ITEM 1. BUSINESS
OVERVIEW
Valence Technology, Inc. was founded in 1989 and has commercialized the industry's first phosphate based lithium-ion 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 Saphion(R) battery technology, the experience of our management team and the significant market opportunity available to us.
In February 2002, we unveiled our Saphion(R) technology, a lithium-ion technology which utilizes a phosphate-based cathode material. Traditional lithium-ion technology utilizes an oxide-based cathode material, which has limited its adoption to small applications such as notebook computers, cellular phones and personal digital assistants (PDAs) due to safety concerns related its use in large applications. We believe that Saphion(R) technology addresses the major weaknesses of this existing technology while offering a solution that is competitive in cost and performance. We believe that by incorporating a phosphate-based cathode material, our Saphion(R) technology is able to offer greater thermal and electrochemical stability than traditional lithium-ion technologies, which will facilitate its adoption in large application markets not traditionally served by lithium-ion batteries such as motive power, vehicular, portable appliances, telecommunications, and utility back-up systems. Currently, we offer our Saphion(R) technology in both cylindrical and polymer construction and have initiated the design of a prismatic cell. We believe offering Saphion(R) technology in multiple constructions will provide us greater flexibility in our response to the needs of the market.
Key product introductions based on our Saphion(R) technology:
o In February 2002, we launched the N-Charge(TM) Power System into several channels for sales and distribution, including national and regional retailers, top tier computer manufacturers, and national resellers. o In February 2003, we launched our first large-format energy storage system, the K-Charge(TM) Power System which was engineered specifically for large-format applications such as those required by the telecommunications, industrial and utility markets. It is currently being offered to customers for evaluation in telecom and utility back-up as well as alternative energy applications. o In February 2004, we announced the second generation N-Charge(TM) Power System II, currently being sold through some of our existing channels. o In February 2004, we also introduced a prototype of the U-Charge(TM) Power System family of large-format products. The U-Charge(TM) Power System is in production in our China facilities and is designed to power a
variety of motive applications from hybrid and electric vehicles to scooters and wheelchairs, and can also be used in stationary applications. o In March 2005, we announced the availability of Saphion(R) powered batteries for Segway's 2005 products. Our batteries doubled the range of Segway's Human Transporters that were using Nickel Metal Hydride batteries. o In May 2005, we launched the industry's first commercially available phosphate-based lithium-ion power cell. This cell is also built with our proprietary Saphion(R) technology and offers high discharge rates required of power cells with the safety features enabled by our phosphate-based cathode material. Our power cell is optimal for use in portable appliances, hybrid and electric vehicles.
As part of our low-cost manufacturing strategy, we have successfully transitioned our powder manufacturing from Henderson, Nevada to Suzhou, China. This transition along with the launching of our pack manufacturing in Suzhou and the opening of our engineering office in Shanghai will allow us to capitalize on lower manufacturing costs and reduced overhead costs related to administrative and product development activities. Our research and development efforts are focused on the design of new products utilizing our Saphion(R) chemistry, the scale-up of our second generation Saphion(R) technology, the development of different cell constructions to optimize power and size for new applications, as well as developing future materials based on the Saphion(R) technology attributes.
STRATEGY
Our business strategy is focused on a mix of system, cell and licensing sales, and includes a manufacturing plan that leverages internal capabilities and partnerships with contract manufacturers. We plan to drive the adoption of our Saphion(R) technology by offering existing and new solutions that differentiate our own products and end-users' products by offering safety and performance characteristics previously unavailable to those end-users products.
Key elements of our strategy include:
o DEVELOP AND MARKET DIFFERENTIATED BATTERY SOLUTIONS FOR A WIDE ARRAY OF APPLICATIONS THAT LEVERAGE THE TECHNOLOGICAL ADVANTAGES OF OUR SAPHION(R) TECHNOLOGY. Our product development and marketing efforts are focused on large format battery solutions, such as our U-Charge(TM) Power System and K-Charge(TM) Power System and other custom battery solutions that require the performance and technological advantages of our Saphion(R) technology. These products are targeted for a broad range of applications in the motive, power and consumer appliance, telecommunication and utility industries and as a substitute for certain applications using lead-acid batteries.
