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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 September 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 80,969,808
- --------------------------------------- ------------------------------
(Class) (Outstanding at October 29, 2004)
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2004
INDEX
PAGES
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets as of
September 30, 2004 and March 31, 2004.................................................3
Condensed Consolidated Statements of Operations and
Comprehensive Loss for Each the Three- and Six-
Month Periods Ended September 30, 2004 and September 30, 2003.........................4
Condensed Consolidated Statements of Cash Flows for
Each of the Three- and Six-
Month Periods Ended September 30, 2004 and September 30, 2003.........................5
Notes to Condensed Consolidated Financial Statements..................................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................................17
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........................39
Item 4. Controls and Procedures..............................................................40
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................................41
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds .........................41
Item 3. Defaults upon Senior Securities......................................................41
Item 4. Submission of Matters to a Vote of Security Holders..................................41
Item 5. Other Information....................................................................41
Item 6. Exhibits and Reports on Form 8-K.....................................................41
SIGNATURE .....................................................................................42
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)
September 30, 2004 March 31, 2004
----------------- -----------------
ASSETS
Current assets:
Cash and cash equivalents $ 2,792 $ 2,692
Trade receivables, net of allowance of $98
as of September 30, 2004 and March 31, 2004 1,903 1,477
Inventory 3,924 3,318
Building and land held for sale, net 4,862 -
Prepaid and other current assets 883 837
----------------- -----------------
Total current assets 14,364 8,324
Property, plant and equipment, net 1,359 12,218
Intellectual property, net 457 514
----------------- -----------------
Total assets $ 16,180 $ 21,056
================= =================
LIABILITIES, PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
Current liabilities:
Note payable $ - $ 2,068
Mortgage debt on building and land held for sale 5,938 967
Accounts payable 2,857 2,263
Accrued expenses 4,724 4,527
Deferred revenue 827 1,593
Grant payable - short term 1,753 1,753
----------------- -----------------
Total current liabilities 16,099 13,171
Grant payable - long term 3,036 3,036
Long-term interest 11,208 9,720
Long-term debt, less current portion - 5,458
Long-term debt to stockholder 34,302 33,949
----------------- -----------------
Total liabilities 64,645 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 September 30, 2004 and
March 31, 2004, liquidation value $8,610 8,467 8,032
----------------- -----------------
Commitments and contingencies
Stockholders' equity (deficit):
Common stock, $0.001 par value, 100,000,000 shares authorized;
80,906,536 and 75,961,826 shares issues and outstanding, respectively 81 76
Additional paid-in capital 397,810 382,282
Deferred compensation (112) (226)
Notes receivable from stockholder (5,023) (5,161)
Accumulated deficit (445,679) (429,724)
Accumulated other comprehensive loss (4,009) (4,041)
----------------- -----------------
Total stockholders' deficit (56,932) (56,794)
----------------- -----------------
Total liabililities, preferred stock and stockholders' deficit $ 16,180 $ 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 September 30, Six Months Ended September 30,
------------------------------- -------------------------------
2004 2003 2004 2003
-------------- -------------- --------------- --------------
Revenue:
Licensing and royalty revenue $ 113 $ 69 $ 186 $ 625
Battery and system sales 2,802 2,276 5,566 3,351
-------------- -------------- --------------- --------------
Total revenues 2,915 2,345 5,752 3,976
Cost of sales: 3,631 4,080 7,554 7,898
-------------- -------------- --------------- --------------
Gross profit (loss) (716) (1,735) (1,802) (3,922)
Operating expenses:
Research and product development 1,736 1,835 3,635 3,891
Marketing 955 1,298 2,286 2,256
General and administrative 2,624 2,673 6,048 5,141
Depreciation and amortization 286 770 559 1,558
(Gain) on sale of assets (459) - (471) -
Contract settlement charge - 3,046 - 3,046
Asset impairment charge 87 13,660 87 13,660
-------------- -------------- --------------- --------------
Total costs and expenses 5,229 23,282 12,144 29,552
-------------- -------------- --------------- --------------
Operating loss (5,945) (25,017) (13,946) (33,474)
Interest and other income 55 85 150 165
Interest and other expense (1,019) (913) (2,071) (2,025)
-------------- -------------- --------------- --------------
Net loss (6,909) (25,845) (15,867) (35,334)
Dividends on preferred stock 43 50 86 66
Preferred stock accretion 218 207 436 207
-------------- -------------- --------------- --------------
Net loss available to common stockholders $ (7,170) $ (26,102) $ (16,389) $ (35,607)
============== ============== =============== ==============
Other comprehensive loss:
Net loss $ (6,909) $ (25,845) $ (15,867) $ (35,334)
Change in foreign currency translation adjustments (19) (51) 31 (6)
-------------- -------------- --------------- --------------
Comprehensive loss $ (6,928) $ (25,896) $ (15,836) $ (35,340)
============== ============== =============== ==============
Net loss per share available to common stockholders $ (0.09) $ (0.36) $ (0.21) $ (0.50)
============== ============== =============== ==============
Shares used in computing net loss
per share available to common
stockholders, basic and diluted 79,352 71,761 78,146 71,745
============== ============== =============== ==============
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)
Six Months Ended September 30,
--------------------------------
2004 2003
--------------- --------------
Cash flows from operating activities:
Net loss $ (15,867) $ (35,334)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 559 1,558
Asset impairment charge 87 13,660
Contract settlement charge - 3,046
Accretion of debt discount and other 356 370
Interest income on stockholder note receivable (164) (138)
Deferred compensation expense (161) 423
Changes in operating and other assets and liabilities:
Trade receivables (426) 55
Inventory (606) (860)
Other current assets (77) 529
Accounts payable 612 (1,231)
Accrued expenses and long-term interest 1,758 1,643
Deferred revenue (766) 1,463
--------------- --------------
Net cash used in operating activities (14,695) (14,816)
--------------- --------------
Cash flows from investing activities:
Effect of deconsolidation of joint venture (913) -
Purchases of property, plant & equipment (254) (72)
--------------- --------------
Net cash used in investing activities (1,167) (72)
--------------- --------------
Cash flows from financing activities:
Proceeds from long-term debt - 277
Payment of long-term debt (501) (457)
Dividends paid (86) (16)
Interest received on stockholder note receivable 301 -
Proceeds from issuance of preferred stock,
net of issuance costs - 9,416
Proceeds from stock option exercises 254 58
Proceeds from issuance of common stock,
net of issuance costs 15,989 4,996
--------------- --------------
Net cash provided by financing activities 15,957 14,274
--------------- --------------
Effect of foreign exchange rates on cash
and cash equivalents 5 53
--------------- --------------
Increase in cash and cash equivalents 100 (561)
Cash and cash equivalents, beginning of period 2,692 6,616
--------------- --------------
Cash and cash equivalents, end of period $ 2,792 $ 6,055
=============== ==============
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
September 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 September 30, 2004, its
consolidated results of operations for each of the three- and six-month
periods ended September 30, 2004 and September 30, 2003, and the
consolidated cash flows for each of the three- and six- month periods ended
September 30, 2004 and September 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- and six-month periods ended September 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 and products include, among others,
electric vehicles, personal transport (e-bikes, wheelchairs, scooters),
backup power systems for the telecom and utility industry and home
appliances.
