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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 June 30, 2004.
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 x No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $0.001 par value 78,488,174
- -------------------------------------- ----------------------------------
(Class) (Outstanding at July 29, 2004)
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2004
INDEX
PAGES
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets as of
June 30, 2004 and March 31, 2004......................................................3
Condensed Consolidated Statements of Operations and
Comprehensive Loss for Each the Three-
Month Periods Ended June 30, 2004 and June 30, 2003...................................4
Condensed Consolidated Statements of Cash Flows
for Each of the Three-
Month Periods Ended June 30, 2004 and June 30, 2003...................................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...........................38
Item 4. Controls and Procedures..............................................................38
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................................39
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities.....39
Item 3. Defaults upon Senior Securities......................................................39
Item 4. Submission of Matters to a Vote of Security Holders..................................39
Item 5. Other Information....................................................................39
Item 6. Exhibits and Reports on Form 8-K.....................................................39
SIGNATURE .....................................................................................41
2
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)
June 30, 2004 March 31, 2004
----------------- -----------------
ASSETS
Current assets:
Cash and cash equivalents $ 3,224 $ 2,692
Trade receivables, net of allowance of $73
as of June 30, 2004 and $98 as of March 31, 2004 1,661 1,477
Inventory 3,483 3,318
Prepaid and other current assets 781 837
----------------- -----------------
Total current assets 9,149 8,324
Property, plant and equipment, net 6,493 12,218
Intellectual property, net 485 514
----------------- -----------------
Total assets $ 16,127 $ 21,056
================= =================
LIABILITIES, PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
Current liabilities:
Note payable $ - $ 2,068
Current portion of long-term debt 1,034 967
Accounts payable 3,606 2,263
Accrued expenses 4,253 4,527
Deferred revenue 1,143 1,593
Grant payable - short term 1,753 1,753
----------------- -----------------
Total current liabilities 11,789 13,171
Grant payable - long term 3,036 3,036
Long-term interest 10,460 9,720
Long-term debt, less current portion 5,186 5,458
Long-term debt to stockholder 34,125 33,949
----------------- -----------------
Total liabilities 64,596 65,334
----------------- -----------------
Minority interest in joint venture - 4,484
----------------- -----------------
Redeemable convertible preferred stock, $0.001 par value, 1,000 shares
authorized, 861 issued and outstanding at June 30, 2004 and
March 31, 2004, liquidation value $8,610 8,250 8,032
----------------- -----------------
Commitments and contingencies
Stockholders' equity (deficit):
Common stock, $0.001 par value, 100,000,000 shares authorized;
78,487, 550 and 75,961,826 shares issues and outstanding,
respectively 78 76
Additional paid-in capital 391,021 382,282
Deferred compensation (149) (226)
Notes receivable from stockholder (4,953) (5,161)
Accumulated deficit (438,726) (429,724)
Accumulated other comprehensive loss (3,990) (4,041)
----------------- -----------------
Total stockholders' deficit (56,719) (56,794)
----------------- -----------------
Total liabililities, preferred stock and stockholders' deficit $ 16,127 $ 21,056
================= =================
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 June 30,
-------------------------------
2004 2003
-------------- --------------
Revenue:
Licensing and royalty revenue $ 73 $ 556
Battery and system sales 2,764 1,075
-------------- --------------
Total revenues 2,837 1,631
Cost of sales: 3,923 3,818
-------------- --------------
Gross profit (loss) (1,086) (2,187)
Operating expenses:
Research and product development 1,899 2,056
Marketing 1,331 958
General and administrative 3,412 2,468
Depreciation and amortization 273 788
-------------- --------------
Total costs and expenses 6,915 6,270
-------------- --------------
Operating loss (8,001) (8,457)
Interest and other income 96 80
Interest and other expense (1,053) (1,112)
-------------- --------------
Net loss (8,958) (9,489)
Dividends on preferred stock 43 16
Preferred stock accretion 218 -
-------------- --------------
Net loss available to common stockholders $ (9,219) $ (9,505)
============== ==============
Other comprehensive loss:
Net loss $ (8,958) $ (9,489)
Change in foreign currency translation adjustments 50 45
-------------- --------------
Comprehensive loss $ (8,908) $ (9,444)
============== ==============
Net loss per share available to common stockholders $ (0.12) $ (0.13)
============== ==============
Shares used in computing net loss
per share available to common
stockholders, basic and diluted 76,941 71,728
============== ==============
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three Months Ended June 30,
--------------------------------
2004 2003
--------------- --------------
Cash flows from operating activities:
Net loss $ (8,958) $ (9,489)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 273 788
Accretion of debt discount and other 177 261
Interest income on stockholder note receivable (93) (69)
Deferred compensation expense (188) 250
Changes in operating and other assets and liabilities:
Trade receivables (183) 413
Inventory (166) (2,151)
Other current assets 18 172
Accounts payable 1,360 (359)
Accrued expenses and long-term interest 469 1,275
Deferred revenue (450) 1,438
--------------- --------------
Net cash used in operating activities (7,741) (7,471)
--------------- --------------
Cash flows from investing activities:
Effect of deconsolidation of joint venture (913) -
Purchases of property, plant & equipment (171) (62)
--------------- --------------
Net cash used in investing activities (1,084) (62)
--------------- --------------
Cash flows from financing activities:
Proceeds from long-term debt - 277
Payment of long-term debt (157) (164)
Dividends paid (43) -
Interest received on stockholder note receivable 301
Proceeds from issuance of preferred stock,
net of issuance costs - 9,458
Proceeds from stock option exercises 231 -
Proceeds from issuance of common stock,
net of issuance costs 8,993 -
--------------- --------------
Net cash provided by financing activities 9,325 9,571
--------------- --------------
Effect of foreign exchange rates on cash
and cash equivalents 32 13
--------------- --------------
Increase in cash and cash equivalents 532 2,051
Cash and cash equivalents, beginning of period 2,692 6,616
--------------- --------------
Cash and cash equivalents, end of period $ 3,224 $ 8,667
=============== ==============
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
1. INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
These interim condensed consolidated financial statements are unaudited but
reflect, in the opinion of management, all normal recurring adjustments
necessary to present fairly the financial position of Valence Technology,
Inc. and its subsidiaries (the "Company") as of June 30, 2004, its
consolidated results of operations for each of the three-month periods
ended June 30, 2004 and June 30, 2003, and the consolidated cash flows for
each of the three-month periods ended June 30, 2004 and June 30, 2003.
Because all the disclosures required by generally accepted accounting
principles are not included, these interim condensed consolidated financial
statements should be read in conjunction with the audited financial
statements and notes thereto in the Company's Annual Report on Form 10-K as
of and for the year ended March 31, 2004. The results for the three-month
period ended June 30, 2004 are not necessarily indicative of the results to
be expected for the entire fiscal year ending March 31, 2005. The year-end
condensed consolidated balance sheet data as of March 31, 2004 was derived
from audited financial statements, but does not include all disclosures
required by generally accepted accounting principles.
2. BUSINESS AND BUSINESS STRATEGY:
Valence Technology, Inc. (with its subsidiaries, "the Company") was founded
in 1989. From 1989 through 2000, the Company's efforts were focused on
developing and acquiring battery technologies. With the appointment of
Stephan B. Godevais as its Chief Executive Officer and President, the
Company initiated the transition of its business by broadening its
marketing and sales efforts to take advantage of its strengths in research
and development. With this strategic shift, the Company has commercialized
the industry's first phosphate-based lithium-ion technology and brought to
market several products utilizing this technology. The Company's mission is
to drive the wide adoption of high-performance, safe, low-cost energy
storage systems by drawing on the numerous benefits of its latest battery
technology, the extensive experience of its management team, and the
significant market opportunity available to it.
In February 2002, the Company unveiled its Saphion(R) technology, a
lithium-ion technology which utilizes a phosphate-based cathode material.
The Company believes that by incorporating a phosphate-based cathode
material, its Saphion(R) technology is able to offer greater thermal and
electrochemical stability than traditional lithium-ion technologies. The
Company believes that the safety characteristics of Saphion(R) technology
will enable it to be designed into a wide variety of products in both
existing lithium-ion markets as well as markets not served by current
lithium-ion solutions. These markets include, among others, notebook
accessories, consumer appliances, vehicles, utility and the
telecommunications sectors.
The Company's business plan and strategy focus on the generation of revenue
from a combination of product sales and licensing activities, while
minimizing costs through a manufacturing plan that utilizes partnerships
with contract manufacturers, as well as through the establishment of a
fully-owned subsidiary in a low-cost geographic region such as China. The
market for Saphion(R) technology will be developed by offering existing and
new solutions that differentiate the Company's products and end-users'
products in both the large-format and small-format markets through the
Company's own product launches, such as the N-Charge(TM) Power System,
K-Charge(TM) Power System, and U-Charge(TM) Power System, and through
products designed by others. In addition, the Company will seek to expand
the fields of use of its Saphion(R) technology through the licensing of its
intellectual property related to its battery chemistries and manufacturing
processes.
3. LIQUIDITY AND CAPITAL RESOURCES:
At June 30, 2004, the Company's principal sources of liquidity were cash
and cash equivalents of $3.2 million and $22 million available under
various financing commitments with Berg & Berg Enterprises, LLC. The $22
million of financing commitments come in the form of two equity lines of
credit. At June 30, 2004, $2 million remained on an existing commitment and
$20 million relates to a backup equity funding commitment, both of which
allow the Company to request Mr. Berg or an affiliate company to purchase
shares of common stock from time to time at the then-current market value.