o EXECUTE ON OUR MANUFACTURING PLAN TO PROVIDE HIGH QUALITY, COST COMPETITIVE PRODUCTS. In fiscal 2004 we determined to move our manufacturing from Mallusk, Ireland to China and other low-cost manufacturing centers, using both internal and contract manufacturing capabilities. We have opened three facilities in China, one for the manufacture of the base powder used in our Saphion(R) cells, one for the manufacture of large-format battery packs and assembly of cylindrical cells, and a third that functions as an engineering office to design and provide sustaining support for new battery systems. We also have arrangements with contract manufacturers for cell production and additional capacity. We believe this manufacturing strategy will allow us to directly control our intellectual property and operations management as well as deliver high quality, cost-competitive products which meet the needs of a broad range of customers and applications.
o IMPLEMENT A PHASED APPROACH TO OUR BUSINESS STRATEGY. Our business strategy has been implemented in three fluid phases, each building on the previous one.
1. Initial Phase: The initial phase of our strategy is complete and the focus was on the first generation of our Saphion(R) technology in our patented polymer construction. During this phase, we introduced the N-Charge Power System which has been sold through national and regional retailers, top-tier computer
manufacturers and national resellers. We also introduced our K-Charge Power System, a large-format product designed for the telecommunications and utility markets. 2. Second Phase: The second phase of the business strategy is nearly complete. Throughout this phase our cell development has focused on commercializing a cylindrical battery construction, developing of a large prismatic cell and introducing a power cell all utilizing our first generation of Saphion(R) material. Additionally, we worked towards completing the development of our second-generation Saphion(R) technology. Our systems development focused on creating energy storage systems for the stationary and motive markets and we launched the U-Charge Power System Family. This family of products is designed for motive applications such as hybrid and electric vehicles, scooters and wheelchairs and has the same dimensions as the most popular lead acid batteries but with significant increases in performance related to cycle life and weight. 3. Final Phase: The final phase of our business strategy will entail the commercial production of Saphion(R) based energy solutions for the vehicular, portable appliance, telecommunications and utility industries, with continuing focus on marketing small format Saphion(R) solutions through our developed sales channels
We believe our strategy will allow us to expand our market opportunity. Through the sales of products based on our differentiated Saphion(R) technology, and the establishment of Asian operations and partnerships to achieve the lowest possible costs, we believe we are equipped to serve existing lithium-ion technology markets as well as open doors to new market opportunities.
FISCAL 2005 HIGHLIGHTS AND RECENT EVENTS
o THE N-CHARGE(TM) POWER SYSTEM
o In October of 2004 the N-Charge(TM) Power System II was selected by Circuit City for roll out to its retails stores nationwide.
o In February 2005, the N-Charge(TM) Power System was shown in six industry leading partner booths at the 2005 Annual HIMMS Conference and Exhibition. The HIMMS conference is a premier marketing event in the healthcare IT industry, with more than 700 exhibitors featuring new products and cutting-edge interoperability demonstrations.
o THE K-CHARGE(TM) POWER SYSTEM
o In June 2004, we 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. Additionally, sales and marketing, technical assistance and customer support will be provided by Tyco Electronics. Tyco has initiated field trials of the K-Charge(TM) Power System with three separate telecommunications companies.
o THE U-CHARGE(TM) POWER SYSTEM AND OTHER MOTIVE BATTERIES
o In November 2004, we announced a Joint Development Program with Segway to provide the first lithium-ion batteries for Segway Human Transporters. The batteries are available through Segway's distribution channels and will offer up to 24 miles of range on a single charge.
o In December 2004, Alternativ Canada selected the U-Charge(TM) Power System to be the battery solution in their fleet of electric vehicles. The U-Charge(TM) Power Systems enabled Alternative Canada to increase the range of their fleet delivery vehicles from 30km to over 100km. The U-Charge(TM) Power Systems have been installed in two vehicles for continuing evaluation.
o In March 2005, we teamed up with EnergyCS to create a plug-in hybrid electric vehicle (PHEV) based on a 2004 Toyota Prius. The concept car uses U-Charge Power Systems as a replacement for the existing nickel-metal-hydride batteries and achieves up to 180 miles per gallon by allowing significant amounts of zero-emission electric-only driving. The vehicle was unveiled at the EVS 21 industry event in Monaco.