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 and internal manufacturing efforts through its
newly-formed Wholly Foreign-Owned Enterprises ("WFOE") in China. These
WFOE's are expected to be fully operational during the second half of
fiscal 2005. The market for Saphion(R) technology will be developed by
offering existing and new solutions that differentiate the Company's
products and its customers' products in both the large-format and
small-format markets. 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 September 30, 2004, the Company's principal sources of liquidity were
cash and cash equivalents of $2.8 million and $15 million remaining under
the $20 million backup equity funding commitment entered into in June 2004
with Mr. Carl Berg. Following the end of the quarter, through the date of
this report, the Company drew down an additional $3.0 million on this back
up equity funding commitment, leaving $12 million remaining. The commitment
allows the Company to request Mr. Berg or an affiliate company to purchase
shares of common stock from time to time at the average closing bid price
of the stock for the five days prior to the purchase date. This commitment
can be reduced by Mr. Berg by the amount of net proceeds received by the
Company 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 September 30, 2004 the Company had received net proceeds of $450,000
related to the sale of equipment from the Company's Northern Ireland
facility. As of the date of this report, Mr. Berg has not requested that
his commitment be reduced by this amount.
Under the terms of the Company's Series C Redeemable Preferred Stock, the
Company is required to redeem all outstanding shares of the Company's
Series C stock on December 2, 2004 at their stated value plus accrued and
unpaid dividends. Based on the number of shares of Series C Stock currently
outstanding, the Company's redemption obligation would aggregate $8.6
million. If these shares are not converted by the holder thereof prior to
December 2, 2004, the Company will need to renegotiate the terms of the
Series C stock or arrange financing to fund the redemption. The Company may
not be able to renegotiate the terms or raise additional financing on terms
that would be favorable to the Company or at all.
Currently, the Company does not have sufficient sales and gross profit to
generate the cash flows required to meet the Company's operating and
capital needs. Therefore, the Company depends upon its ability to
periodically arrange for additional equity or debt financing to meet its
liquidity requirements. Unless the Company's product sales are greater than
management currently forecasts or there are other changes to the Company's
business plan, the Company will need to arrange for additional financing
within the next twelve months to fund its operating and capital needs. This
financing could take the form of debt or equity. Given the Company's
historical operating results, the stage of development of its products and
the amount of its existing debt, as well as the other factors described
under the section titled "Risk Factors," the Company may not be able to
arrange for debt or equity financing from third parties on favorable terms
or at all.
The Company's current forecast assumes product sales during fiscal 2005
from its N-Charge(TM) Power System, which are subject to seasonal
fluctuations, of between $2.0 million and $3.5 million per quarter, and
increasing revenues from shipments of the Company's large-format products.
The Company also anticipates further cash benefits from continued
reductions in its operating expenses and manufacturing costs, offset by
increases to capital expenditures associated with the Company's
establishment of manufacturing and development operations in China.
6
The Company's cash requirements may vary materially from those now planned
because of changes in the Company's operations, including the failure to
achieve expected revenues, greater than expected expenses, changes in OEM
relationships, market conditions, the failure to timely realize the
Company's product development goals and other adverse developments. In
addition, the Company is subject to contingent obligations, including the
possible redemption of its outstanding Series C stock in December 2004 and
demand for repayment of a portion or all of its existing grants, which
could have negative impact on the Company's available liquidity sources
prior to the end of fiscal 2005.
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 second quarter and the
first six months of fiscal 2005 and 2004 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 Six Months Ended
September 30, September 30,
-------------------------- --------------------
2004 2003 2004 2003
-------------------------- --------------------
Net loss available to common stockholders
- as reported $ (7,170) $ (26,102) $(16,389) $(35,607)
Add: stock-based compensation expense,
net of related taxes (903) (1,338) (1,806) (2,677)
-------- -------- -------- --------
Net loss available to common stockholders
- pro forma (8,073) (27,440) (18,195) (38,284)
Net loss available to common stockholders per share
- as reported (0.09) (0.36) (0.21) (0.50)
Net loss available to common stockholders,
basic and diluted, pro forma (0.10) (0.38) (0.23) (0.53)
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 six months of fiscal 2005 and 2004:
2005 2004
-------------------------
Risk-free interest rate 3.38% 2.46%
Expected life 5.00 years 5.00 years
Volatility 105.27% 109.82%
Dividend yield - -
8
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 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
proposed contract settlement with Invest Northern Ireland (Note 10,
Commitments and Contingencies) 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. In December 2003, FIN 46 R, "Consolidation of Variable Interest
Entities," was issued, which clarified and replaced FIN 46. The Company
adopted FIN 46 in its second quarter of fiscal year 2004, and FIN 46 R in
the fourth quarter of its fiscal year 2004, and the adoption of FIN 46 and
FIN 46 R 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 three- and
six-month periods ended September 30, 2004 and 2003 were as follows:
Three Months Ended Six Months Ended
September 30, September 30,
2004 2003 2004 2003
---------------------- -----------------------
Shares reserved for conversion of Series C
preferred stock 2,026,000 2,353,000 2,026,000 2,353,000
Common stock options 9,027,000 8,698,000 9,027,000 8,698,000
Warrants to purchase common stock 1,889,000 2,375,000 1,889,000 2,375,000
---------------------- -----------------------
Total 12,942,000 13,426,000 12,942,000 13,426,000
====================== =======================
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 Mr. Carl Berg. Under the terms of the equity commitment,
the Company issued West Coast Venture Capital, Inc., an affiliate of Mr.