During the first quarter of fiscal 2005, the Company determined that in
order to reach its long-term objectives and minimize its fixed operating
costs, the Company requires the transition of more of its operations to
lower cost geographic regions. In order to achieve this plan, Mr. Berg has
agreed to provide the additional $20 million backup
6
equity funding commitment. This commitment can be reduced by the amount of
net proceeds received from the sale of building or equipment from the
Company's Mallusk, Northern Ireland facility or the amount of net proceeds
in a debt or equity transaction, and may be increased if necessary under
certain circumstances. As of June 30, 2004 the Company had not received any
net proceeds from the above-mentioned transactions.
On June 2, 2003 the Company 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 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. The Company's business plan contemplates conversion of all remaining
shares of Series C stock prior to their maturity date. On the maturity
date, the Company is required to redeem for cash any unconverted shares of
the Series C stock at their stated value plus any accrued and unpaid
dividends. If the remaining Series C stock shares have not been converted
by the maturity date, the Company may need to raise additional debt or
equity financing to facilitate any required redemption. There can be no
assurance that the Company could obtain the additional financing.
The Company's current forecast projects that these sources of liquidity
will be sufficient for at least the 12 months following March 31, 2004.
This forecast assumes product sales during fiscal 2005 from our
N-Charge(TM) Power System, which are subject to seasonal fluctuations, of
between $2.0 million to $3.5 million per quarter, and additional revenues
from volume shipments of our large-format applications commencing in the
fourth quarter of fiscal 2005. The Company also anticipates further cash
benefits from continued reductions in operating expenses and manufacturing
costs, offset by small increases to capital expenditures associated with
the Company's expected establishment of a presence in China.
The Company's cash requirements may vary materially from those now planned
because of changes in its operations, including the failure to achieve
expected revenues, greater than expected expenses, changes in OEM
relationships, market conditions, the failure to timely realize its product
development goals, and other adverse developments. In addition, the Company
is subject to contingent obligations, including the possible redemption of
the Company's outstanding Series C Preferred stock and demand for repayment
of a portion or all of the Company's existing grants.
Currently, the Company does not have sufficient sales and gross profit to
generate the cash flows required to meet its operating and capital needs.
If during the next 12 months the Company's cash requirements increase, or
its cash sources decline, the Company would require additional debt or
equity financing. In addition, unless the Company is able to achieve
substantially greater product sales or reduced expenses over this period,
it will require additional debt or equity financing in fiscal 2006.
Currently the Company depends on Carl Berg's continued willingness to fund
its operations. Mr. Berg has made no commitments to provide any additional
equity or debt financing above his current contractual commitments, and
there can be no assurance that he or any of his affiliates will do so in
the future. Consequently, if the Company needs additional debt or equity
financing, the Company assumes that it will need to obtain such financing
from parties other than Mr. Berg and his affiliates. The Company is not
currently aware of any available source for such debt or equity financing
and may not be able to arrange for such financing on favorable terms or at
all.
4. 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, primarily 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. For reseller shipments where revenue recognition is deferred, the
Company records revenue based upon resellers' supplied reporting of sales
to end customers or upon their inventory reporting. For direct customers,
the Company estimates a return percentage based upon its historical
experience, reviewed on a quarterly basis. Customer rebates and other price
adjustments are recognized as incurred. 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 licensee revenue reporting and when
collectibility is reasonably assured.
7
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." 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. Had
compensation expense for the stock plans been determined based on the fair
value at the grant date for options granted in the first quarter of fiscal
2004 and 2003 consistent with the provisions of SFAS 123, as amended by
SFAS 148, the pro forma net loss would have been reported as follows (in
thousands):
Three Months Ended
June 30,
-------------------------
2004 2003
-------------------------
Net loss available to common stockholders - as reported $ (9,219) $ (9,505)
Add: stock-based compensation expense, net of related taxes (903) (1,382)
-------- -------
Net loss available to common stockholders - pro forma (10,122) (10,887)
Net loss available to common stockholders per share - as reported (0.12) (0.13)
Net loss available to common stockholders, basic and diluted, pro forma (0.13) (0.15)
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 three months of fiscal 2005 and 2004:
2005 2004
---------------------
Risk-free interest rate 3.81% 2.46%
Expected life 5.00 years 5.00 years
Volatility 106.15% 109.82%
Dividend yield - -
RECENT ACCOUNTING PRONOUNCEMENTS:
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
8
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 10, 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 June 30 were as follows:
Three Months Ended
June 30
2004 2003
----------------------
Shares reserved for conversion of Series C
preferred stock 2,026,000 2,353,000
Common stock options 8,812,000 8,764,000
Warrants to purchase common stock 2,469,000 3,590,000
----------------------
Total 13,307,000 14,707,000
======================
5. 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 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 were
used for working capital purposes.
On April 19, 2004, the Company drew down $3 million from its equity
commitment with Berg & Berg. Under the terms of the equity commitment, the
Company issued Berg & Berg 710,900 shares of its restricted common stock at
the then-current market price.
On May 24, 2004, the Company drew down $3 million from its equity
commitment with Berg & Berg. Under the terms of the equity commitment, the
Company issued Berg & Berg 829,190 shares of its restricted common stock at
the then-current market price.
On June 28, 2004, the Company drew down $3 million from its equity
commitment with Berg & Berg. Under the terms of the equity commitment, the
Company issued Berg & Berg 877,193 shares of its restricted common stock at
the then-current market price.
9
On July 27, 2004, the Company drew down $2 million from its equity
commitment with Berg & Berg. Under the terms of the equity commitment, the
Company issued Berg & Berg 728,332 shares of its restricted common stock at
the then-current market price.
6. INVENTORY:
Inventory consisted of the following (in thousands) at:
June 30, 2004 March 31, 2004
---------------- ----------------
Raw materials $ 301 $ 317
Work in process 1,666 1,330
Finished goods 1,516 1,671
---------------- ----------------
$ 3,483 $ 3,318
================ ================
7. PROPERTY, PLANT, AND EQUIPMENT:
Property, plant, and equipment, net of accumulated depreciation and
impairment consisted of the following (in thousands) at:
June 30, 2004 March 31, 2004
----------------- ----------------
Building and land $ 12,435 $ 15,726
Leasehold improvements 50 50
Machinery and equipment 13,583 13,609
Office and computer equipment 1,227 960
Construction in progress - 2,490
----------------- ----------------
Total cost 27,295 32,835
Less: accumulated depreciation (15,636) (15,451)
Less: impairment (5,166) (5,166)
----------------- ----------------
Total cost, net of depreciation $ 6,493 12,218
================= ================
8. 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:
June 30, 2004 March 31, 2004
--------------- ---------------
Intellectual property before impairment $ 13,602 $ 13,602
Less: accumulated amortization (4,622) (4,594)
Less: Impairment (8,494) (8,494)
--------------- ---------------
Intellectual property, net $ 485 $ 514
=============== ===============
Amortization expense for the three-month period ended June 30, 2004 was
approximately $29,000. Amortization expense for the three-month period
ended June 30, 2003 was approximately $362,000. Amortization expense on
intellectual property at June 30, 2004 will be $85,000 for the remaining
nine months of fiscal 2005 and will be $114,000 in fiscal years 2006
through 2008 and $58,000 for fiscal 2009.
10
9. DEBT TO STOCKHOLDER:
(in thousands) June 30, 2004 March 31, 2004
----------------- --------------
2001 Loan balance $ 20,000 $ 20,000
1998 Loan balance 14,950 14,950
Unaccreted debt discount (825) (1,001)
----------------- --------------
Balance $ 34,125 $ 33,949
================= ==============
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 June 30, 2004, accrued
interest on the loan totaled $3.868 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 June 30, 2004, a total of approximately $1.944 million has
been accreted and included as interest expense. The amounts charged to
interest expense on the outstanding balance of the loan for each of the
three-month periods ended June 30, 2004 and 2003 was $404,000. 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 June 30, 2004, 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 June 30, 2004). 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 June 30, 2004, accrued
interest on the loan totaled $6.436 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 June 30, 2004, a total of $2.159 million has been
accreted. The amount charged to interest expense for each of the
three-month periods ended June 30, 2004 and 2003 was $335,000. Interest
payments on the loan are currently being deferred, and are recorded as
long-term interest.
10. 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
11
established its initial product warranty reserves as 10% of N-Charge(TM)
Power System sales. The Company will adjust the percentage based on actual
experience for future warranty provisions. In addition, the Company has
established a reserve for its 30-day right of return policy under which a
customer may return a purchased N-Charge(TM) Power System. The Company has
estimated its right of return liability as 5% of the previous month's
N-Charge(TM) Power System sales. The total warranty liability as of June
30, 2004 is $1.039 million.
Product warranty liabilities for the three months ended June 30, 2004 and
the year ended March 31, 2004 are as follows (in thousands):
June 30, 2004 March 31, 2004
----------------- -----------------
Beginning balance $ 490 $ 123
Less: claims (190) (445)
Less: returns (17) (34)
Plus: accruals 616 846
----------------- -----------------
Ending balance $ 899 $ 490
================= =================
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, pursuant to a Letter of Offer, the Company 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 or for sale, on August 13,
2003, the Company obtained verbal assurance that it had reached agreement
with INI to terminate the Letter of Offer. Pursuant to this proposed
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. The INI has not yet completed its
formal approval process for this agreement. Based on current conversations,
the INI would like to investigate options in addition to the proposed
settlement. Although a range of the potential liability is expected to be
$1.7 million to $7.7 million, the Company believes that the amount
previously recorded of $4.7 million remains the best estimate of the
potential liability to the INI for settlement and termination of the Letter
of Offer.