o In March 2005, Phoenix Motorcars became the only car on the market to achieve CARB level II certification with full zero emission credits using the U-Charge(TM) Power System. The vehicles built by Phoenix Motorcars with our battery systems were able to travel up to 120 miles on a single charge and have four to five times the cycle life of the competing technology, nickel-zinc.
o OPERATIONAL ACHIEVEMENTS
o In August 2004, we began the transition of several engineering and operations functions to China.
o In January 2005, we hired a new vice president of Sales and Marketing, Dean Bogues. Dean brings a great deal of sales and operational experience from companies like AMD, Dell, and APC to the team.
o In January 2005, our powder manufacturing facility in Suzhou China began mass producing Saphion(R) I powder. Our pack assembly facility began producing U-Charge Power Systems and components for Segway batteries and we established our engineering team in Shanghai.
o In April 2005, we hired a president of our Asian-Pacific operations, JR Hwang. JR has 30+ years of experience in materials and chemicals, with a history of success in the Asia-Pacific region.
o In May 2005, we announced the industry's first phosphate-based lithium-ion power cell. This cell is based on our Saphion(R) technology and offers a safe upgrade path for portable appliances and hybrid and electric vehicles that are currently using nickel-metal-hydride and nickel-cadmium technologies.
SAPHION(R): THE NEXT-GENERATION IN LITHIUM-ION TECHNOLOGY
The driving force behind the introduction of lithium-ion technology to the rechargeable battery industry was consumer demand for high energy, small battery solutions to power portable electronic devices. Lithium-ion cobalt-oxide technology was developed to meet that demand and represented a significant advancement in battery technology. Today, however, the challenge is to find ways to maintain costs and meet safety and environmental concerns, while increasing energy density. Additionally, as a result of the safety concerns associated with producing traditional Lithium-ion cobalt-oxide technology in large-format applications, many markets today remain served by older technologies, such as lead-acid, nickel cadmium, and nickel metal hydride, which offer low energy density and significant maintenance costs.
We believe our Saphion(R) technology, which utilizes a natural, phosphate-based cathode in place of other less stable and more costly materials, addresses the current challenges facing the rechargeable battery industry and provides us with several competitive advantages. Key attributes of our Saphion(R) technology include:
o INCREASED SAFETY. We believe that our Saphion(R) technology significantly reduces the safety risks associated with oxide based lithium-ion technologies. Our Saphion(R) technology utilizes less lithium than other lithium-ion technologies. The unique chemical properties of phosphates render them incombustible if mishandled during charging or discharging. As a result, we believe Saphion(R) technology is more stable under overcharge or short circuit conditions than existing lithium-ion technology and has the ability to withstand higher temperatures and electrical stress. The thermal and chemical stability inherent in our Saphion(R) technology enables the creation of large, high energy density lithium-ion solutions.
o PERFORMANCE ADVANTAGES. We believe Saphion(R) technology offers several performance advantages over the competing battery chemistries of lead-acid, nickel cadmium, nickel metal-hydride and traditional lithium-ion technologies, including high rate capability, long cycle life, long shelf life, and lower total cost of ownership.
o HIGH ENERGY DENSITY. In its large format application, our Saphion(R) technology exhibits an energy density which exceeds other battery chemistries utilized in this market such as lead-acid, nickel-metal hydride and nickel cadmium.
o HIGH RATE CAPABILITY. In the power cell construction, our Saphion(R) technology offers an exceptional rate capability with sustained 10 to 15C discharges and low impedance of less than 20mOhms. These two characteristics result in a cell that provides larger bursts of power while generating less heat than energy cells.
o INCREASED CYCLE LIFE. Current testing of Saphion(R) technology has yielded cycle life of 2000 cycles at 23(degree)C to 70% of the battery's initial capacity, resulting in a longer life span.
o NO MEMORY EFFECT AND MAINTENANCE FREE. Saphion(R) technology does not exhibit the "memory effect" of nickel cadmium and nickel metal-hydride solutions and is maintenance free.