Berg, 710,900 shares of its restricted common stock at the average closing
bid price of the stock for the five days prior to the purchase date.
On May 24, 2004, the Company drew down $3 million from its equity
commitment with Mr. Carl Berg. Under the terms of the equity commitment,
the Company issued West Coast Venture Capital, Inc., an affiliate of Mr.
Berg, 829,187 shares of its restricted common stock at the average closing
bid price of the stock for the five days prior to the purchase date.
On June 28, 2004, the Company drew down $3 million from its equity
commitment with Mr. Carl Berg. Under the terms of the equity commitment,
the Company issued West Coast Venture Capital, Inc., an affiliate of Mr.
Berg, 877,193 shares of its restricted common stock at the average closing
bid price of the stock for the five days prior to the purchase date.
9
On July 27, 2004, the Company drew down $2 million from its equity
commitment with Mr. Carl Berg. Under the terms of the equity commitment,
the Company issued West Coast Venture Capital, Inc., an affiliate of Mr.
Berg, 728,332 shares of its restricted common stock at the average closing
bid price of the stock for the five days prior to the purchase date.
On September 1, 2004, the Company drew down $3 million from its equity line
of credit with Mr. Carl Berg. Under the terms of the equity commitment, the
Company issued West Coast Venture Capital, Inc., an affiliate of Mr. Berg,
1,050,420 shares of its restricted common stock at the average closing bid
price of the stock for the five days prior to the purchase date.
On September 30, 2004, the Company drew down $2 million from its equity
line of credit with Mr. Carl Berg. Under the terms of the equity
commitment, the Company issued West Coast Venture Capital, Inc., an
affiliate of Mr. Berg, 623,052 shares of its restricted common stock at the
average closing bid price of the stock for the five days prior to the
purchase date.
6. INVENTORY:
Inventory consisted of the following (in thousands) at:
September 30, 2004 March 31, 2004
------------------ ---------------
Raw materials $ 229 $ 317
Work in process 2,576 1,330
Finished goods 1,119 1,671
---------------- -----------------
$ 3,924 $ 3,318
================ =================
7. PROPERTY, PLANT, AND EQUIPMENT:
Property, plant, and equipment, net of accumulated depreciation and
impairment consisted of the following (in thousands) at:
September 30, 2004 March 31, 2004
------------------- ----------------
Building and land $ - $ 15,726
Leasehold improvements 50 50
Machinery and equipment 12,089 13,609
Office and computer equipment 1,077 960
Construction in progress - 2,490
----------------- ----------------
Total cost 13,216 32,835
Less: accumulated depreciation (6,604) (15,451)
Less: impairment (5,253) (5,166)
----------------- ----------------
Total cost, net of depreciation $ 1,359 12,218
================= ================
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 geographic regions. As of
December 31, 2003, the Company had completed the transition of
manufacturing to ATL and other manufacturers, and all production at the
Northern Ireland facility had ceased. Following the cessation of production
operations in the Northern Ireland facility, during the first half of
fiscal 2005, the Company was engaged in preparing the Northern Ireland
facility for sale. During the
10
second quarter of fiscal 2005, the Company engaged a broker to sell its
Northern Ireland facility, received an offer for the facility and is
currently working to close that potential transaction. As of September 30,
2004, the cost of the land and building is $12.410 million and the
accumulated depreciation on the building is $7.548 million, for a net cost
of $4.862 million, which is lower than the estimated fair value. As of
September 30, 2004, the land and building are classified as assets held for
sale, with no further depreciation expense recorded.
8. INTELLECTUAL PROPERTY:
Intellectual property consisting of stacked battery construction technology
acquired from Telcordia Technologies, Inc. in December 2000 is amortized
over the remaining five years of its useful life. Intellectual property,
net of accumulated amortization and impairment, consisted of the following
(in thousands) at:
September 30, 2004 March 31, 2004
----------------- -----------------
Intellectual property before impairment $ 13,602 $ 13,602
Less: accumulated amortization (4,651) (4,594)
Less: Impairment (8,494) (8,494)
----------------- -----------------
Intellectual property, net $ 457 $ 514
================= =================
Amortization expense for the three-month period ended September 30, 2004
was approximately $29,000. Amortization expense for the three-month period
ended September 30, 2003 was approximately $362,000. Amortization expense
for the six-month period ended September 30, 2004 was $58,000. Amortization
expense for the six-month period ended September 30, 2003 was $725,000.
Amortization expense on intellectual property at September 30, 2004 will be
$58,000 for the remaining six months of fiscal 2005 and will be $114,000 in
fiscal years 2006 through 2008, and $58,000 for fiscal 2009.
9. DEBT TO STOCKHOLDER:
(in thousands) September 30, 2004 March 31, 2004
----------------- --------------
2001 Loan balance $20,000 $20,000
1998 Loan balance 14,950 14,950
Unaccreted debt discount (648) (1,001)
----------------- --------------
Balance $34,302 $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. On October 21, 2004 Berg & Berg
agreed to extend the maturity date for the loan principal and interest from
September 30, 2005 to September 30, 2006. On November 8, 2002, the Company
and Berg & Berg amended an affirmative covenant in the agreement to
acknowledge The Nasdaq SmallCap Market as an acceptable market for the
listing of the Company's common stock. As of September 30, 2004, accrued
interest on the loan totaled $4.277 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 warrant was exercisable beginning on the date it was
issued and will 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 September 30, 2004, a total of approximately $2.120
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 September 30, 2004 and 2003 was $409,000.
Interest expense for each of the six-month periods ended September 30, 2004
and September 30, 2003 was $813,000. 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.
11
In November 2000, the 1998 Loan agreement was amended to increase the
maximum amount to $15 million. As of September 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 September 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, and effective October 21, 2004, the
parties agreed to extend the loan's maturity date to September 30, 2006. On
November 8, 2002, the Company and Berg & Berg amended an affirmative
covenant in the agreement to acknowledge The Nasdaq SmallCap Market as an
acceptable market for the listing of the Company's common stock. As of
September 30, 2004, accrued interest on the loan totaled $6.775 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 expired
on June 16, 2004. 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 September 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 September 30, 2004 and 2003 was $339,000.