11. 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.
12
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 remaining redemption value of $8.6 million is being
recorded over the eighteen-month period of the Series C stock.
On January 22, 2004, the holder of the Series C Redeemable Convertible
Preferred Stock converted 139 of its 1,000 shares with the principal amount
of $1.39 million, including accrued and unpaid dividends, into 327,453
shares of the Company's common stock at the conversion price of $4.25 per
share.
12. RELATED PARTY TRANSACTIONS:
In June 2004, Mr. Carl Berg, a director and shareholder in the Company,
agreed to provide an additional $20 million backup equity funding
commitment. This commitment can be reduced by the amount of net proceeds
received from the sale of the building or equipment from the Company's
Mallusk, Northern Ireland facility or the amount of net proceeds in a debt
or equity transaction, and may be increased if necessary under certain
circumstances. This additional finding commitment will come in the form of
equity line of credit and will allow the Company to request Mr. Berg to
purchase shares of common stock from time to time at the then-current
market value.
On June 10, 2003, Berg & Berg, an affiliate of Carl Berg, a director and
shareholder in the Company, 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 then-existing commitment). Berg & Berg will fund the
commitments by purchasing shares of common stock from time to time as
requested by the Company at the then-current market price. At June 30,
2004, $2.0 million remained available under this financing commitment.
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 June
30, 2004, amounts of $3.406 million and $1.547 million were outstanding
under Dawson Note One and Dawson Note Two, respectively, and under each of
the Dawson Notes, interest from the Issuance Date accrues on unpaid
principal at the rate of 5.69% per annum, or at the maximum rate
permissible by law, whichever is less.
In accordance with the Dawson Notes, interest is payable annually in
arrears and has been paid through March 4, 2004.
13. GEOGRAPHIC INFORMATION:
The Company conducts its business in two geographic segments.
13
Long lived asset information by geographic segment at June 30, 2004 and
March 31, 2004 is as follows (in thousands):
June 30, 2004 March 31, 2004
----------------- ----------------
United States $ 1,687 $ 1,656
International 5,291 11,076
----------------- ----------------
Total $ 6,978 $ 12,732
================= ================
Revenues by geographic segment for the three-month periods ended June 30,
2004 and 2003 are as follows (in thousands):
Three Months Ended June 30,
---------------------------------
2004 2003
---------------- ----------------
United States $ 2,633 $ 912
International 204 719
---------------- ----------------
Total $ 2,837 $ 1,631
================ ================
14. JOINT VENTURE:
On July 9, 2003, Boading Fengfan-Valence Battery Company, a joint venture
between the Company and Fengfan Group, Ltd. ("Fengfan") was formed. The
purpose of the joint venture was to provide low cost manufacturing of the
Company's Saphion(R) Lithium-ion batteries. Under the terms of the joint
venture agreement, the Company was to contribute 51% of the joint venture's
registered capital, consisting of capital equipment, a nonexclusive license
to its technology, and engineering expertise. Fengfan was to 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.
In January of 2004, the Company identified and the board of the joint
venture approved, the hiring of a CEO of the joint venture. Construction
continued on the Baoding facility and computer equipment was purchased for
venture activities. During the remainder of the fourth quarter, memoranda
and letters between the Company and Fengfan were exchanged which expressed
concerns about the operational direction of the joint venture. The
correspondence culminated in letter dated March 2004 in which the Company
gave Fengfan notice of termination of the joint venture due to breach of
contract by Fengfan. Through the period ended March 31, 2004, the Company
was the majority owner of the joint venture and its control over the joint
venture's activities and property was not then in doubt. Therefore it
consolidated the joint venture into its consolidated financial statements.
During the first quarter of fiscal 2005, several events occurred that
resulted in the Company losing its control of the joint venture. After
numerous attempts to set a date for a meeting of the joint venture's board
of directors, the Company has been unable to receive a commitment from
Fengfan for a date for the meeting. FengFan removed the joint venture's
office furniture and equipment, has renounced the authority of the joint
venture board-appointed CEO, denied access by the joint venture's employees
and the Company's employees to the joint venture's facilities, and has
refused access to the joint venture's technical and financial records. The
joint venture agreement provides for termination through negotiation or
other means, including arbitration in Singapore. The Company continues
negotiations with Fengfan, is preparing for arbitrating the termination of
the joint venture in Singapore, and is preparing for the liquidation of the
joint venture through special liquidation procedures under the applicable
China law. The Company is initiating these actions to enforce its rights
under China law and the joint venture agreement.
As of March 31, 2004, the Company's consolidated financial statements
included the consolidation of the balance sheet, results of operations, and
cash flows of the joint venture. As a result of the Company's loss of
control over the joint venture, and its initiation of actions to enforce
its rights, the Company is accounting for its investment in the joint
venture under the cost method with no further recognition of assets,
liabilities, operating results, and cash flows until such time as the terms
of termination and liquidation of the joint venture are concluded.
As of June 30, 2004, the joint venture had cash of $31,000, other current
assets of $21,000, property, plant, and equipment, primarily a land license
and a building, of $5.586 million, a note payable of $2.068 million related
to the land license, and other current liabilities of $95,000. Cumulative
operating loss since inception is $211,000, of which
14
$108,000 represents the Company's interest. The Company's interest in the
joint venture's operating losses is recorded as a liability and will be
adjusted if necessary upon final resolution of the termination and
liquidation of the joint venture. There may be additional liabilities in
the future related to negotiation or arbitration leading to the final
termination and liquidation of the joint venture. However, at this time no
further liability related to the final termination and liquidation of the
joint venture can be reasonably estimated, and the Company's management
believes that there will be no material impact on its financial statements
as a result.
15. 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.
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 Company's contract manufacturers or for
sale are expected to continue in fiscal 2005.
Liabilities related to restructuring at June 30, 2004 consisted of inactive
operating leases of approximately $110,000.
16. 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, OAccounting for Impairment or Disposal of
Long-Lived Assets.O 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%.
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-MONTH PERIOD ENDED JUNE 30, 2004 ARE NOT NECESSARILY
INDICATIVE OF THE RESULTS TO BE EXPECTED FOR THE ENTIRE FISCAL YEAR ENDING MARCH
31, 2005.
OVERVIEW
We have commercialized the first phosphate-based lithium-ion technology and
have brought to market several products utilizing this technology. Our mission
is to drive the wide adoption of high-performance, safe, low-cost energy storage
systems by drawing on the numerous benefits of our latest battery technology,
Saphion(R), the extensive experience of our management team and the significant
market opportunity available to us. The push 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.
Additionally, due to safety concerns, lithium-ion technology has been limited in
adoption to small-format applications. Our Saphion(R) technology, a
phosphate-based cathode material, addresses the need for a safe lithium-ion
solution, especially in large-format applications.
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 Chief Executive Officer and President,
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 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 costs
through a manufacturing plan that utilizes partnerships with contract
manufacturers, as well as through the establishment of a fully-owned subsidiary
in a low-cost geographic region such as China. We plan to drive the adoption of
our Saphion(R) technology by offering 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 will seek 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 family and our K-Charge(TM) Power System, which
meet market needs of a large customer base; and introduced our U-Charge(TM)
Power System family of products, which is intended to be a direct
replacement for existing lead acid battery solutions in the market today;
16
o Established relationships with top tier customers across many of the target
markets for our products, while continuing to build our brand awareness in
multiple channels;
o Closed our high-cost manufacturing facility in Northern Ireland and
established key manufacturing partnerships in Asia to facilitate low-cost,
quality production;
o Signed an agreement granting Tyco Electronics Power Systems, Inc. the
exclusive right to resell our K-Charge(TM) Power System to its
telecommunications and utility customers for a period of three years. The
K-Charge(TM) Power System will be privately labeled and marketed by Tyco
Electronics under its ELiTE RK brand. The agreement is conditioned on the
product meeting performance criteria and on Tyco Electronics achieving
specific quarterly volume requirements. Tyco Electronics will provide
sales, marketing, technical assistance and customer support; and
o Signed an agreement granting GF Health Products, Inc, (Graham-Field), a
manufacturer and distributor of healthcare products, the exclusive right to
resell our U-Charge(TM) Power System in the power wheelchair and medical
scooter market in the United States and its territories for three years.
Additionally, under the agreement Graham-Field will provide sales and
marketing, technical assistance and customer support functions.
Our financial results for the first quarter of fiscal 2005 were consistent
with our expected progress in our business. Most significantly, revenue grew by
73.9% as compared to the prior year to $2.8 million. Additionally, we achieved
improvement of our negative gross margin to (38%) from (134%) and expanded our
development and channel launch of Saphion(R)-based products. During the quarter
we continued our efforts to transition our manufacturing and other operations to
low-cost regions. We believe our long-term success requires the transition of
additional operations to Asia. We are exploring a variety of different areas to
achieve this transition and generate additional cost savings during fiscal 2005.
To support the transition to China and help manage potential delays in product
transitions and receiving customer purchase orders, we have received an
additional $20 million backup equity funding commitment, which can be increased
in certain circumstances, from Carl Berg, a director and principal stockholder,
to cover our fiscal 2005 cash requirements. This commitment can be reduced if
funds to support operational needs are received from the sale of our Northern
Ireland facility and equipment or from other funding transactions.
Our business headquarters are located in Austin, Texas, our research and
development centers are in Henderson, Nevada and Oxford, England, and our
European sales and OEM manufacturing support center is in Mallusk, Northern
Ireland.
