to grow as we expand and develop our channels, launch additional Saphion(R)
products, and continue our branding efforts.
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,
including our China joint venture. General and administrative expenses totaled
$3.128 million and $2.468 million for the third fiscal quarters of 2004 and
2003, respectively. General and administrative expenses totaled $8.269 million
and $7.611 million for the nine-month periods ended December 30, 2003 and 2002,
respectively. Increases in general and administrative expenses are caused by the
establishment and accounting consolidation of our joint venture, increased
regulatory and compliance costs, and retention bonuses for key employees
incurred in our Northern Ireland facility in December 2003.
OTHER COSTS RELATED TO OUR MANUFACTURING TRANSITION
IMPAIRMENT CHARGE: During the second quarter of fiscal 2004, we recorded an
impairment charge of approximately $13.7 million. The charge was recorded
pursuant to FASB Statement No. 144 "Accounting for Impairment or Disposal of
Long-Lived Assets". During the second quarter of fiscal 2004, we arrived at our
decision to transfer manufacturing from our Northern Ireland facility to
low-cost manufacturing regions, including China. Additionally, we continued to
progress in our development of our cylindrical battery construction technology
and expect continued emphasis on the licensing and manufacturing of our
cylindrical technology to the detriment of the licensing and manufacturing of
our stacked technology (which was the technology acquired from Telcordia in
December 2000). As a result of these developments, we determined that the future
cash flows expected to be generated from assets in our Northern Ireland facility
and intellectual property acquired in the Telcordia transaction in December 2000
did not exceed their carrying value. The impairment charge was recorded against
property, plant, and equipment and intellectual property with a carrying value
of $19.5 million to recognize these assets at their fair value. Fair value was
determined based on estimated future cash flows to be generated by these assets,
discounted at our market rate of interest of 8%.
20
CONTRACT SETTLEMENT CHARGE: During the second quarter of fiscal 2004, we
recorded a contract settlement charge of $3 million. Beginning in 1994, we
received employment and capital grants from the Ireland Development Board, now
known as Invest Northern Ireland, or INI, for our 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 and
our desire to obtain unencumbered access to all of its equipment for transfer to
the Baoding Fengfan-Valence Battery Company joint venture or for sale, on August
1, 2003, we reached agreement with INI to terminate the Letter of Offer.
Pursuant to this agreement, INI would unconditionally and irrevocably release us
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 our common
stock at any time and not to trade the restricted common stock received for at
least one year from the respective payment dates). We had previously accrued a
$1.7 million liability with respect to the INI claim, and recorded a $3
million contract settlement expense in our September 30, 2003 fiscal quarter.
RESTRUCTURING CHARGE. In the third fiscal quarter of 2004, we recorded
restructuring charges of $926,000 related to the closing of our Northern Ireland
facility. During the third quarter of fiscal 2004, we completed the transition
of our battery production from our Northern Ireland manufacturing facility to
our OEM supplier. As of December 31, 2003, all production at our Northern
Ireland facility had ceased. Activities related to closing the facility and
preparing equipment for transition to the joint venture are expected to continue
throughout the quarter ending March 31, 2004. All inventory remaining at the
conclusion of manufacturing operations was determined to be obsolete and
unusable by any of our battery manufacturing sources. Raw materials inventory
obsolescence expense of approximately $178,000 and work in process inventory
obsolescence expense of approximately $517,000 were recorded as restructuring
charges during the quarter ended December 31, 2003. Remaining payment
obligations for factory equipment operating leases that extended beyond December
31, 2003 were approximately $231,000. These lease payment obligations provide no
economic benefit to us, and contractual lease costs of approximately $231,000
were recorded as restructuring charges during the quarter ended December 31,
2003. When the Northern Ireland manufacturing transition was initiated, an
incentive payment plan was established for certain employees. The employees
earned the bonus, payable in January 2004, if they were in good standing at
December 31, 2003. The cost of this bonus plan was $352,000 and was charged to
general and administrative expense during the quarter ended December 31, 2003.
DEPRECIATION AND AMORTIZATION, AND NON OPERATING INCOME AND EXPENSES
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses were
$286,000 and $662,000 for the third fiscal quarters of 2004 and 2003,
respectively, and $1.8 million and $2 million for the nine-month periods ended
December 31, 2003 and 2002, respectively. The decrease in depreciation resulted
from the impairment charge to intellectual property and property, plant, and
equipment recorded in the second quarter of fiscal 2004.