Interest expense for each of the six-month periods ended September 30, 2004
and September 30, 2003 was $674,000. 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 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 direct 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 direct N-Charge(TM) Power System sales. The total
warranty liability as of September 30, 2004 is $1.144 million.
Product warranty liabilities for the six months ended September 30, 2004
and the year ended March 31, 2004 are as follows (in thousands):
September 30, 2004 March 31, 2004
------------------------------------
Beginning balance $ 490 $ 123
Less: claims (504) (445)
Less: returns (17) (34)
Plus: accruals 1,175 846
------------------------------------
Ending balance $ 1,144 $ 490
====================================
LITIGATION:
The Company is subject to various claims and litigation in the normal
course of business. Any contingent liabilities are recorded on a gross
basis if probable and estimable. 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. Under certain circumstances, the INI has the right
to reclaim a portion of these grants and has a security interest in the
facility's land, building, and equipment. As a result of the planned
transition of manufacturing from the Mallusk facility to China and other
low cost manufacturing regions, the Company desired to obtain unencumbered
access to all of its equipment
12
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. During
current dialogue with INI officials, it has become apparent that the
proposed settlement terms would not be approved based on the provision that
the Company provide exclusively equity for settlement. Therefore, the
Company and the INI are negotiating to adjust the structure of the
settlement offer to provide for a combination of cash and equity payment.
Although a range of the potential liability is expected to be $1.7 million
to $10.2 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.
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 stockholder in the Company,
agreed to provide an additional $20 million backup equity funding
commitment. This additional funding commitment will come in the form of an
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 average closing
bid price of the stock for the five days prior to the purchase date. As of
September 30, 2004, the Company has drawn down $5 million of this
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. As of September 30, 2004 the Company had received net
proceeds of $450,000 from the sale of equipment from its Northern Ireland
facility. As of the date of this report, Mr. Berg has not requested that
his commitment be reduced by this amount.
On January 1, 1998, the Company granted 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
13
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 September 30, 2004, amounts of
$3.454 million and $1.569 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
5.77% 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. SEGMENT AND GEOGRAPHIC INFORMATION:
The Company's chief operating decision maker is its Chairman and Chief
Executive Officer, who reviews operating results to make decisions about
resource allocation and to assess performance. The Company's chief
operating decision maker views results of operations of a single operating
segment, the development and marketing of the Company's Saphion(R)
technology. The Company's Chairman and Chief Executive Officer has
organized the Company functionally to develop, market, and manufacture
Saphion(R) products.
Long lived asset information by geographic area at September 30, 2004 and
March 31, 2004 is as follows (in thousands):
September 30, 2004 March 31, 2004
----------------- ----------------
United States $1,119 $ 1,656
International 697 11,076
----------------- ----------------
Total $1,816 $12,732
================= ================
Revenues by geographic area for the three- and six-month periods ended
September 30, 2004 and 2003 are as follows (in thousands):
Three Months Ended September 30, Six Months Ended September 30,
--------------------------------- --------------------------------
2004 2003 2004 2003
---------------- ---------------- --------------- ---------------
United States $2,605 $1,905 $5,238 $2,817
International 310 440 514 1,159
---------------- ---------------- --------------- ---------------
Total $2,915 $2,345 $5,752 $3,976
================ ================ =============== ===============
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 as a
corporation in China. 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. As a result of the Company's 51% ownership of the joint
venture, its right to name the majority of the joint venture's board of
directors, and its right to name the Chief Executive Officer, 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.
In January 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 a letter dated March 2004 in which the Company
gave Fengfan notice of termination of the joint
14
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 was 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 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 was $211,000, of which $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 resolution 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 September 30, 2004 consisted of
inactive operating leases of approximately $65,000.
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, "Accounting for Impairment or Disposal of
Long-Lived Assets." During the second quarter of fiscal 2004 the Company
completed qualification of its OEM manufacturer in China, Amperex
Technology Limited (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
15
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%.
An impairment charge of $87,000 was recorded during the fiscal quarter
ended September 30, 2004 pursuant to FASB Statement No. 144, OAccounting
for Impairment or Disposal of Long-Lived Assets.O As a result of the
Company's decision to relocate manufacturing operations from its leased
Henderson, Nevada facility to a newly formed subsidiary in Suzhou, China,
equipment and fixtures in the Nevada facility will not generate cash flows
greater than their carrying value. Assets with a carrying value of
approximately $87,000 were written down in full to fair value, as the
company estimates that there will be no future cash flows from these
assets.
17. SUBSEQUENT EVENTS:
On October 28, 2004, at the Company's annual meeting, stockholders approved
an amendment to the Company's Second Restated Certificate of Incorporation
to increase the number of authorized shares of common stock from
100,000,000 to 200,000,000, elected five members of the board of directors
to serve until the 2005 annual meeting, and approved an increase of
2,000,000 in the number of shares reserved for issuance under the Company's
2000 Stock Option Plan from 4,000,000 to 6,000,000.
On November 3, 2004, the Company drew down $3 million from its equity line
of credit with Mr. Carl Berg. Under the terms of the equity commitment, the
Company issued West Coast Venture Capital, Inc., an affiliate of Mr. Berg,
911,854 shares of its restricted common stock at the average closing bid
price of the stock for the five days prior to the purchase date.
16
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 AND SIX-MONTH PERIODS ENDED SEPTEMBER 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, because of 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, and internal manufacturing efforts through our newly-formed
Wholly Foreign-Owned Enterprises (WFOE) in China. We expect that these WFOE's
will be fully operational during the second half of fiscal 2005. We plan to
drive the adoption of our Saphion(R) technology by offering existing and new
solutions that differentiate our own products and customers' 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;
17
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. Since execution of this agreement,
our K-Charge product achieved NEBS level three certification which resulted
in the first order from Tyco Electronics for field trials. Tyco Electronics
will provide sales, marketing, technical assistance and customer support;
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; and
o Announced a joint technology development program with Segway LLC to develop
long-range battery packs using our Saphion(R) technology for Segway's human
transporter product.