o LOWER COST. The phosphate material used in our Saphion(R) technology is less expensive than the cobalt-oxide material used in competing lithium-ion technologies. As a result, we believe that as demand increases for our batteries, resulting in larger production volumes, we will be able to lower material costs. Finally, the lower maintenance costs, long cycle life and long service life associated with Saphion(R) technology, lead to a lower total cost of ownership in numerous applications.
o FLEXIBILITY. Due to the stability of Saphion(R) technology, it can be manufactured to fit small as well as large applications. Small applications include those utilized in the portable device applications, while large applications include high energy, high power applications such as back-up power systems and vehicles. Additionally, Saphion(R) technology is available in both a polymer and cylindrical construction. In the future, we plan to offer it in a prismatic construction as well.
o ENVIRONMENTAL FRIENDLINESS. Rechargeable batteries that contain nickel-metal-hydride, nickel-cadmium, lead-acid, or other toxic metals raise environmental concerns. Saphion(R) technology incorporates a natural, environmentally friendly, phosphate-based cathode material, and does not have the same disposal issues as other types of batteries.
COMPETITIVE STRENGTHS
Competition in the battery industry is intense. In the rechargeable battery market, the principal competitive technologies currently marketed are lead-acid, nickel-cadmium, nickel-metal-hydride, liquid lithium-ion and lithium-ion polymer batteries.
The industry consists of major domestic and international companies, which have substantial financial, technical, marketing, sales, manufacturing, distribution and other resources available to them. Our primary competitors who have announced availability of either lithium-ion or other competing rechargeable battery products include Sony, Panasonic, Saft, and EOne Moli among others.
The performance characteristics of lithium-ion batteries, in particular, have consistently improved over time as the market leaders have matured the technology. Other contenders have recently emerged with a primary focus on price competition. In addition, a number of companies are undertaking research in other rechargeable battery technologies, including work on lithium-ion phosphate technology. Nevertheless, we are continually evolving our technology to meet these and other competitive threats.
We believe that we have important technological advantages over our competitors in terms of our ability to compete in the rechargeable battery market. We believe that our phosphate battery chemistry, construction and
manufacturing processes enable us to serve a wide range of markets that do not currently use lithium-ion batteries. We believe that our next-generation Saphion(R) technology will provide additional advantages in the areas of safety, cost, size and energy density relative to competing products.
Valence is uniquely positioned for growth due to the following:
o LEADING TECHNOLOGY. Our phosphate-based Saphion(R) lithium-ion technology offers many performance advantages over competing battery technologies. We believe the safety advantages inherent to Saphion(R) technology allow for the creation of large format lithium-ion energy systems. As the first company in the battery industry to commercialize phosphates, we believe we have a significant advantage in terms of time to market as well as chemistry and manufacturing expertise..
o NEW MARKET OPPORTUNITIES. We believe that Saphion(R) technology enables the production of high-energy density, large-format batteries without the safety concerns presented by oxide based lithium-ion batteries. Consequently, we believe that Saphion technology energy and power systems can be designed in a wide variety of products in markets not served by current lithium-ion technology. And, with our new Saphion(R) power cells, we now offer the only safe, large-format alternative to nickel-metal-hydride and nickel-cadmium batteries. We intend to be able to expand the market opportunity for lithium-ion by designing our Saphion technology into a wide variety of products for the telecommunications, utility, motive power and vehicular markets.
o REFINED STRATEGIC FOCUS. We have transitioned to a company capitalizing on the results of our research and development by strengthening our sales and marketing efforts. We are expanding our vision to become an energy solutions company, and plan to enter markets previously not served by lithium-ion solutions. Additionally, we have established a low cost manufacturing plan, which includes leveraging internal capabilities as well as contract manufacturing partnerships in low cost regions..