INTEREST EXPENSE. Interest expense relates to mortgages on our Northern Ireland
facility as well as interest on our long-term debt to stockholder. Interest
expense was $1 million for the fiscal quarter ended December 31, 2003 and
$987,000 for the fiscal quarter ended December 31, 2002. Interest expense was
$3.1 million in each of the first nine months of fiscal 2004 and 2003.
COST OF WARRANTS. In November 2003, we agreed to extend the time period in which
a warrant holder is able to exercise its warrants. The warrant exercise period
originally ended on July 27, 2003, and has been extended to July 27, 2004. The
non-cash expense related to the exercise period extension of $181,000 was
determined using the Black-Scholes model, with risk free rate of 1.04%, expected
life of 0.75 years, and volatility of 69.88. A total of 202,842 shares may be
purchased at an average exercise price of approximately $4.26 per share.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
At December 31, 2003, our principal sources of liquidity were cash and cash
equivalents of $7.5 million and $14 million available under financing
commitments with Berg & Berg Enterprises, LLC. Our current forecasts project
that these sources of liquidity will be sufficient to allow us to execute our
business plan. Our business plan contemplates that we will realize increases in
cash flow from the future sale of our Mallusk, Northern Ireland facilities
(which are expected to remain in use to support the manufacturing transition and
European sales operations until sold), the projected increases in product sales
and licensing revenue, the introduction of new and enhanced products that have
improved gross profit margins, and further cash flow 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 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.
21
On June 2, 2003 we raised net proceeds of approximately $9.4 million
through the sale of 1,000 shares of newly issued Series C Redeemable Convertible
Preferred Stock to an unaffiliated investor. The Series C 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 Stock at their stated value plus any accrued and unpaid
dividends. On January 22, 2004, the holder of the Series C Stock converted 139
of its 1,000 shares with principal amount of $1.39 million including accrued and
unpaid dividends into 327,453 shares of common stock at the conversion price of
$4.25 per share. Our business plan contemplates conversion of all remaining
shares of Series C Stock prior to their maturity date. If the remaining Series C
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.
Currently, we do not have sufficient sales and gross profit to generate the
cash flows required to meet our operating needs. Consequently, we depend on Berg
& Berg's continued willingness to fund our operations. We expect that Berg &
Berg will fund the $14 million of commitments by purchasing shares of our common
stock from time to time at our request at the then-current market value.
The following table summarizes our statement of cash flows for the nine months
ended December 31, 2003 and 2002:
Nine Months Ended December 31,
--------------------------------
(Dollars in thousands) 2003 2002
------------ -----------
Net cash flows provided by (used in):
Operating activities $ (21,639) $ (25,730)
Investing activities 920 (986)
Financing activities 21,440 29,055
Effect of foreign exchange rates 131 260
------------ -----------
Net increase in cash and cash equivalents $852 $2,599
============ ===========
Our use of cash from operations for the first nine months of fiscal 2004
and 2003 was $21.6 million and $25.7 million, respectively. The cash used for
operating activities during the first three quarters of our fiscal 2004
operating activities was primarily for operating losses net of non-cash expenses
as described above in the section titled "Operating Expenses". Cash used for
operations in the first nine months of fiscal 2004 was lower than the comparable
period in 2003 primarily from cash collected from deferred revenue shipments and
other lower net working capital requirements.
We received $920,000 from investing activities during the first three
quarters of fiscal 2004. Purchases of property, plant and equipment in our joint
venture were offset by our sale of the Henderson, Nevada facility. In the first
three quarters of 2003, $986,000 was invested in property, plant and equipment
in our Northern Ireland facility, our Austin, Texas, and Henderson, Nevada
facilities.
We obtained cash from financing activities of $21.440 million and $29.055
million during the first nine months of fiscal 2004 and 2003, respectively. The
2004 financing included $10 million from our Berg & Berg equity line, $9.4
million from the issuance of Series C Stock, and a cash investment by Fengfan in
our joint venture of $2.5 million. The cash invested in our joint venture will
be used exclusively for its purposes.