Our financial results for the second quarter and first half of fiscal 2005
were consistent with our expected progress in our business. Most significantly,
second quarter of fiscal 2005 revenue grew by 24.3% as compared to the second
quarter of the prior year to $2.9 million. Revenue for the first half of fiscal
2005 grew by 44.7% over the first half of fiscal 2004. Additionally in the
second quarter of fiscal 2005, we achieved improvement of our negative gross
margin to (25%) from (74%) in the comparable period of fiscal 2004. For the
first half of fiscal 2005, negative gross margin improved to (31%) from (99%) in
the first half of fiscal 2004. During the second quarter of fiscal 2005 we
continued our efforts to transition our manufacturing and other operations to
China through the establishment of two wholly-owned subsidiaries in Suzhou,
China. 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. As of September 30, 2004, $5 million
had been drawn down and $15 million remained under the equity commitment. 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. As of September 30, 2004, we had received net proceeds of
$450,000 from the sale of equipment from our Northern Ireland facility. As of
the date of this report, Mr. Berg has not requested that his commitment be
reduced by this amount.
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
18
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 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 16, 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. Under certain circumstances, the INI has the right to
reclaim a portion of these grants and has a security interest in the facility's
land, building, and equipment. As a result of our planned transition of
manufacturing from the Mallusk facility to China and other low cost
manufacturing regions, we desired 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. During current dialogue with INI
officials, it has become apparent that the proposed settlement terms would not
be approved based on the provision that we provide exclusively equity for
settlement. Therefore, we are negotiating with the INI to adjust the structure
of the settlement offer to provide for a combination of cash and equity payment.
Although a range of the potential liability is expected to be $1.7 million to
$10.2 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 as a corporation
in China. 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. As a result of our 51% ownership of the joint venture,
its right to name the majority of the joint venture's board of directors and its
right to name the Chief Executive Officer, 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.
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 our control of the joint venture. After numerous attempts to set a
date for a meeting of the joint venture's board of directors, we had been unable
to receive a
19
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 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.
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 was $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.
RESULTS OF OPERATIONS
The following table summarizes the results of our operations for the three
months and six months ended September 30, 2004 (also referred to as the second
quarter and first half, respectively, of fiscal 2005) and September 30, 2003
(also referred to as the second quarter and first half, respectively, of fiscal
2004):
Three Months Ended Six Months Ended
---------------------------------------- ------------------------------------------
September 30, 2004 September 30,2003 September 30, 2004 September 30,2003
---------------------------------------- ------------------------------------------
(dollars in thousands) % of Revenue % of Revenue % of Revenue % of Revenue
Licensing and royalty revenue $ 113 4% $ 69 3% $ 186 3% $ 625 16%
Battery and system sales 2,802 96% 2,276 97% 5,566 97% 3,351 84%
---------------------------------------- ------------------------------------------
Total revenues 2,915 100% 2,345 100% 5,752 100% 3,976 100%
Gross profit (loss) (716) -25% (1,735) -74% (1,802) -31% (3,922) -99%
Operating expenses 5,229 179% 23,282 993% 12,144 211% 29,552 743%
Operating loss (5,945) -204% (25,017) -1067% (13,946) -242% (33,474) -842%
---------------------------------------- ------------------------------------------
Net loss $ (6,909) -237% $ (25,845) -1102% $ (15,867) -276% $ (35,334) -889%
======================================== ==========================================
REVENUES AND GROSS MARGIN
BATTERY AND SYSTEM SALES: Battery and system sales increased by $526,000, or
23%, to $2.802 million in the quarter ended September 30, 2004 from $2.276
million for the quarter ended September 30, 2003. Battery and system sales
increased by $2.215 million, or 66%, in the first half of fiscal 2005 from
$3.351 million in the first half of fiscal 2004. 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. In addition to our
retail channels we expanded our sales efforts into the educational sector, in
which we sold $607,000 for the second quarter of fiscal 2005 and $1.335 million
for the first half 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 $827,000 in deferred revenue on our balance sheet at September
30, 2004.
20
LICENSING AND ROYALTY REVENUE: Licensing and royalty revenues relate to revenue
from licensing agreements for our technology. Fiscal second quarter 2005
licensing and royalty revenue of $113,000 was from our license agreement with
Amperex Technology Limited (ATL). For the first half of fiscal 2005, licensing
and royalty revenue from the agreement with ATL was $186,000. 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. We expect our second-generation
Saphion(R) technology to begin commercialization for energy applications by the
end of 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 (25%)
for the second quarter of fiscal 2005 and was (74 %) in the second quarter of
fiscal 2004. Gross margin (loss) was (31%) in the first half of fiscal 2005 and
was (99%) in the first half of fiscal 2004. The primary reduction in cost of
sales as a percentage of revenue was the result of ceasing manufacturing
operations at our Northern Ireland factory. The cessation of manufacturing in
Northern Ireland reduced cost of sales in the second quarter of fiscal 2005 by
$1.150 million, an improvement of 40 percentage points of gross margin. The
cessation of manufacturing in Northern Ireland reduced cost of sales in the
first half of fiscal 2005 by $2.786 million, an improvement of 48 percentage
points of gross margin. Additional improvements in gross profit included the
results of reduced domestic manufacturing overhead expenses as a percent of
revenue, which contributed to an improvement in gross margin in the second
quarter of fiscal 2005 over the second quarter of fiscal 2004 by 6 percentage
points and in the first half of fiscal 2005 over the first half of fiscal 2004
by 7 percentage points. The increase in license and royalty revenue of $44,000
in the second quarter of fiscal 2005 over the second quarter of fiscal 2004
improved gross margin for the period by 2 percentage points. The decrease in
license and royalty revenue of $439,000 in the first half of fiscal 2005 from
the first half of fiscal 2004 decreased gross margin by 8 percentage points,
while direct manufacting cost reductions improved gross margin in the period by
19 percentage points. Although gross margin has improved, 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 operations to contract manufacturers
in Asia and intend to transition additional manufacturing and product
development operations to our newly-established WFOE's in Suzhou, 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 lower-cost manufacturing strategy, and as we launch higher-margin products.