BASIS OF PRESENTATION, CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our condensed consolidated financial statements in conformity with
generally accepted accounting principles in the United States. 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. Our accounting policies are described in Note 4 of the Notes to
Condensed Consolidated Financial Statements. The following further describes the
methods and assumptions we use in our critical accounting policies and
estimates:
REVENUE RECOGNITION: We generate revenues 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, primarily product shipments to
resellers that are subject to right of return, are recorded as deferred revenue
and reflected as a liability on our balance sheet. For reseller shipments where
revenue recognition is deferred, we record revenue based upon the
reseller-supplied reporting of sales to their end customers or their inventory
reporting. For direct customers, we estimate a return rate percentage based upon
our historical experience. We review this estimate on a quarterly basis. From
time to time we provide sales incentives in the form of rebates or other price
adjustments; these are recorded as reductions to revenue as incurred. 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 licensee revenue reporting and when
collectibility is reasonably assured.
IMPAIRMENT OF LONG-LIVED ASSETS: We perform 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
17
made. The estimated cash flows used in our impairment analyses reflect our
assumptions about average selling prices, royalties, sales volumes, product
costs, operating costs (including costs associated with our manufacturing
transition to China), disposal costs, and market conditions. These assumptions
are sometimes subjective and may require us to make estimates of matters that
are uncertain. Additionally, we use probability-weighted scenarios to
incorporate the impact of alternative outcomes, where applicable. See Notes to
Condensed Consolidated Financial Statements, Note 15, Impairment Charge,
regarding impairment of tangible and intangible assets.
EXIT COSTS: We incurred exit costs associated with the closure of our Northern
Ireland manufacturing facility. In accordance with, SFAS No. 146, "Accounting
for Costs Associated with Exit or Disposal Activities," we recognize liabilities
for costs associated with exit or disposal activities at fair value in the
period during which the liability is incurred. We estimate the liabilities
related to exit or disposal activities including lease termination costs,
compensation of staff, inventory obsolescence, costs to prepare assets for
disposal or sale, and other one-time expenses based upon our analysis of
individual transaction circumstances, agreements and commitments. 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 the footnotes to condensed consolidated financial
statements. Costs associated with exit or disposal activities are included in
restructuring charges. See Notes to Condensed Consolidated Financial Statements,
Note 15 Facility Closing, regarding costs of closing our Northern Ireland
facility.
CONTRACT SETTLEMENT CHARGE. Beginning in 1994, pursuant to a Letter of Offer, 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 our equipment for transfer or
for sale, on August 13, 2003, we obtained verbal assurance that we had reached
an agreement with the INI to terminate the Letter of Offer. Pursuant to this
proposed agreement, the 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. The INI has not yet completed its formal approval
process for this agreement. Based on current conversations, the INI would like
to investigate options in addition to the proposed settlement. Although a range
of our potential liability is expected to be $1.7 million to $7.7 million, we
believe that the amount previously recorded of $4.7 million remains the best
estimate of the potential liability to the INI for settlement and termination of
the Letter of Offer.
JOINT VENTURE. On July 9, 2003, Boading Fengfan-Valence Battery Company, a joint
venture between us and Fengfan Group, Ltd. (Fengfan) was formed. The purpose of
the joint venture was to provide low cost manufacturing of our Saphion(R)
Lithium-ion batteries. Under the terms of the joint venture agreement, we were
to contribute 51% of the joint venture's registered capital, consisting of
capital equipment, a nonexclusive license to its technology, and engineering
expertise. Fengfan was to 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.
In January 2004, we identified, and the board of the joint venture approved, the
hiring of a CEO of the joint venture. Construction continued on the Baoding
facility and computer equipment was purchased for venture activities. During the
remainder of the fourth quarter, memoranda and letters between Fengfan and us
were exchanged which expressed concerns about the operational direction of the
joint venture. The correspondence culminated in letter dated March 2004 in which
we gave Fengfan notice of termination of the joint venture due to breach of
contract by Fengfan. Through the period ended March 31, 2004, we were the
majority owner of the joint venture and our control over the joint venture's
activities and property was not then in doubt. Therefore we consolidated the
joint venture into our consolidated financial statements.
During the first quarter of fiscal 2005, several events occurred that resulted
in our losing its control of the joint venture. After numerous attempts to set a
date for a meeting of the joint venture's board of directors, we have been
unable to receive a commitment from Fengfan for a date for the meeting. FengFan
removed the joint venture's office furniture and equipment, has renounced the
authority of the joint venture board-appointed CEO, denied access by the joint
venture's employees and our employees to the joint venture's facilities, and has
refused access to the joint venture's technical and financial records. The joint
venture agreement provides for termination through negotiation or other means,
including arbitration in Singapore. We are continuing negotiations with Fengfan,
are preparing for arbitrating the termination of the joint venture in Singapore,
and are preparing for the liquidation of the joint venture through special
liquidation procedures under the applicable China law. We are is initiating
these actions to enforce our rights under China law and the joint venture
agreement.
As of March 31, 2004 our consolidated financial statements included the
consolidation of the balance sheet, results of operations, and cash flows of the
joint venture. As a result of our loss of control over the joint venture, and
our initiation of actions to enforce our rights, we are accounting for our
investment in the joint venture under the cost method with no further
recognition of assets, liabilities, operating results, and cash flows until such
time as the terms of termination and liquidation of the joint venture are
concluded.
18
As of June 30, 2004, the joint venture had cash of $31,000, other current assets
of $21,000, property, plant, and equipment, primarily a land license and a
building, of $5.586 million, a note payable of $2.068 million related to the
land license, and other current liabilities of $95,000. Cumulative operating
loss since inception is $211,000, of which $108,000 represents our interest. Our
interest in the joint venture's operating losses is recorded as a liability and
will be adjusted if necessary upon final resolution of the termination and
liquidation of the joint venture. There may be additional liabilities in the
future related to negotiation or arbitration leading to the final termination
and liquidation of the joint venture. However, at this time no further liability
related to the final termination and liquidation of the joint venture can be
reasonably estimated, and our management believes that there will be no material
impact on our financial statements as a result.
19
RESULTS OF OPERATIONS
The following table summarizes the results of our operations for the three
months ended June 30, 2004 (also referred to as the first quarter of fiscal
2005) and June 30, 2003 (also referred to as the first quarter of fiscal 2004):
Three Months Ended
---------------------------------------------------
June 30, 2004 June 30,2003
---------------------------------------------------
(dollars in thousands) % of Revenue % of Revenue
Licensing and royalty revenue $ 73 3% $ 556 34%
Battery and system sales 2,764 97% 1,075 66%
---------------------------------------------------
Total revenues 2,837 100% 1,631 100%
Gross profit (loss) (1,086) -38% (2,187) -134%
Operating expenses 6,915 244% 6,270 384%
Operating loss (8,001) -282% (8,457) -519%
---------------------------------------------------
Net loss $ (8,958) -316% $ (9,489) -582%
===================================================
REVENUE AND GROSS MARGIN
BATTERY AND SYSTEM SALES: Battery and system sales increased by $1.689 million,
or 157%, to $2.764 million for the quarter ended June 30, 2004 from $1.075
million for the quarter ended June 30, 2003. The increase in battery and system
sales was 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 quarter of fiscal 2005 were $2.5 million compared to
$2.4 million during the first quarter of fiscal 2004. In addition to our retail
channels we expanded our sales efforts into the educational sector, which
totaled $728,000 for the first quarter of fiscal 2005. Product shipments to
resellers that are subject to right of return are recorded on the balance sheet
as deferred revenue. We had $1.143 million in deferred revenue on our balance
sheet at June 30, 2004.
LICENSING AND ROYALTY REVENUE: Licensing and royalty revenues relate to revenue
from licensing agreements for our technology. Fiscal first quarter 2005
licensing and royalty revenue of $73,000 was from our license agreement with
Amperex Technology Limited (ATL). During the first quarter of fiscal 2004, in
addition to royalty payments, we received a license fee payment from ATL in the
amount of $500,000. Our large-format applications (the K-Charge(TM) Power System
and the U-Charge(TM) Power System) are currently in the prototype phase and are
expected to reach the pilot stage of development in later fiscal 2005. We expect
our second-generation Saphion(R) technology to begin commercialization for
energy applications later in fiscal 2005 and as a result we do not anticipate
significant licensing revenues in fiscal 2005.
GROSS MARGIN (LOSS): Gross margin (loss) as a percentage of revenue was (38%)
for the first quarter of fiscal 2005 as compared to (134%) in the first quarter
of fiscal 2004. 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 manufacturing operating costs.
We have successfully transitioned our battery manufacturing and product assembly
needs to providers in Asia and intend to transition additional operations to
China during fiscal 2005. We expect cost of sales to continue to decrease as a
percentage of sales as production volumes continue to increase, as we continue
to implement our low-cost manufacturing strategy, and as we launch higher-margin
potential channels and products.
OPERATING EXPENSES
The following table summarizes operating expenses for the three months ended
June 30, 2004 and June 30, 2003:
20
Three Months Ended June 30
-------------------------------------------
Increase/
(Dollars in thousands) 2004 2003 (Decrease) %Change
-------------------------------------------
Research and product development 1,899 2,056 (157) -8%
Marketing 1,330 958 372 39%
General and administrative 3,412 2,468 944 38%
Depreciation and amortization 273 788 (515) -65%
Total operating expenses 6,914 6,270 644 10%
Percentage of revenues 244% 384%
During the first quarter of 2005, operating expenses were 244% of sales as
compared to 384% in the same quarter last year. The decrease is a result of
increased revenues and improved focus on expense management during the quarter.