As a result of the above, we had a net increase in cash and cash
equivalents of $852,000 during the first nine months of fiscal 2004 and a net
increase of $2.6 million for the first nine months of fiscal 2003.
CAPITAL COMMITMENTS AND DEBT
At December 31, 2003, we had commitments for capital expenditures for the
next 12 months of approximately $189,000 relating to the implementation of
enterprise software. Fengfan has committed cash of $14.7 million to fund our
joint venture, of which $12.2 remains outstanding. Fengfan's funding will
finance land acquisition and construction of facilities, and provide capital for
the first two years of operations. We may require additional capital
expenditures in order to meet greater demand levels for our products than
currently are anticipated.
22
Our cash obligations for short-term and long-term debt, net of unaccreted
discount, excluding our obligation to INI, which is payable in stock, consisted
of:
(Dollars in thousands) December 31, 2003
-----------------
Mortgages on Northern Ireland facility, short-term $ 946
Mortgages on Northern Ireland facility, long-term 5,646
1998 long-term debt to Berg & Berg 14,950
2001 long-term debt to Berg & Berg 20,000
Interest on long-term debt 8,972
-----------------
Total long-term debt $ 50,514
=================
Repayment obligations of short-term and long-term debt principal are:
Fiscal year
----------------------------------------------------------------------------------
(Dollars in thousands) 2004 2005 2006 2007 2008 Thereafter Total
---------- ---------- ---------- ---------- ---------- ---------- ----------
Principal repayment 232 960 35,968 1,070 1,132 2,180 41,542
Payment obligations in our common stock to INI are as follows:
Fiscal Year
------------------------------------
(Dollars in thousands) 2005 2006 2007 Total
---------- ---------- ---------- ----------
Value of restricted common stock 1,700 1,500 1,500 4,700
If not converted to common stock prior to maturity, the redemption
obligation for the remaining Series C Preferred Stock is $8.6 million on
December 2, 2004.
The future sale of our facility in Northern Ireland will eliminate debt of
approximately $6.6 million. If cash flow from operations is not adequate to meet
debt obligations, additional debt or equity financing will be required. There
can be no assurance that we could obtain the additional financing.
23
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. The risks and
uncertainties described below are not the only risks and uncertainties we face.
Additional risks and uncertainties not presently known to us or that we
currently deem immaterial also may impair our business operations. If any of the
following risks actually occur, our business, financial condition, and results
of operations could suffer. In that event, the trading price of our common stock
could decline, and you may lose all or part of your investment in our common
stock. The risks discussed below also include forward-looking statements and our
actual results may differ substantially from those discussed in these
forward-looking statements.
RISKS RELATED TO OUR BUSINESS
WE MAY BE REQUIRED TO RAISE ADDITIONAL DEBT OR EQUITY FINANCING TO EXECUTE OUR
BUSINESS PLAN.
At December 31, 2003, our principal sources of liquidity were cash and cash
equivalents of $7.5 million and a total of $14 million of funding commitments
from Berg & Berg Enterprises, LLC, an entity controlled by Carl E. Berg, a
director and principal stockholder of ours. We expect that Berg & Berg will fund
the $14 million commitments by purchasing shares of common stock from time to
time at our request at the then current market value.
Our current forecasts project that these sources of liquidity will be sufficient
to allow us to execute on our business plan without the need for additional
financing. Our business plan contemplates that we will realize increases in cash
flow from the sale of our Mallusk, Northern Ireland facilities, projected
increases in product sales and licensing revenue, introduction of new and
enhanced products that have improved gross profit margins, 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 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
execute on all aspects of 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 $9.4 million through
the sale of one thousand shares of newly issued Series C Preferred Stock. The
Series C Preferred Stock matures on December 2, 2004 and carries a 2% annual
dividend, paid quarterly in cash or shares of common stock. The preferred stock
is convertible into common stock at $4.25 per share, and we have the right to
convert the preferred stock if the average of the volume weighted average price
of our common stock for a ten-day trading period is at or above $6.38 per share.