OPERATING EXPENSES
The following table summarizes operating expenses for the three months and six
months ended September 30, 2004 and September 30, 2003:
Three Months Ended September 30, Six Months Ended September 30,
----------------------------------- -----------------------------------
Increase/ Increase/
(Dollars in thousands) 2004 2003 Decrease/ %Change) 2004 2003 Decrease %Change)
----------------------------------- -----------------------------------
Research and product
development $ 1,736 $ 1,835 $ (99) -5% $ 3,635 $ 3,891 $ (256) -7%
Marketing 955 1,298 (343) -26% 2,286 2,256 30 1%
General and administrative 2,624 2,673 (49) -2% 6,048 5,141 907 18%
Depreciation and amortization 286 770 (484) -63% 559 1,558 (999) -64%
Total operating expenses $ 5,601 $ 6,576 $ (975) -15% $12,528 $12,846 $ (318) -2%
Percentage of revenues 192% 280% 218% 323%
During the second quarter of fiscal 2005, operating expenses were 192% of
revenue and were 280% of revenue in the same quarter last year. The decrease is
a result of increased revenues and focus on expense reductions during the
quarter. In the first half of fiscal 2005, operating expenses were 218% of
revenue and were 323% of revenue in the first half of fiscal 2004. The decrease
in operating expenses as a percentage of revenue is the result of increased
revenue and expense reductions in research and product development offset by
increases in marketing and general and administrative expenses.
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
$99,000, or 5%, to $1.736 million in the second quarter of fiscal 2005 from
$1.835 million in the second quarter of fiscal 2004. Research and product
development expenses decreased by $256,000, or 7%, in the first half of fiscal
2005 to $3.635 million from $3.891 million in the first half of fiscal 2004. The
decrease in research and development expenses is the result of cessation of
process development work in our Northern Ireland facility, as well as reduced
temporary staff and consulting expenses 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 efforts. Marketing
expenses of $955,000 in the second quarter of fiscal 2005 were $343,000 lower
than the
21
comparable period of fiscal 2004. First half of fiscal 2005 marketing
expenses of $2.286 million were $30,000 higher than the comparable period in
fiscal 2004. The decrease in marketing expenses in the second quarter of fiscal
2005 over the comparable period in fiscal 2004 was the result of reduced
spending for consulting related to European market development, and for reduced
media advertising expenditures. The increases in the first half of 2005 were the
result of 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
of $2.624 million in the second quarter of fiscal 2005 decreased by $49,000, or
2%, over general and administrative expenses of $2.673 million in the comparable
period in fiscal 2004. General and administrative expenses increased by
$907,000, or 18%, to $6.048 million in the first half of fiscal 2005 from $5.141
million in the first half of fiscal 2004. Increases in general and
administrative expenses are caused by our ongoing relocation and establishment
of manufacturing and development operations to China, increased costs of
compliance with the Sarbanes-Oxley Act of 2002, 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 in place 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%.
An impairment charge of $87,000 was recorded during the fiscal quarter ended
September 30, 2004. As a result of our decision to relocate manufacturing
operations from our leased Henderson, Nevada facility to a newly formed
subsidiary in Suzhou, China, equipment and fixtures in the Nevada facility will
not generate cash flows greater than their carrying value. Assets with a
carrying value of approximately $87,000 were written down in full to fair value,
as we estimates that there will be no future cash flows from these assets.
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. Under certain circumstances, the INI has the right to
reclaim a portion of these grants and has a security interest in the facility's
land, building, and equipment. As a result of our planned transition of
manufacturing from our now closed Mallusk facility to China and other low cost
manufacturing regions, we desired to obtain unencumbered access to all of its
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. During current dialogue with INI
officials, it has become apparent that the proposed settlement terms would not
be approved based on the provision that we provide exclusively equity for
settlement. Therefore, we are negotiating with the INI to adjust the structure
of the settlement offer to provide for a combination of cash and equity payment.
Although a range of the potential liability is expected to be $1.7 million to
$10.2 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.
GAIN ON SALE OF ASSETS: Gain on sales of production and development equipment
from our former Mallusk, Northern Ireland facility were $459,000 in the second
quarter of fiscal 2005 and $471,000 in the first half of fiscal 2005. We
determined that the equipment was not required in our manufacturing and
development operations in Suzhou, China, and was sold for fair value.
22
DEPRECIATION AND AMORTIZATION, AND INTEREST EXPENSE
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses were
$286,000 and $770,000 in the second quarters of fiscal 2005 and 2004,
respectively. Depreciation and amortization expenses were $559,000 and $1.558
million in the first halves 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.
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 $1.003 million and $913,000 for the second quarter of fiscal 2005
and 2004, respectively, and was $2.035 million and $2.025 million for the first
half of fiscal 2005 and fiscal 2004, respectively.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
At September 30, 2004, our principal sources of liquidity were cash and
cash equivalents of $2.8 million and $15 million remaining under the $20 million
backup equity funding commitment entered into in June 2004 with Mr. Carl Berg.
Following the end of the quarter, through the date of this report, we drew down
an additional $3.0 million on this back up equity funding commitment, leaving
$12 million remaining. The commitment allows us to request Mr. Berg or an
affiliate company to purchase shares of common stock from time to time at the
average closing bid price of the stock for the five days prior to the purchase
date. This commitment can be reduced by Mr. Berg 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 September
30, 2004 we had received net proceeds of $450,000 related to the sale of
equipment from our Northern Ireland facility. As of the date of this report, Mr.
Berg has not requested that his commitment be reduced by this amount.
Under the terms of our Series C Redeemable Preferred Stock, we are required
to redeem all outstanding shares of our Series C stock on December 2, 2004 at
their stated value plus accrued and unpaid dividends. Based on the number of
shares of Series C Stock currently outstanding, our redemption obligation would
aggregate $8.6 million. If these shares are not converted by the holder thereof
prior to December 2, 2004, we will need to renegotiate the terms of the Series C
stock or arrange financing to fund the redemption. We may not be able to
renegotiate the terms or raise additional financing on terms that would be
favorable to us or at all.
Currently, we do not have sufficient sales and gross profit to generate the
cash flows required to meet our operating and capital needs. Therefore, we
depend upon our ability to periodically arrange for additional equity or debt
financing to meet our liquidity requirements. Unless our product sales are
greater than we currently forecast or there are other changes to our business
plan, we will need to arrange for additional financing within the next twelve
months to fund our operating and capital needs. This financing could take the
form of debt or equity. Given our historical operating results, the stage of
development of our products and the amount of our existing debt, as well as the
other factors described under the section titled "Risk Factors," we may not be
able to arrange for debt or equity financing from third parties on favorable
terms or at all.