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 decreased by
$157,000, or 8%, to $1.899 million for the first quarter of fiscal 2005 from
$2.056 million for the first quarter of fiscal 2004. The decrease in research
and development expenses is related to cessation of process development work in
our Northern Ireland facility, as well as reduced consulting expense and
materials usage in our Henderson, Nevada facility.
MARKETING. Marketing expenses consist primarily of costs related to sales and
marketing personnel, public relations and promotional materials. Marketing
expenses totaled $1.331 million and $958,000 for the first quarters of fiscal
2005 and 2004, respectively. Increases were the result of increased staffing,
advertising, and promotions to support brand awareness, lead generation, 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,
facilities, accounting, information technology, legal, and corporate-related
expenses, including our China initiatives. General and administrative expenses
totaled $3.412 million and $2.468 million for the first fiscal quarters of 2004
and 2003, respectively. Increases in general and administrative expenses are
caused by our continuing transition of operations to China, increased regulatory
and compliance costs, and costs related to shutting down our Northern Ireland
facility.
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%.
CONTRACT SETTLEMENT CHARGE: Beginning in 1994, pursuant to a Letter of Offer, 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 our equipment for transfer or
for sale, on August 13, 2003, we obtained verbal assurance that we had reached
agreement with INI to terminate the Letter of Offer. Pursuant to this proposed
agreement, the 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. The INI has not yet completed its formal approval process for this
agreement. Based on current conversations, the INI would like to investigate
21
options in addition to the proposed settlement. Although a range of the
potential liability is expected to be $1.7 million to $7.7 million, we believe
that the amount previously recorded of $4.7 million remains the best estimate of
the potential liability to the INI for settlement and termination of the Letter
of Offer.
DEPRECIATION AND AMORTIZATION, AND INTEREST EXPENSE
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses were
$273,000 and $788,000 for the first quarters of fiscal 2005 and 2004,
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, and to the sale of our Henderson, Nevada facility
in the third 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 $1.032 million and $1.112 million for the first quarter of fiscal
2005 and 2004, respectively.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
At June 30, 2004, our principal sources of liquidity were cash and cash
equivalents of $3.2 million and $22 million available under various financing
commitments with Berg & Berg Enterprises, LLC. The $22 million of financing
commitments come in the form of two equity lines of credit. On July 27, 2004, we
drew down $2 million of these financing commitments, and $20 million remain
under a backup equity funding commitment which allows us to request Mr. Berg or
an affiliate company to purchase shares of common stock from time to time at the
then-current market value.
During the first quarter of fiscal 2005, we determined that in order to
reach our long-term objectives and minimize our fixed operating costs, we
require the transition of more of our operations to lower cost geographic
regions. In order to achieve this plan, Mr. Berg has agreed to provide the
additional $20 million backup equity funding commitment. This commitment can be
reduced by the amount of net proceeds received from the sale of building or
equipment from our Mallusk, Northern Ireland facility or the amount of net
proceeds in a debt or equity transaction, and may be increased if necessary
under certain circumstances. As of June 30, 2004, we had not received any net
proceeds from the above mentioned transactions.
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 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 the Series C stock prior to their maturity date. On the maturity date,
we are required to redeem for cash any unconverted shares of the Series C stock
at their stated value plus any accrued and unpaid dividends. If the remaining
shares of Series C stock have not been converted by the maturity date, we may
need to raise additional debt or equity financing to facilitate any required
redemption. We cannot assure you that we could obtain the additional financing.
Our current forecast projects that these sources of liquidity will be
sufficient for at least the 12 months following March 31, 2004. This forecast
assumes product sales during fiscal 2005 from our N-Charge(a) Power System,
which are subject to seasonal fluctuations, of between $2.0 million and $3.5
million per quarter, and additional revenues from volume shipments of our
large-format applications commencing in the fourth quarter of fiscal 2005. We
also anticipate further cash benefits from continued reductions in our operating
expenses and manufacturing costs, offset by small increases to capital
expenditures associated with our expected establishment of a presence in China.
Our cash requirements may vary materially from those now planned because of
changes in our operations, including the failure to achieve expected revenues,
greater than expected expenses, changes in OEM relationships, market conditions,
the failure to timely realize our product development goals and other adverse
development. In addition, we are subject to contingent obligations, including
the possible redemption of our outstanding Series C stock and demand for
repayment of a portion or all of our existing grants.
22
Currently, we do not have sufficient sales and gross profit to generate the
cash flows required to meet our operating and capital needs. If during the next
12 months our cash requirements increase, or our cash sources decline, we would
require additional debt or equity financing. In addition, unless we are able to
achieve substantially greater product sales or reduced expense over this period,
we will require additional debt or equity financing in fiscal 2006. Currently we
depend on Carl Berg's continued willingness to fund our operations. Mr. Berg has
made no commitments to provide any additional equity or debt financing above his
current contractual commitments, and we cannot assure you that he or any of his
affiliates will do so in the future. Consequently, if we need additional debt or
equity financing, we will need to obtain financing from parties other than Mr.
Berg and his affiliates. We are not currently aware of any available source for
debt or equity financing and may not be able to arrange for financing on
favorable terms or at all.
The following table summarizes our statement of cash flows for the three months
ended June 30, 2004 and 2003:
Three Months Ended June 30,
--------------------------------
(Dollars in thousands) 2004 2003
------------ -----------
Net cash flows provided by (used in):
Operating activities $ (7,741) $ (7,471)
Investing activities (1,084) (62)
Financing activities 9,325 9,571
Effect of foreign exchange rates 32 13
------------ -----------
Net increase in cash and cash equivalents $ 532 $ 2,051
============ ===========
Our use of cash from operations the first three months of fiscal 2005 and
fiscal 2004 was $7.7 million and $7.5 million, respectively. The cash used for
operating activities during the first three months of our fiscal 2005 operating
activities was primarily for operating losses and working capital. Cash used for
operating loss in the first three months of fiscal 2005 was lower than the
comparable period in 2004 primarily from reductions in gross profit (loss),
offset by increases in some operating expenses as described above in the section
titled "Operating Expenses."
In the first three months of 2005, we invested $171,000 in property, plant
and equipment in our Austin, Texas, facility, primarily for enterprise software.
The effect of deconsolidation of our China joint venture, as described in Note
14 was to reduce cash by $913,000, as the assets, liabilities, and operating
results of the joint venture are no longer being consolidated into our financial
statements.
We obtained cash from financing activities of $9.3 million and $9.6 million
during the first three months of fiscal 2005 and 2004, respectively. The 2005
financing included $9 million from our Berg & Berg equity line, less cash used
for payment of long-term debt related to our Northern Ireland facility.
As a result of the above, we had a net increase in cash and cash
equivalents of $532,000 during the first three months of fiscal 2005 and a net
increase of $2.1 million for the first three months of fiscal 2004.
CAPITAL COMMITMENTS AND DEBT
At June 30, 2004, we had commitments for capital expenditures for the next
12 months of approximately $150,000 relating to the continued implementation of
enterprise software. We anticipate that we will incur capital expenses as we
establish our China operations. We may require additional capital expenditures
in order to meet greater demand levels for our products than currently are
anticipated.
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) June 30, 2004
-----------------
Mortgages on Northern Ireland facility, short-term $ 1,034
Mortgages on Northern Ireland facility, long-term 5,186
1998 long-term debt to Berg & Berg 14,950
2001 long-term debt to Berg & Berg 20,000
Interest on long-term debt 10,304
-----------------
Total long-term debt $ 51,474
=================
23
Repayment obligations of short-term and long-term debt principal are:
Fiscal year
----------------------------------------------------------------------------------
(Dollars in thousands) 2005 2006 2007 2008 2009 Thereafter Total
---------- ---------- ---------- ---------- ---------- ---------- ----------
Principal repayment 425 35,542 624 657 644 488 38,380
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. We
cannot assure you that we could obtain the additional financing.
INFLATION
Historically, our operations have not been materially affected by
inflation. However, our operations may be affected by inflation in the future.
TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The following table sets forth, as of June 30, 2004, our scheduled principal,
interest and other contractual annual cash obligations due for each of the
periods indicated below (in thousands):
PAYMENT DUE BY PERIOD
--------------------------------------------------------------
Less than More than
Contractual Obligations Total One Year 1-3 Years 3 - 5 Years 5 Years
- -------------------------- ---------- ---------- ---------- ---------- ----------
Long-term debt obligations 51,628 1,034 48,541 1,877 176
Operating lease obligations 1,285 401 764 120 -
Purchase obligations 3,102 3,102 - - -
Other long-term liabilities 4,789 1,753 3,036 - -
---------- ---------- ---------- ---------- ----------
Total $ 60,804 $ 6,290 $ 52,341 $ 1,997 $ 176
========== ========== ========== ========== ==========
24
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 June 30, 2004, our principal sources of liquidity were cash and cash
equivalents of $3.2 million and $22 million available under various financing
commitments with Berg & Berg Enterprises, LLC. The $22 million of financing
commitments come in the form of two equity lines of credit. On July 27, 2004 we
drew down $2 million of those financing commitments, and $20 million remain
under a backup equity funding commitment, which allows us to request Mr. Berg or
an affiliate company to purchase shares of common stock from time to time at the
then-current market value.
During the first quarter of fiscal 2005, we determined that in order to reach
our long-term objectives and minimize our fixed operating costs, we require the
transition of more of our operations to lower cost regions. In order to achieve
this plan, Mr. Berg has agreed to provide the additional $20 million backup
equity funding commitment. This commitment can be reduced by the amount of net
proceeds received by us from the sale of building or equipment from our Mallusk,
Northern Ireland facility or the amount of net proceeds in a debt or equity
transaction, and may be increased if necessary under certain circumstances. As
of June 30, 2004 we had not received any net proceeds from the above mentioned
transactions.