On January 22, 2004, the holder of the Series C Preferred Stock converted 139 of
its 1,000 shares with principal amount of $1.39 million, plus accrued and unpaid
dividends of $1,676, into 327,453 shares of common stock at the conversion price
of $4.25 per share. On the maturity date, we will redeem for cash any remaining
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 sufficient sales and gross profit to generate the cash
flows required to meet our operating needs. Consequently, we depend on Berg &
Berg's continued willingness to fund our continued operations.
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
24
demand would depend 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.
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 our inception in 1989 and had
an accumulated deficit of $420.9 million as of December 31, 2003. We had working
capital of $1.9 million as of December 31, 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(R) 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 depends 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 our customers or we are unable to gain
any significant market acceptance for Saphion(R) technology based batteries, our
business will be adverselY affected. It is too early to determine if Saphion(R)
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 these 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 that differ from those of the United States, and thus we cannot be
certain that foreign patent applications related to issued U.S. patents will
issue. Furthermore, if these patent applications issue, some foreign countries
provide significantly less effective patent enforcement than in 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
the patent applications that 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.
25
IF WE CANNOT PROTECT OR ENFORCE OUR EXISTING INTELLECTUAL PROPERTY RIGHTS OR IF
OUR PENDING PATENT APPLICATIONS DO NOT RESULT IN ISSUED PATENTS, WE MAY LOSE THE
ADVANTAGES OF OUR RESEARCH AND MANUFACTURING SYSTEMS.
Our ability to compete successfully will depend on whether we can protect our
existing proprietary technology and manufacturing processes. We rely on a
combination of patent and trade secret protection, non-disclosure agreements and
cross-licensing agreements. These measures may not be adequate to safeguard the
proprietary technology underlying our batteries. Employees, consultants, and
others who participate in the development of our products may breach their
non-disclosure agreements with us, and we may not have adequate remedies in the
event of their breaches. In addition, our competitors may be able to develop
products that are equal or superior to our products without infringing on any of
our intellectual property rights. Moreover, we may not be able to effectively
protect our intellectual property rights outside of the United States.
We have established a program for intellectual property documentation and
protection in order to safeguard our technology base. We intend to vigorously
pursue enforcement and defense of our patents and our other proprietary rights.
We could incur significant expenses in preserving our proprietary rights, and
these costs could harm our financial condition. We also are attempting to expand
our intellectual property rights through our applications for new patents. We
cannot be certain that our pending patent applications will result in issued
patents or that our issued patents will afford us protection against a
competitor. Our inability to protect our existing proprietary technologies or to
develop new proprietary technologies may substantially impair our financial
condition and results of operations.
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS BROUGHT AGAINST US COULD BE
TIME-CONSUMING AND EXPENSIVE TO DEFEND, AND IF ANY OF OUR PRODUCTS OR PROCESSES
IS 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 not be economically or technologically feasible.
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(R) 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.
26
IN ADDITION TO BEING USED IN OUR OWN PRODUCT LINES, OUR BATTERIES ARE INTENDED
TO BE INCORPORATED INTO OTHER PRODUCTS. IF WE DO NOT FORM EFFECTIVE ARRANGEMENTS
WITH OEMS TO COMMERCIALIZE THESE PRODUCTS, OUR PROFITABILITY COULD BE IMPAIRED.
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 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(R) technology, we significantly increased the
role of licensing in ouR business strategy. We have not entered into any
licensing agreements for our Saphion(R) technology. Our future operating results
could be adversely 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 at which 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.
Our Saphion(R) technology licensing strategy, our introduction of products using
Saphion(R) technology in retail sales channels, and our acquisition of the
Telcordia Technologies, Inc.'s intellectual property assets have 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 a potential conflict does occur, 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 we intend
to do 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 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 only limited experience with
receiving 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 have ceased production in our Northern Ireland manufacturing facility because
of its high cost of manufacturing. We believe that we have sufficient inventory
on hand and production capability at our OEM to meet our anticipated customer
demand for the immediate future. However, if our OEM partner is unable to
continue to manufacture product in commercial quantities on a timely and
efficient basis and/or the 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.
27
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.
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 may 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 the first nine months of fiscal 2004, two
customers, Best Buy and Amperex Technology Limited, each contributed more than
10% of revenue. During fiscal 2003, two customers, Alliant Techsystems Inc. and
Pabion Corporation, Ltd., each contributed more than 10% of total revenues.