PRODUCTS
THE N-CHARGE(TM) POWER SYSTEM FAMILY
The N-Charge(TM) Power System Family includes two generations of a universal, external battery for mobile devices featuring our Saphion(R) technology. It is a stand-alone tool that provides easy-to-use, anytime, anywhere power for a wide variety of portable electronic devices. Our N-Charge(TM) Power System is available in commercial quantities and is currently offered through major retailers, resellers and tier-one companies, as well as through our own direct sales organization. We offer two generations of the N-Charge(TM) Power System, with the following specifications:
N-Charge(TM) Power System I
Feature Model VNC-130 Model VNC-65 High power port voltage 15.3-24 V DC 15.3-24 V DC Low power port voltage 5-12 V DC 5-12 V DC Capacity 10 Ah 5 Ah Energy 120-130 Wh 60-65 Wh Charge time (typical) 3-4 hours 2-3hours Thickness 13 mm 13 mm Length 300 mm 300 mm Width 230 mm 230 mm Weight 1.35 kg .866 kg Cycle Life > 600 to 70% capacity > 600 to 70% capacity
The K-Charge(TM) Power System
The K-Charge(TM) Power System is a large-format energy storage system designed for the telecommunications and utility industries. Our K-Charge(TM) Power System, based on Saphion(R) technology, has been evaluated by a number of customers and is currently being marketed into telecommunication back-up systems, marine buoys and alternative energy markets.
Our K-Charge(TM) Power System has the following specifications:
Operating Voltage 48V
Energy 2.6 KWH (2.3 KWH WITH EXSITING INVENTORY) Cycle Life > 2000 Cycles (80% Depth of Discharge) Operating Temperature -20~60(degree)C (-4~140 (degree)(F) Dimensions 546mm x 295mm x 87.4mm (21.5in. x 11.61in. x 3.44in.) Weight 30.4 Kg (67 Lb.)
The U-Charge(TM) Power System
The U-Charge(TM) Power System is a family of products based on Saphion(R) technology and designed to be a direct replacement for standard-sized lead-acid batteries. The batteries in this line of 12-volt energy storage systems offer twice the run-time and a third less weight than lead-acid, expanded calendar life, and greater cycle life with full depth of discharge, resulting in significantly lower total costs of ownership. U-Charge(TM) Power Systems have been designed for applications, such as electric vehicles, wheelchairs, scooters and other motive devices.
Our U-Charge(TM) Power Systems have the following specifications:
SALES AND MARKETING
At June 3, 2005 we had a sales and marketing team consisting of seventeen persons, headed up by our Vice President of Sales and Marketing. Our sales and marketing staff are located in Chicago, Illinois; Raleigh, North Carolina; Atlanta, Georgia; Mallusk, Northern Ireland, Shanghai, China and Austin, Texas.
Our N-Charge(TM) Power Systems are marketed and sold to national retailers, distributors and value-added resellers, and directly by our sales force and through our Web site. Sales are generally made by standard purchase order. Our K-Charge(TM) Power System was engineered specifically for large-format applications such as those required by the telecommunications and utility markets. Our U-Charge(TM) Power System is customized to a particular customer's application and can require a significant amount of attention and commitment, including potentially capital outlays, by prospective customers. We anticipate sales will typically be made through separately negotiated supply agreements, rather than standard purchase orders. The client evaluation and approval process is generally between six and twenty-four months. Our K-Charge(TM) and U-Charge(TM) Power Systems are expected to be sold in both standard and custom configurations. In addition, we expect to design and sell custom battery systems based on our Saphion(R) technology. We provide pack level design and engineering services to assist the customer in configuring a product that meets its needs.
Sales of our products are typically denominated in United States dollars. Consequently, our sales historically have not been subject to currency fluctuation risk.
MANUFACTURING
During fiscal 2004 we closed our Northern Ireland manufacturing facility and now rely on contracts with third-party manufacturers for all of our cell manufacturing requirements. Our base Saphion(R) battery cathode powder is now manufactured in one of our Wholly Foreign Owned Enterprise's (WFOE's) in Suzhou, China. Polymer batteries are manufactured for us by Amperex Technology, Ltd. (ATL) under a manufacturing contract, cylindrical batteries are manufactured for us by ATL and Pihsiang Energy Technology Co., Ltd. (PHET), formerly Pacific Energytech Co., Ltd, or PETC. Our products are assembled into complete systems using both contract manufacturers in Taiwan and the US or our own assembly facilities in Suzhou, China.. We have multi-year contracts with each of our manufacturing sources. However, we believe there are multiple manufacturers of batteries that are capable of manufacturing our products to our quality and cost specifications if we require changing or expanding our manufacturing relationships. With these relationships we believe that we will have sufficient capacity to meet or exceed the expected demand in fiscal 2006.