Our current 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 increasing revenues from
shipments of our large-format products. We also anticipate further cash benefits
from continued reductions in our operating expenses and manufacturing costs,
offset by increases to capital expenditures associated with our establishment of
manufacturing and development operations 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 in December 2004 and
demand for repayment of a portion or all of our existing grants, which could
have negative impact on our available liquidity sources prior to the end of
fiscal 2005.
23
The following table summarizes our statement of cash flows for the six months
ended September 30, 2004 and 2003:
Six Months Ended September 30,
----------------------------
(Dollars in thousands) 2004 2003
----------- -----------
Net cash flows provided by (used in):
Operating activities $ (14,695) $ (14,816)
Investing activities (1,167) (72)
Financing activities 15,957 14,274
Effect of foreign exchange rates 5 53
----------- -----------
Net increase/(decrease) in cash and cash
equivalents $100 ($561)
=========== ===========
Our use of cash from operations the first six months of fiscal 2005 and
fiscal 2004 was $14.7 million and $14.8 million, respectively. The cash used for
operating activities during the first six months of our fiscal 2005 operating
activities was primarily for operating losses and working capital. Cash used for
operating loss in the first six 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 six months of fiscal 2005, we invested $254,000 in property,
plant and equipment, primarily for enterprise software and manufacturing
fixtures. 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 $16 million and $14.3 million
during the first six months of fiscal 2005 and 2004, respectively. The 2005
financing included $16 million from our Berg & Berg equity lines, 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 $100,000 during the first six months of fiscal 2005 and a net
decrease of $561,000 million for the first six months of fiscal 2004.
CAPITAL COMMITMENTS AND DEBT
At September 30, 2004, we had commitments for capital expenditures for the
next 12 months of approximately $100,000 relating to the continuing
implementation of enterprise software and $117,000 for production equipment in
our new manufacturing facility in China. We anticipate that we will incur
additional capital expenses as we start up and expand 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 the potential settlement with the INI consisted of:
(Dollars in thousands) September 30, 2004
-----------------
Mortgages on building and land held for sale, short-term $ 5,938
1998 long-term debt to Berg & Berg 14,950
2001 long-term debt to Berg & Berg 20,000
Interest on long-term debt 11,208
-----------------
Total long-term debt $ 52,096
=================
Repayment obligations of short-term and long-term debt principal are:
24
Fiscal year
----------------------------------------------------------------------------------
(Dollars in thousands) 2005 2006 2007 2008 2009 Thereafter Total
---------- ---------- ---------- ---------- ---------- ---------- ----------
Principal repayment $ 5,863 - 34,950 - - - $ 40,813
Payment obligations recorded for our proposed settlement 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 $5.9 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 September 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 Less than 1- 2 Years 3 - 5 Years 5 Years
- ----------------------------------- ---------- ---------- ---------- ---------- ----------
Short- and long-term debt obligations 52,096 5,938 46,158 - -
Operating lease obligations 1,696 467 1,064 165 -
Purchase obligations 3,214 3,214 - - -
Other long-term liabilities 4,789 1,753 3,036 - -
---------- ---------- ---------- ---------- ----------
Total $ 61,795 $ 11,372 $ 50,258 $ 165 $ -
========== ========== ========== ========== ==========
25
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 NEED TO RAISE ADDITIONAL DEBT OR EQUITY FINANCING TO EXECUTE OUR BUSINESS
PLAN.
At September 30, 2004, our principal sources of liquidity were cash and cash
equivalents of $2.8 million and $15 million remaining under the $20 million
backup equity funding commitment entered into in June 2004 with Mr. Carl Berg.
Following the end of the quarter, through the date of this report, we drew down
an additional $3.0 million on this back up equity funding commitment, leaving
$12 million remaining. The commitment allows us to request Mr. Berg or an
affiliate company to purchase shares of common stock from time to time at the
average closing bid price of the stock for the five days prior to the purchase
date. This commitment can be reduced by Mr. Berg 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 September
30, 2004 we had received net proceeds of $450,000 related to the sale of
equipment from our Northern Ireland facility. As of the date of this report, Mr.
Berg has not requested that his commitment be reduced by this amount.
Under the terms of our Series C Redeemable Preferred Stock, we are required to
redeem all outstanding shares of our Series C stock on December 2, 2004 at their
stated value plus accrued and unpaid dividends. Based on the number of shares of
Series C Stock currently outstanding, our redemption obligation would aggregate
$8.6 million. If these shares are not converted by the holder thereof prior to
December 2, 2004, we will need to renegotiate the terms of the Series C stock or
arrange financing to fund the redemption. We may not be able to renegotiate the
terms or raise additional financing on terms that would be favorable to us or at
all.
Currently, we do not have sufficient sales and gross profit to generate the cash
flows required to meet our operating and capital needs. Therefore, we depend
upon our ability to periodically arrange for additional equity or debt financing
to meet our liquidity requirements. Unless our product sales are greater than we
currently forecast or there are other changes to our business plan, we will need
to arrange for additional financing within the next twelve months to fund our
operating and capital needs. This financing could take the form of debt or
equity. Given our historical operating results, the stage of development of our
products and the amount of our existing debt, as well as the other factors
described below, we may not be able to arrange for debt or equity financing from
third parties on favorable terms or at all.
Our current 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 increasing revenues from
shipments of our large-format products. We also anticipate further cash benefits
from continued reductions in our operating expenses and manufacturing costs,
offset by increases to capital expenditures associated with our establishment of
manufacturing and development operations 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 in December 2004 and
demand for repayment of a portion or all of our existing grants, which could
have negative impact on our available liquidity sources prior to the end of
fiscal 2005.
26
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 $445.7 million as of September 30, 2004. We had
negative working capital of $1.7 million as of September 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 $15.9 million in the six months ended September 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
27
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.
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 September 30, 2004, we had approximately $62 million of
total consolidated indebtedness and other obligations. 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.
28
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.
29
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 MANUFACTURING AND DEVELOPMENT 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 relocating our manufacturing and development 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 manufacturing and
development operations. While we intend to implement a plan to relocate our
manufacturing and development 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:
30
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 PRODUCTS AT OUR OEM
FACILITIES, 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 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,
31
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 and
establishing manufacturing and development operations in our wholly-owned
subsidiaries in China. 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
32
incur significant expenses in preserving our proprietary rights, and these costs
could harm our financial condition. We also are attempting to expand our
intellectual property rights through our applications for new patents. We cannot
be certain that our pending patent applications will result in issued patents or
that our issued patents will afford us protection against a competitor. Our
inability to protect our existing proprietary technologies or to develop new
proprietary technologies may substantially impair our financial condition and
results of operations.