During fiscal 2002, four customers, Hanil Joint Venture, Amperex Technology
Limited, Alliant Techsystems Inc., and Samsung Corporation, each contributed
more than 10% of total revenues. For fiscal 2001, four customers, Alliant
Techsystems Inc., MicroEnergy Technologies Inc., Moltech Corporation, and
Qualcomm, each contributed 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 MAY 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. In the past, we have experienced delays in product development
due to the delivery of nonconforming raw materials from our suppliers 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.
28
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. If
the amounts of active materials in our batteries are not properly balanced and
if the charge/discharge system is not properly managed, a dangerous situation
may result. Battery pack assemblers using batteries incorporating technology
similar to ours include special safety circuitry within the battery to prevent
such a dangerous condition. We expect that our customers will have to use a
similar type of circuitry in connection with their use of our oxide-based
products.
ACCIDENTS AT OUR FACILITIES COULD DELAY PRODUCTION AND ADVERSELY AFFECT OUR
OPERATIONS.
An accident in our facilities could occur. Any accident, whether due to the
production of our batteries or otherwise resulting from our facilities'
operations, could result in significant manufacturing delays or claims for
damages resulting from personal or property injuries, which would adversely
affect our operations and financial condition.
WE 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, 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 U.S. 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 including China 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
including China 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.
29
WE MAY NEED TO EXPAND OUR EMPLOYEE BASE AND OPERATIONS IN ORDER TO EFFECTIVELY
DISTRIBUTE OUR PRODUCTS COMMERCIALLY, WHICH MAY STRAIN OUR MANAGEMENT AND
RESOURCES AND COULD HARM OUR BUSINESS.
To implement our growth strategy successfully, we will have to increase our
staff, primarily with personnel in sales, marketing, and product support
capabilities, as well as third party and direct distribution channels. However,
we face the risk that we may not be able to attract new employees to
sufficiently increase our staff or product support capabilities, or that we will
not be successful in our sales and marketing efforts. Failure in any of these
areas could impair our ability to execute our plans for growth and adversely
affect our future profitability.
COMPETITION FOR PERSONNEL, IN PARTICULAR FOR PRODUCT DEVELOPMENT AND PRODUCT
IMPLEMENTATION PERSONNEL, IS INTENSE, AND WE MAY HAVE DIFFICULTY ATTRACTING THE
PERSONNEL NECESSARY TO EFFECTIVELY OPERATE OUR BUSINESS.
We believe that our future success will depend in large part on our ability to
attract and retain highly skilled technical, managerial, and marketing personnel
who are familiar with and experienced in the battery industry. 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 who have significantly greater financial
resources than we do. 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.
INTERNATIONAL POLITICAL EVENTS AND THE THREAT OF ONGOING TERRORIST ACTIVITIES
COULD INTERRUPT MANUFACTURING OF OUR BATTERIES AND END USER PRODUCTS AT OUR OEMS
AND JOINT VENTURE, AND CAUSE US TO LOSE SALES AND MARKETING OPPORTUNITIES.
The terrorist attacks that took place in the United States on September 11,
2001, along with the U.S. military campaigns against terrorism in Iraq,
Afghanistan, and elsewhere, and continued violence in the Middle East have
created many economic and political uncertainties, some of which may materially
harm our business and revenues. International political instability resulting
from these events could temporarily or permanently disrupt our manufacturing of
batteries and end-user products at our OEM facilities in Asia and elsewhere, and
have an immediate adverse impact on our business. Since September 11, 2001, some
economic commentators have indicated that spending on capital equipment of the
type that use our batteries has been weaker than spending in the economy as a
whole, and many of our customers are in industries that also are viewed as
under-performing the overall economy, such as the telecommunications,
industrial, and utility industries. The long-term effects of these events on our
customers, the market for our common stock, the markets for our products, and
the U.S. economy as a whole are uncertain. Terrorist activities could
temporarily or permanently interrupt our manufacturing, development, sales, and
marketing activities anywhere in the world. Any delays also could cause us to
lose sales and marketing opportunities, as potential customers would find other
vendors to meet their needs. The consequences of any additional terrorist
attacks, or any expanded armed conflicts are unpredictable, and we may not be
able to foresee events that could have an adverse effect on our markets or our
business.