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 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. On the maturity date, we
are required to redeem for cash any unconverted shares of the Series C stock at
their stated value plus any accrued and unpaid dividends. 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. We cannot assure you that we could obtain the additional financing.
Our current forecast projects that these sources of liquidity will be sufficient
for at least the 12 months following March 31, 2004. This forecast assumes
product sales during fiscal 2005 from our N-Charge(TM) Power System, which are
subject to seasonal fluctuations, of between $2.0 million and $3.5 million per
quarter, and additional revenues from volume shipments of our large-format
applications commencing in the fourth quarter of fiscal 2005. We also anticipate
further cash benefits from continued reductions in our operating expenses and
manufacturing costs, offset by small increases to capital expenditures
associated with our expected establishment of a presence in China.
Our cash requirements may vary materially from those now planned because of
changes in our operations, including the failure to achieve expected revenues,
greater than expected expenses, changes in OEM relationships, market conditions,
the failure to timely realize our product development goals and other adverse
developments. In addition, we are subject to contingent obligations, including
the possible redemption of our outstanding Series C stock and demand for
repayment of a portion or all of our existing grants.
Currently, we do not have sufficient sales and gross profit to generate the cash
flows required to meet our operating and capital needs. If during the next 12
months our cash requirements increase, or our cash sources decline, we would
require
25
additional debt or equity financing. In addition, unless we are able to achieve
substantially greater product sales or reduced expense over this period, we will
require additional debt or equity financing in fiscal 2006. Currently we depend
on Carl Berg's continued willingness to fund our operations. Mr. Berg has made
no commitments to provide any additional equity or debt financing above his
current contractual commitments, and we cannot assure you that he or any of his
affiliates will do so in the future. Consequently, if we need additional debt or
equity financing, we will need to obtain such financing from parties other than
Mr. Berg and his affiliates. We are not currently aware of any available source
for debt or equity financing and may not be able to arrange for financing on
favorable terms or at all.
OUR LIMITED FINANCIAL RESOURCES COULD MATERIALLY AFFECT OUR BUSINESS, OUR
ABILITY TO COMMERCIALLY EXPLOIT OUR TECHNOLOGY AND OUR ABILITY TO RESPOND TO
UNANTICIPATED DEVELOPMENTS, AND COULD PLACE US AT A DISADVANTAGE TO OUR
COMPETITORS.
Currently, we do not have sufficient sales and gross profit to generate the cash
flows required to meet our operating and capital needs. Nor do we have committed
financing to provide for our operations for more than the next 12 months. As a
consequence, one of our primary objectives has been to reduce expenses and
overhead and thus limiting the resources available for the development and
commercialization of our technology. Our limited financial resources could
materially affect our ability, and the pace at which, we are able to
commercially exploit our Saphion technology. For example, it could:
o limit the research and development resources we are able to commit to
the further development of our technology and the development of
products that can be commercially exploited in our marketplace;
o limit the sales and marketing resources that we are able to commit to
the marketing of our technology;
o have an adverse impact on our ability to attract top-tier companies as
our technology and marketing partners;
o have an adverse impact on our ability to employ and retain qualified
employees with the skills and expertise necessary to implement our
business plan;
o make us more vulnerable to failure to achieve our forecasted results;
economic downturns; adverse industry conditions; and catastrophic
external events;
o limit our ability to withstand competitive pressures and reduce our
flexibility in planning for, or responding to, changing business and
economic conditions; and
o place us at a competitive disadvantage to our competitors that have
greater financial resources than we have.
WE HAVE A HISTORY OF LOSSES AND 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 $438.7 million as of June 30, 2004. We had negative
working capital of $2.6 million as of June 30, 2004, and have sustained
recurring losses related primarily to the research and development and marketing
of our products combined with the lack of sufficient sales to provide for these
needs. We may continue to incur operating losses and negative cash flows during
fiscal 2005. We may never achieve or sustain sufficient revenues or
profitability in the future.
IF WE CONTINUE TO EXPERIENCE SIGNIFICANT LOSSES WE MAY BE UNABLE TO MAINTAIN
SUFFICIENT LIQUIDITY TO PROVIDE FOR OUR OPERATING NEEDS.
We reported a net loss of $8.9 million in the fiscal quarter ended June 30,
2004, a net loss of $55.0 million for the fiscal year ended March 31, 2004 and a
net loss of $37.9 million for the fiscal year ended March 31, 2003. If we cannot
achieve a competitive cost structure, achieve profitability and access the
capital markets on acceptable terms, we will be unable to fund our obligations
and sustain our 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 demand would depend on our ability to arrange for additional equity or
debt financing since it is likely that cash flow from sales will lag behind
these increased working capital requirements.
26
OUR INDEBTEDNESS AND OTHER OBLIGATIONS ARE SUBSTANTIAL AND COULD MATERIALLY
AFFECT OUR BUSINESS AND OUR ABILITY TO INCUR ADDITIONAL DEBT TO FUND FUTURE
NEEDS.
We now have and will continue to have a significant amount of indebtedness and
other obligations. As of June 30, 2004, we had approximately $53 million of
total consolidated indebtedness. Our substantial indebtedness and other
obligations could negatively impact our operations in the future. For example,
it could:
o limit our ability to obtain additional financing for working capital,
capital expenditures, acquisitions and general corporate purposes;
o require us to dedicate a substantial portion of our cash flow from
operations to the payment of principal of, and interest on, our
indebtedness, thereby reducing the funds available to us for other
purposes;
o make us more vulnerable to failure to achieve our forecasted results,
economic downturns, adverse industry conditions or catastrophic
external events, limit our ability to withstand competitive pressures
and reduce our flexibility in planning for, or responding to, changing
business and economic conditions; and
o place us at a competitive disadvantage to our competitors that have
relatively less debt than we have.
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 this were to occur, we would not have the
financial resources to repay our debt and these lenders could proceed against
our assets.
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. Technical issues may 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 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.
IF OUR PRODUCTS FAIL TO PERFORM AS EXPECTED, WE COULD LOSE EXISTING AND FUTURE
BUSINESS, AND OUR ABILITY TO DEVELOP, MARKET AND SELL OUR BATTERIES COULD BE
HARMED.
If our products when introduced do not 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
develop, market and sell our products.
IN ADDITION TO BEING USED IN OUR OWN PRODUCT LINES, OUR BATTERY CELLS 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.
27
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 power system and the
commencement of volume shipments of the power system to the customer, but also
requires the cooperation and assistance of the OEMs for purposes of determining
the 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 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.
Our long-term business strategy anticipates achieving significant revenue from
the licensing of our intellectual property assets, such as our Saphion(R)
technology. 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 licensees 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.
WE DEPEND ON A SMALL NUMBER OF CUSTOMERS FOR OUR REVENUES, AND OUR RESULTS OF
OPERATIONS AND FINANCIAL CONDITION COULD BE HARMED IF WE WERE TO LOSE THE
BUSINESS OF ANY ONE OF THEM.
To date, our existing purchase orders in commercial quantities are from a
limited number of customers. During fiscal 2004, one customer, Best Buy,
contributed 30% 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.
28
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 power systems. 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.
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 PLANNED RELOCATION OF CORE OPERATIONS TO CHINA IS A COMPLEX PROCESS THAT MAY
DIVERT MANAGEMENT ATTENTION, LEAD TO DISRUPTIONS IN OPERATIONS AND DELAY
IMPLEMENTATION OF OUR BUSINESS STRATEGY.
We are planning to relocate our core operations to China, which is a
time-consuming and complicated process. The relocation will require physically
moving and setting up operations as well as ensuring that we have adequate
staffing, including administrative and executive personnel. Some of our
employees may not wish to relocate and we will have to find suitable employees
in China. If the labor pool does not have adequate resources, we may have to
train personnel to perform necessary functions for our core operations. While we
intend to implement a plan to relocate our core operations that will minimize
disruption, our failure to do so could result in service disruptions that would
negatively affect our business and could reduce our revenue and result in
customer dissatisfaction. Furthermore, planning for the relocation is also
expected to divert the attention of our key management personnel. We cannot
assure you that key management will not be distracted by planning for our
relocation. We also cannot assure you that we will be able to complete the
relocation efficiently or effectively, or that we will not experience service
disruptions, loss in customers, or decreased revenue as a result of the
relocation. Additionally, some of our key employees, including executives, may
choose not to remain employed with us after the relocation. The occurrence of
any of the foregoing events affecting or resulting from our move could harm our
business.
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 those 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.
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, represent a significant portion of our sales potential.
International business can be subject to many inherent risks that are difficult
or impossible for us to predict or control, including:
29
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 impositions by foreign governments of 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, which 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, which may
reduce or eliminate our ability to sell or license in certain markets; and
o political and economic instability in countries, including China, where we
intend to conduct business, which may reduce the demand for our batteries
and our technology or our ability to market our batteries and our
technology in those countries.
These risks may increase our costs of doing business internationally and reduce
our sales and royalties or future profitability.
WE MAY NEED TO EXPAND OUR EMPLOYEE BASE AND OPERATIONS IN ORDER TO EFFECTIVELY
DISTRIBUTE OUR PRODUCTS COMMERCIALLY, WHICH MAY STRAIN OUR MANAGEMENT AND
RESOURCES AND COULD HARM OUR BUSINESS.