RESEARCH AND PRODUCT DEVELOPMENT
We conduct materials research and development at our Henderson, Nevada and Oxford, England facilities and product development at our Shanghai and Suzhou, China facilities. Our battery research and development group develops and improves the existing technology, materials and processing methods and develops the next generation of our battery technology. Our areas of expertise include: chemical engineering; process control; safety; and anode, cathode and electrolyte chemistry and physics; polymer and radiation chemistries; thin film technologies; coating technologies; and analytical chemistry; and material science. Our research and development efforts over the past year and ongoing have focused on three areas:
o CONTINUING DEVELOPMENT OF SAPHION(R) TECHNOLOGY IN MULTIPLE CONSTRUCTIONS. Our first generation Saphion(R) material was successfully scaled in cylindrical construction in fiscal 2004. Throughout fiscal 2005 our development team focused on increasing capacity of the energy cell, offering other constructions such as a large prismatic cell and designing the power cell. In late fiscal 2005 our team implemented a product change which increased the capacity of the energy cell. We have also nearly completed the prismatic cell which is targeted for launch this summer and officially launched the industriy's first commercially available phosphate based power cell in May of 2005.
o DEVELOPMENT OF SECOND GENERATION OF SAPHION(R) TECHNOLOGY. We are currently working on the development of an energy cylindrical cell and a power cylindrical cell using our second generation Saphion(R) technology. The applications for the energy cell include electric vehicles, motive applications, notebook computers, and consumer electronics. The applications for the power cell include consumer appliances, such as power tools, and hybrid electric vehicles. The second generation energy cells are expected to ramp over the next few quarters, while the power cells are still under development. The second generation Saphion(R) technology is expected to deliver similar safety attributes with greater energy and power density capabilities than our first generation Saphion(R) technology and a cycle life similar to existing lithium-ion technologies
o LARGE FORMAT APPLICATIONS FOR SAPHION(R) TECHNOLOGY. The benefits of Saphion(R) technology have led to interest across a broad spectrum of industries from potential customers for large format solutions. In large format applications, Saphion(R) technology provides kilowatts of safe, lithium-ion power that is long-lasting, reliable and maintenance free. It offers excellent cycle life and run-time, and as a result has attracted customers such as EV manufacturers, AEP, Tyco and Graham Field, who are currently evaluating the product.
We intend to continuously improve our technology, and are currently focusing on improving the energy density of our products. We are working to advance these improvements into production. We also are working with new materials to make further improvements to the performance of our products. We believe the safety features of our technology and the ongoing improvement in the performance of our batteries will allow us to maintain our competitive advantage.
CUSTOMERS
Over the last three fiscal years, a limited number of our customers have accounted for a significant portion of our net revenues. During fiscal 2005, three customers, D&H Distributors, PC Connection, and Best Buy accounted for 46% of our revenue. During fiscal 2004, sales to Best Buy's accounted for 30% of our total revenues. During fiscal 2003, two customers, Alliant Techsystems Inc. and Pabion Corporation, Ltd., 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. Currently, we do not have any long-term agreements with any of our customers.
INTELLECTUAL PROPERTY
Our ability to compete effectively depends in part on our ability to maintain the proprietary nature of our technology and manufacturing processes through a combination of patent and trade secret protection, non-disclosure agreements and cross-licensing agreements.
We rely on patent protection for certain designs and products. We hold approximately 182 United States patents, which have expiration dates through 2023 and have about 51 patent applications pending in the United States. We continually prepare new patent applications for filing in the United States. We also actively pursue patent protection in certain foreign countries.
In addition to potential patent protection, we rely on the laws of unfair competition and trade secrets to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information through agreements with customers and suppliers, proprietary information agreements with employees and consultants and other security measures.
REGULATIONS
Before we commercially introduce our batteries into certain markets, we may be required, or may decide to obtain approval of our materials and/or products from one or more of the organizations engaged in regulating
product safety. These approvals could require significant time and resources from our technical staff and, if redesign were necessary, could result in a delay in the introduction of our products in those markets.