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.
30
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.
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 COULD 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-ChargeTM Power 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 U.N.
guidelines. At present it is not known if or when the proposed regulations would
be adopted by the United States. While we fall under the equivalency levels for
the United States 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 February 6, 2004, our officers, directors and their affiliates as a group
beneficially owned approximately 36.9% of our outstanding common stock. Carl
Berg, one of our directors, beneficially owns approximately 33.8% 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 THAT POTENTIAL
ACQUIRERS MAY BE WILLING TO PAY FOR OUR COMMON STOCK.
Our board of directors has the authority, without any action by the outside
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, may decrease the market price, and may infringe upon the
voting and other rights of the holders of our common stock.
31
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 February 6, 2004, the
closing price of our common stock was $5.21. 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.
The market price 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 74,906,078 shares of common stock as of
December 31, 2003. In addition, at December 31, 2003, we had 12,625,845 shares
of our common stock reserved for issuance under warrants and 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 an additional 2,025,882 shares of our common stock (based on a conversion
price of $4.25) and up to 352,900 shares upon exercise of the related warrant
issued on June 2, 2003. To fulfill our obligations to INI), we would issue
915,496 shares of our common stock at its current market price.
32
WE DO NOT INTEND TO PAY DIVIDENDS ON OUR COMMON STOCK, AND THEREFORE
STOCKHOLDERS WILL BE ABLE TO RECOVER THEIR INVESTMENT IN OUR COMMON STOCK, IF AT
ALL, ONLY 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 December 31, 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 December 31, 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% above the
lender's borrowing rate (9% at December 31, 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 232 960 15,968 1,070 1,132 2,180 21,542
Based on borrowing rates currently available to us for loans with similar
terms, the carrying value of our debt obligations approximates fair value.
ITEM 4. CONTROLS AND PROCEDURES
We conducted an evaluation, under the supervision and with the participation of
our Principal Executive Officer and Principal Financial Officer, of the
effectiveness of our disclosure controls and procedures as of the end of the
third quarter of fiscal 2004. Based on this evaluation, our Principal 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 Principal 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 Principal 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.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and may not be detected.
33
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 December 22, 2003, we sold 1,525,506 shares of our restricted common stock at
an aggregate price of $5 million to Berg & Berg Enterprises, LLC, an affiliate
of Carl Berg, a director and principal stockholder, in a private placement
transaction exempt from registration pursuant to Section 4(2) of the Securities
Act of 1933, as amended. The issuance was made without general solicitation or
advertising. The single purchaser is a knowledgeable and sophisticated investor
and was provided with the opportunity to ask questions and receive answers
concerning the terms and conditions of the offering and obtain additional
information that was in our possession or we could acquire without unreasonable
effort or expense. Net proceeds to us from this sale were $5 million, and are
being used to fund corporate operating needs and working capital.
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
31.1 Rule 13a-14/15d-14(a) Certifications
32.1 Section 1350 Certifications
(b) Reports on Form 8-K:
Current Report on Form 8-K, filed October 1, 2003, disclosing under Item 5 and 7
that, on September 30, 2003, we sold 1,543,925 shares of our restricted common
stock to Berg & Berg Enterprises, LLC.
Current Report on Form 8-K, filed November 14, 2003, disclosing under Item 7 and
12 our press release issued on November 13, 2003, disclosing our condensed
consolidated balance sheets and condensed consolidated statements of operations
and comprehensive loss, each for the quarter ended September 30, 2003.
Current Report on Form 8-K, filed December 17, 2003, disclosing under Item 2 and
7 the Purchase and Sale Agreement and Escrow Instructions between Valence
Technology Nevada, Inc. and Mars Partners, dated August 8, 2003.
Current Report on Form 8-K, filed December 23, 2003, disclosing under Item 5
that, on December 22, 2003, we sold 1,525,506 shares of our restricted common
stock to Carl Berg's 401(k) plan (the assignee of Berg & Berg Enterprises, LLC).
34
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: February 13, 2004 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 and
Assistant Secretary (Principal
Financial and Accounting Officer)
35
EXHIBIT INDEX
EXHIBIT NO.
31.1 Rule 13a-14/15d-14(a) Certifications
32.1 Section 1350 Certifications