To implement our growth strategy successfully, we will have to increase our
staff, primarily with personnel in sales, marketing, and product support
capabilities, as well as third party and direct distribution channels. However,
we face the risk that we may not be able to attract new employees to
sufficiently increase our staff or product support capabilities, or that we will
not be successful in our sales and marketing efforts. Failure in any of these
areas could impair our ability to execute our plans for growth and adversely
affect our future profitability.
COMPETITION FOR PERSONNEL, IN PARTICULAR FOR PRODUCT DEVELOPMENT AND PRODUCT
IMPLEMENTATION PERSONNEL, IS INTENSE, AND WE MAY HAVE DIFFICULTY ATTRACTING THE
PERSONNEL NECESSARY TO EFFECTIVELY OPERATE OUR BUSINESS.
We believe that our future success will depend in large part on our ability to
attract and retain highly skilled technical, managerial, and marketing personnel
who are familiar with and experienced in the battery industry. 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 assure you 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,
30
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.
IF WE ARE SUED ON A PRODUCT LIABILITY CLAIM, OUR INSURANCE POLICIES MAY NOT BE
SUFFICIENT.
Although we maintain general liability insurance and product liability
insurance, our insurance may not cover all potential types of product liability
claims to which manufacturers are exposed or may not be adequate to indemnify us
for all liability that may be imposed. Any imposition of liability that is not
covered by insurance or is in excess of our insurance coverage could harm our
business.
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 further reduce our manufacturing costs, which
we intend to do through the effective utilization of manufacturing partners. We
currently manufacture our batteries and assemble our products in China and
Taiwan. We intend to transition additional operations to Asia over the course of
fiscal 2005. We have ceased production in our Northern Ireland manufacturing
facility and are attempting to sell the facility. As a consequence, we are
dependent on the performance of our manufacturing partners to manufacture and
deliver our products to our customers. If any of our manufacturing partners is
unable to continue to manufacture products in commercial quantities on a timely
and efficient basis, we could lose customers and adversely impact our ability to
attract future customers.
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 are 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 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.
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. We currently manufacture and export some of
our products from China. The legal regime protecting intellectual property
rights in China is weak. Because the Chinese legal system in general, and the
intellectual property regime in particular, are relatively weak, it is often
difficult to enforce intellectual property rights in China. In addition, there
are other countries where effective copyright, trademark and trade secret
protection may be unavailable or limited. Accordingly, 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
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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.
RISKS ASSOCIATED WITH DOING BUSINESS IN CHINA
SINCE OUR PRODUCTS ARE MANUFACTURED IN CHINA AND WE INTEND TO TRANSFER
ADDITIONAL OPERATIONS TO CHINA, WE FACE RISKS IF CHINA LOSES NORMAL TRADE
RELATIONS WITH THE UNITED STATES.
We manufacture and export our products from China. Our products sold in the
United States are currently not subject to U.S. import duties. On September 19,
2000, the U.S. Senate voted to permanently normalize trade with China, which
provides a favorable category of U.S. import duties. In addition, on December
11, 2001 China was accepted into the World Trade Organization (WTO), a global
international organization of 144 countries that regulates international trade.
As a result of opposition to certain policies of the Chinese government and
China's growing trade surpluses with the United States, there has been, and in
the future may be, opposition to the extension of Normal Trade Relations, or
NTR, status for China. The loss of NTR status for China, changes in current
tariff structures or adoption in the Unites States of other trade policies
adverse to China could have an adverse effect on our business.
Furthermore, our business may be adversely affected by the diplomatic and
political relationships between the United States and China. These influences
may adversely affect our ability to operate in China. If the relationship
between the United States and China were to materially deteriorate, it could
negatively impact our ability to control our operations and relationships in
China, enforce any agreements we have with Chinese manufacturers or otherwise
deal with any assets or investments we may have in China.
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BECAUSE THE CHINESE LEGAL SYSTEM IN GENERAL AND THE INTELLECTUAL PROPERTY REGIME
IN PARTICULAR, ARE RELATIVELY WEAK, WE MAY NOT BE ABLE TO ENFORCE INTELLECTUAL
PROPERTY RIGHTS IN CHINA AND ELSEWHERE.
We currently manufacture and export some of our products from China. The legal
regime protecting intellectual property rights in China is weak. Because the
Chinese legal system in general, and the intellectual property regime in
particular, are relatively weak, it is often difficult to enforce intellectual
property rights in China. In addition, there are other countries where effective
copyright, trademark and trade secret protection may be unavailable or limited.
Accordingly, we may not be able to effectively protect our intellectual property
rights outside of the United States.
ENFORCING AGREEMENTS AND LAWS IN CHINA IS DIFFICULT OR MAY BE IMPOSSIBLE AS
CHINA DOES NOT HAVE A COMPREHENSIVE SYSTEM OF LAWS.
We are dependent on our agreements with our Chinese manufacturing partners. In
addition, we are currently party to a dispute with our joint venture partner in
our unsuccessful Fengfan joint venture. Enforcement of agreements may be
sporadic and implementation and interpretation of laws may be inconsistent. The
Chinese judiciary is relatively inexperienced in interpreting agreements and
enforcing the laws, leading to a higher than usual degree of uncertainty as to
the outcome of any litigation. Even where adequate law exists in China, it may
be impossible to obtain swift and equitable enforcement of the law, or to obtain
enforcement of a judgment by a court of another jurisdiction.
THE GOVERNMENT OF CHINA MAY CHANGE OR EVEN REVERSE ITS POLICIES OF PROMOTING
PRIVATE INDUSTRY AND FOREIGN INVESTMENT, IN WHICH CASE OUR ASSETS AND OPERATIONS
MAY BE AT RISK.
China is a socialist state, which since 1949 has been, and is expected to
continue to be, controlled by the Communist Party of China. Our existing and
planned operations in China are subject to the general risks of doing business
internationally and the specific risks related to the business, economic and
political conditions in China, which include the possibility that the central
government of China will change or even reverse its policies of promoting
private industry and foreign investment in China. Many of the current reforms
which support private business in China are unprecedented or experimental. Other
political, economic and social factors, such as political changes, changes in
the rates of economic growth, unemployment or inflation, or the disparities of
per capita wealth among citizens of China and between regions within China,
could also lead to further readjustment of the government's reform measures. It
is not possible to predict whether the Chinese government will continue to be as
supportive of private business in China, nor is it possible to predict how
future reforms will affect our business.
THE GOVERNMENT OF CHINA CONTINUES TO EXERCISE SUBSTANTIAL CONTROL OVER THE
CHINESE ECONOMY WHICH COULD HAVE A NEGATIVE IMPACT ON OUR BUSINESS.
The government of China has exercised and continues to exercise substantial
control over virtually every section of the Chinese economy through regulation
and state ownership. China's continued commitment to reform and the development
of a vital private sector in that country have, to some extent, limited the
practical effects of the control currently exercised by the government over
individual enterprises. However, the economy continues to be subject to
significant government controls, which, if directed towards our business
activities, could have a significant adverse impact on us. For example, if the
government were to limit the number of foreign personnel who could work in the
country, or substantially increase taxes on foreign businesses or were to impose
any number of other possible types of limitations on our operations, the impact
would be significant.
CHANGES IN CHINA'S POLITICAL AND ECONOMIC POLICIES COULD HARM OUR BUSINESS.
The economy of China has historically been a planned economy subject to
governmental plans and quotas and has, in certain aspects, been transitioning to
a more market-oriented economy. Although we believe that the economic reform and
the macroeconomic measures adopted by the Chinese government have had a positive
effect on the economic development of China, we cannot predict the future
direction of these economic reforms or the effects these measures may have on
our business, financial position or results of operations. In addition, the
Chinese economy differs from the economies of most countries belonging to the
Organization for Economic Cooperation and Development, or OECD. These
differences include:
o economic structure;
o level of government involvement in the economy;
33
o level of development
o level of capital reinvestment;
o control of foreign exchange;
o methods of allocating resources; and
o balance of payments position.
As a result of these differences, our operations, including our current
manufacturing operations in China, may not develop in the same way or at the
same rate as might be expected if the Chinese economy were similar to the OECD
member countries.
BUSINESS PRACTICES IN CHINA MAY ENTAIL GREATER RISK AND DEPENDENCE UPON THE
PERSONAL RELATIONSHIPS OF SENIOR MANAGEMENT THAN IS COMMON IN NORTH AMERICA AND
THEREFORE SOME OF OUR AGREEMENTS WITH OTHER PARTIES IN CHINA COULD BE DIFFICULT
OR IMPOSSIBLE TO ENFORCE.
The business culture of China is, in some respects, different from the business
culture in Western countries and may present some difficulty for Western
investors reviewing contractual relationships among companies in China and
evaluating the merits of an investment. Personal relationships among business
principals of companies and business entities in China are very significant in
the business culture. In some cases, because so much reliance is based upon
personal relationships, written contracts among businesses in China may be less
detailed and specific than is commonly accepted for similar written agreements
in Western countries. In some cases, material terms of an understanding are not
contained in the written agreement but exist as oral agreements only. In other
cases, the terms of transactions which may involve material amounts of money are
not documented at all. In addition, in contrast to Western business practices
where a written agreement specifically defines the terms, rights and obligations
of the parties in a legally binding and enforceable manner, the parties to a
written agreement in China may view that agreement more as a starting point for
an ongoing business relationship which will evolve and require ongoing
modification. As a result, written agreements in China may appear to the Western
reader to look more like outline agreements that precede a formal written
agreement. While these documents may appear incomplete or unenforceable to a
Western reader, the parties to the agreement in China may feel that they have a
more complete understanding than is apparent to someone who is only reading the
written agreement without having attended the negotiations. As a result,
contractual arrangements in China may be more difficult to review and
understand. Also, despite legal developments in China over the past 20 years,
adequate laws, comparable with Western standards, do not exist in all areas and
it is unclear how many of our business arrangements would be interpreted or
enforced by a court in China.