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS BROUGHT AGAINST US COULD BE
TIME-CONSUMING AND EXPENSIVE TO DEFEND, AND IF ANY OF OUR PRODUCTS OR PROCESSES
IS FOUND TO BE INFRINGING, WE MAY NOT BE ABLE TO PROCURE LICENSES TO USE PATENTS
NECESSARY TO OUR BUSINESS AT REASONABLE TERMS, IF AT ALL.
In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights. While we currently are
not engaged in any intellectual property litigation or proceedings, we may
become involved in these proceedings in the future. In the future we may be
subject to claims or inquiries regarding our alleged unauthorized use of a third
party's intellectual property. An adverse outcome in litigation could force us
to do one or more of the following:
o stop selling, incorporating, or using our products that use the challenged
intellectual property;
o pay significant damages to third parties;
o obtain from the owners of the infringed intellectual property right a
license to sell or use the relevant technology, which license may not be
available on reasonable terms, or at all; or
o redesign those products or manufacturing processes that use the infringed
technology, which may not be economically or technologically feasible.
Whether or not an intellectual property litigation claim is valid, the cost of
responding to it, in terms of legal fees and expenses and the diversion of
management resources, could be expensive and harm our business.
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 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.
33
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;
34
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.
35
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.
36
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 October 29, 2004, our officers, directors and their affiliates as a group
beneficially owned approximately 40.7% of our outstanding common stock. Carl
Berg, one of our directors, beneficially owns approximately 37.7% 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
37
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 October 29, 2004, the
closing price of our common stock was $3.22. 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 80,906,536 shares of common stock as of
September 30, 2004. In addition, at September 30, 2004, we had 12,135,740 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.
38
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.
OUR BUSINESS IS SUBJECT TO CHANGING REGULATION RELATING TO CORPORATE GOVERNANCE
AND PUBLIC DISCLOSURE THAT HAS INCREASED BOTH OUR COSTS AND THE RISK OF
NONCOMPLIANCE.
Because our common stock is publicly traded, we are subject to certain rules and
regulations of federal, state and financial market exchange entities charged
with the protection of investors and the oversight of companies whose securities
are publicly traded. These entities, including the Public Company Accounting
Oversight Board, the Commission, and Nasdaq, have recently issued new
requirements and regulations and continue to develop additional regulations and
requirements in response to recent laws enacted by Congress, most notably
Section 404 of the Sarbanes-Oxley Act of 2002. Our efforts to comply with these
new regulations have resulted in, and are likely to continue to result in,
increased general and administrative expenses and a diversion of management time
and attention from revenue-generating and cost reduction activities to
compliance activities.
In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act
of 2002 and the related regulations regarding our required assessment of our
internal controls over financial reporting and our registered independent public
accounting firm's audit of that assessment has required, and continues to
require, the commitment of significant financial and managerial resources.
Although we believe that the ongoing review of our internal controls will enable
us to provide an assessment of our internal controls and our registered
independent public accounting firm to provide its audit opinion as of March 31,
2005 as required by Section 404 of the Sarbanes-Oxley Act of 2002, we cannot
assure you that these efforts will be completed on a timely and successful
basis.
Because these laws, regulations and standards are subject to varying
interpretations, their application in practice may evolve over time as new
guidance becomes available. This evolution may result in continuing uncertainty
regarding compliance matters and additional costs necessitated by ongoing
revisions to our disclosure and governance practices.
In the event that our Chief Executive Officer, Vice President of Finance, or
registered independent public accounting firm determine that our internal
controls over financial reporting are not effective as defined under Section 404
of the Sarbanes-Oxley Act of 2002, there may be a material adverse impact in
investor perceptions and a decline in the market price of our stock.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We considered the provisions of Financial Reporting Release No. 48,
"Disclosures of Accounting Policies for Derivative Financial Instruments and
Derivative Commodity Instruments, and Disclosures of Quantitative and
Qualitative Information about Market Risk Inherent in Derivative Commodity
Instruments." We had no holdings of derivative financial or commodity
instruments at September 30, 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% (5.05% and 4.95%, respectively, at September 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 2006, to a stockholder. The first loan has an
adjustable rate of interest at 1% above the lender's borrowing rate (9% at
September 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.
39
2005 2006 2007 2008 2009 THEREAFTER TOTAL
---------- ---------- ---------- ---------- ---------- ---------- ----------
(dollars in thousands)
Liabilities:
Fixed rate debt: $ - - 20,000 - - - $20,000
Variable rate debt $ 5,864 - 14,950 - - - $20,814
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
second 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.
40
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are subject to various claims and litigation in the normal course of
business. Any contingent liabilities are recorded on a gross basis if probable
and estimable. 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. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None, other than as previously reported in Current Reports on Form 8-K filed by
us with the Commission.
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
10.1 Equity Line of Credit between Carl Berg and Valence Technology, Inc., dated
June 11, 2004.
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 July 30, 2004, under Item 5, disclosing 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).
Current Report on Form 8-K, filed August 5, 2004, under Items 7 and 12,
attaching our press release issued on August 5, 2004, regarding the financial
results for the first quarter ended June 30, 2004.
Current Report on Form 8-K, filed August 19, 2004, under Item 5, disclosing
that, our board of directors appointed Dr. Vassilis G. Keramidas to the Board of
Directors effective August 17, 2004.
Current Report on Form 8-K, filed September 3, 2004, under Item 3.02, disclosing
that, on September 1, 2004, we sold 1,050,420 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 September 29, 2004, under Items 8.01 and 9.01,
disclosing that we obtained NEBS battery certification for telecommunications
and utility markets.
41
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
VALENCE TECHNOLOGY, INC.
Date: November 9, 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)
42
EXHIBIT INDEX
EXHIBIT NO.
10.1 Equity Line of Credit between Carl Berg and Valence Technology, Inc.,
dated June 11, 2004.
31.1 Rule 13a-14/15d-14(a) Certifications
32.1 Section 1350 Certifications
43