OUR OPERATIONS COULD BE MATERIALLY INTERRUPTED, AND WE MAY SUFFER A LARGE AMOUNT
OF LOSS, IN THE CASE OF FIRE, CASUALTY OR THEFT AT ONE OF OUR MANUFACTURING OR
OTHER FACILITIES.
Firefighting and disaster relief or assistance in China is substandard by
Western standards. Consistent with the common practice in China for companies of
our size and or the size of our business partners in China, neither we nor they,
to our knowledge, maintain fire, casualty, theft insurance or business
interruption insurance. In the event of any material damage to, or loss of, the
manufacturing plants where our products are or will be produced due to fire,
casualty, theft, severe weather, flood or other similar causes, we would be
forced to replace any assets lost in those disasters without the benefit of
insurance. Thus our financial position could be materially compromised or we
might have to cease doing business. Also, consistent with customary business
practices in China, we do not carry business interruption insurance.
THE SYSTEM OF TAXATION IN CHINA IS UNCERTAIN AND SUBJECT TO UNPREDICTABLE CHANGE
THAT COULD AFFECT OUR PROFITABILITY.
Many tax rules are not published in China and those that are published can be
ambiguous and contradictory leaving a considerable amount of discretion to local
tax authorities. China currently offers tax and other preferential incentives to
encourage foreign investment. However, the country's tax regime is undergoing
review and we cannot assure you that such tax and other incentives will continue
to be made available. Currently, China levies a 10% withholding tax on dividends
received from Chinese-foreign joint ventures. If we enter into a joint venture
with a Chinese company as part of our strategy to reduce costs, the joint
venture may be considered a Chinese-foreign joint venture if the majority of its
equity interests are owned by a foreign shareholder. A temporary exemption from
this withholding tax has been granted to foreign investors. However, there is no
indication when this exemption will end.
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IT IS UNCERTAIN WHETHER WE WILL BE ABLE TO RECOVER VALUE ADDED TAXES IMPOSED BY
THE CHINESE TAXING AUTHORITIES.
China's turnover tax system consists of value-added tax, consumption tax and
business tax. Export sales are exempted under VAT rules and an exporter who
incurs input Value Added Tax (VAT) on purchase or manufacture of goods should be
able to claim a refund from Chinese tax authorities. However, due to a reduction
in the VAT export refund rate of some goods, exporters might bear part of the
VAT they incurred in conjunction with the exported goods. In 2003, changes to
the Chinese VAT system were announced affecting the recoverability of input VAT
beginning January 1, 2004. Our VAT expense will depend on the reaction of both
our suppliers and customers. Continued efforts by the Chinese government to
increase tax revenues could result in revisions to tax laws or their
interpretation, which could increase our VAT and various tax liabilities.
ANY RECURRENCE OF SEVERE ACUTE RESPIRATORY SYNDROME, OR SARS, AVIARY FLU, OR
ANOTHER WIDESPREAD PUBLIC HEALTH PROBLEM, COULD ADVERSELY AFFECT OUR BUSINESS
AND RESULTS OF OPERATIONS.
A renewed outbreak of SARS, aviary flu, or another widespread public health
problem in China, where we have moved our manufacturing operations and may move
additional operations, could have a negative effect on our operations. Our
operations may be impacted by a number of health-related factors, including the
following:
o quarantines or closures of some of our manufacturing or other
facilities which would severely disrupt our operations; or
o the sickness or death of key officers or employees of our
manufacturing or other facilities.
Any of the foregoing events or other unforeseen consequences of public health
problems in China could adversely affect our business and results of operations.
OUR PRODUCTION AND SHIPPING CAPABILITIES COULD BE ADVERSELY AFFECTED BY ONGOING
TENSIONS BETWEEN THE CHINESE AND TAIWANESE GOVERNMENTS.
Key components of our products are manufactured in China and assembled in Taiwan
into end products or systems. In the event that Taiwan does not adopt a plan for
unifying with China, the Chinese government has threatened military action
against Taiwan. As of yet, Taiwan has not indicated that it intends to propose
or adopt a reunification plan. If an invasion by China were to occur, the
ability of our manufacturing and assembly partners could be adversely affected,
potentially limiting our production capabilities. An invasion could also lead to
sanctions or military action by the United States and/or European countries,
which could further adversely affect 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 obsolete. Other companies are seeking to
enhance traditional battery technologies, such as lead acid and nickel cadmium,
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.
35
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.
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, and local laws do 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 (Model VNC-65) and N-ChargeTM
Power System II are exempt from a Class 9 designation for transportation, while
our N-ChargeTM Power System (Model VNC-130), our K-Charge(TM) Power System, and
U-Charge(TM) Power System currently fall within the level such that they are not
exempt and require 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 Department of Transportation (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 July 29, 2004, our officers, directors and their affiliates as a group
beneficially owned approximately 39.7% of our outstanding common stock. Carl
Berg, one of our directors, beneficially owns approximately 36.8% 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 MARKET 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
36
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.
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 July 29, 2004, the
closing price of our common stock was $2.75. In addition, in order to comply
with the listing requirements of The Nasdaq SmallCap Market, effective with our
2004 annual meeting of stockholders, we may need to add an additional director
to the audit committee of our board of directors that is "independent" as
defined by those rules. We may have difficulty identifying a suitable candidate.
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 78,487,550 shares of common stock as of
June 30, 2004. In addition, at June 30, 2004, we had 12,715,124 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, based on our proposed
settlement, we would issue 1,734,446 shares of our common stock at its current
market price.
37
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 June 30, 2004. 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% (5.50% and 5.75%, respectively, at June 30, 2004). Each 0.25% increase
in interest would increase our annual interest expense by approximately $16,000
for these loans. 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 June 30, 2004)
and the second loan has a fixed interest rate of 8%. Each 0.25% increase in
interest on the adjustable-rate loan would increase our annual interest expense
by approximately $37,000. The table below presents principal amounts by fiscal
year for our long-term debt.
2005 2006 2007 2008 2009 THEREAFTER TOTAL
---------- ---------- ---------- ---------- ---------- ---------- ----------
(dollars in thousands)
Liabilities:
Fixed rate debt: -- 20,000 -- -- -- -- 20,000
Variable rate debt 425 15,543 624 657 644 489 18,382
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
first quarter of fiscal 2005. 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 have materially affected or are 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.
As of March 31, 2004, our consolidated financial statements included the
consolidation of the balance sheet, results of operations, and cash flows of our
joint venture in China. As a result of our loss of control over the joint
venture and our initiation of actions to enforce our rights, we are accounting
for our investment in the joint venture under the cost method with no further
recognition of assets, liabilities, operating results, and cash flows. We intend
to continue to account for the joint venture in this manner until the terms of
termination and liquidation of the joint venture are concluded.
Because we no longer include the joint venture in our consolidated operations,
this discussion of our controls and procedures does not encompass the operations
of the joint venture. The current discussion considers only consolidated
operations.
38
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
condensed consolidated financial statements.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On April 19, 2004, we sold 710,900 shares of our restricted common stock at an
aggregate price of $3 million to West Coast Venture Capital, Inc., 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 $3 million, and are
being used to fund corporate operating needs and working capital.
On May 24, 2004, we sold 829,187 shares of our restricted common stock at an
aggregate price of $3 million to West Coast Venture Capital, Inc., 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 $3 million, and are
being used to fund corporate operating needs and working capital.
On June 28, 2004, we sold 877,193 shares of our restricted common stock at an
aggregate price of $3 million to West Coast Venture Capital, Inc., 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 $3 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 April 22, 2004, disclosing under Item 5 that,
on April 19, 2004, we sold 710,900 shares of our restricted common stock to West
Coast Venture Capital, Inc. (the assignee of Berg & Berg Enterprises, LLC).
39
Current Report on Form 8-K, filed May 26, 2004, disclosing under Item 5 that, on
May 24, 2004, we sold 829,187 shares of our restricted common stock to West
Coast Venture Capital, Inc. (the assignee of Berg & Berg Enterprises, LLC).
Current Report on Form 8-K, filed June 15, 2004, disclosing under items 7 and 12
our press release issued on June 14, 2004, regarding the fourth quarter and
fiscal year ending March 31, 2004 financial results.
Current Report on form 8-K, filed June 30, 2004, disclosing under item 5 that,
on June 28, 2004, we sold 877,193 shares of our restricted common stock to West
Coast Venture Capital, Inc. (the assignee of Berg & Berg Enterprises, LLC).
Current Report on Form 8-K, filed July 30, 2004, disclosing under Item 5 that,
on July 27, 2004, we sold 728,332 shares of our restricted common stock to West
Coast Venture Capital, Inc. (the assignee of Berg & Berg Enterprises, LLC).
40
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
VALENCE TECHNOLOGY, INC.
Date: August 5, 2004 By: /s/ Stephan B. Godevais
-------------------------------------
Stephan B. Godevais
President, Chief Executive Officer
and Chairman of the Board (Principal
Executive Officer)
By: /s/ Kevin W. Mischnick
-------------------------------------
Kevin W. Mischnick
Vice President of Finance and
Assistant Secretary (Principal
Financial and Accounting Officer)
41
EXHIBIT INDEX
EXHIBIT NO.
31.1 Rule 13a-14/15d-14(a) Certifications
32.1 Section 1350 Certifications
42