The United States Department of Transportation, or DOT, and the International Air Transport Association, or IATA, regulate the shipment of hazardous materials. The United Nations Committee of Experts for the Transportation of Dangerous Goods has adopted amendments to the international regulations for "lithium equivalency" tests to determine the aggregate lithium content of lithium ion polymer batteries. In addition, IATA has adopted special size limitations for applying exemptions to these batteries. Under IATA, our N-Charge(TM) Power System (65) and N-Charge(TM) Power System II are exempt from a class 9 designation for transportation. Our N-Charge(TM) Power System (130), The 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. We comply with all safety-packaging requirements worldwide and 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.
The Nevada Occupational Safety and Health Administration and other regulatory agencies have jurisdiction over the operation of our Henderson, Nevada facility. Because of the risks generally associated with the use of flammable solvents and other hazardous materials, we expect rigorous enforcement of applicable health and safety regulations. In addition, we currently are regulated by the State Fire Marshall's office and local Fire Departments. Frequent audits or changes in their regulations may cause unforeseen delays and require significant time and resources from our technical staff.
The Clark County Air Pollution Control District has jurisdiction over our Henderson, Nevada facility and annual audits and changes in regulations could impact current permits affecting production or time constraints placed upon personnel.
Federal, state and local regulations impose various environmental controls on the storage, use and disposal of certain chemicals and metals used in the manufacture of lithium-ion batteries. There are similar national, provincial and local regulations in China. Although we believe that our activities conform to current environmental regulations, any changes in these regulations may impose costly equipment or other requirements. Our failure to adequately control the discharge of hazardous wastes also may subject us to future liabilities.
HUMAN RESOURCES
As of June 3, 2005, we had a total of 86 regular full-time employees in the United States at our Austin, Texas headquarters and our Henderson, Nevada research and development facility. We have 40 total employees in the areas of administration, sales, legal, marketing, finance, management information systems, purchasing, quality control and shipping & receiving. We had 29 total employees in the areas of engineering, facilities maintenance and environmental health & safety. We had 17 total employees in the areas of research & development and product development; product development includes mixing, coating and assembly. As of June 3, 2005, our Cayman subsidiary had 8 regular full time employees in the areas of engineering and sales located in the United Kingdom. In addition, as of June 3, 2005, our China operations, consisting of two Wholly-owned Foreign Entities, had 206 regular full-time employees and 37 persons working through Foreign Enterprise Services Co. (FESCO). None of our employees are covered by a collective bargaining agreement, and we consider our relations with our employees to be good.
WEBSITE AVAILABILITY OF OUR REPORTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
We maintain a website with the address www.valence.com. We are not including the information contained on our website as a part of, or incorporating it by reference into, this annual report on Form 10-K. We make available free of charge through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file that material with, or furnish such material to, the Securities and Exchange Commission.
ITEM 2.
ITEM 2. PROPERTIES
Our corporate offices are located in a leased facility in Austin, Texas. We also rent a research and development facility in Henderson, Nevada under a lease agreement. Our two Wholly-owned Foreign Entities in China lease three separate facilities, a 35,000 square meter powder manufacturing facility in Suzhou, China, a 58,000 square meter product assembly facility in Suzhou, China and a 7,500 square meter research and development facility in Shanghai, China.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are subject to various claims and litigation in the normal course of business. In our opinion, all pending legal matters are either covered by insurance or, if not insured, will not have a material adverse impact on our consolidated financial statements.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is quoted on the Nasdaq SmallCap Market under the symbol "VLNC." The following table sets forth, for the periods indicated, the high and low sale prices of our common stock, as reported by published financial sources:
On June 3, 2005, the last reported sale price of our common shares on the Nasdaq SmallCap Market was $3.02 per share. On that date, we had 89,152,479 shares of common stock outstanding held of record.
We have never declared or paid any cash dividends on our common stock and do not anticipate paying cash dividends in the foreseeable future.
The following table includes, as of March 31, 2005, information regarding common stock authorized for issuance under our equity compensation plans:
RECENT SALES OF UNREGISTERED SECURITIES
On September 30, 2002, the Company drew down $5.0 million from its equity line financing commitment from Berg & Berg and issued approximately 9.5 million shares of the Company's common stock.
On November 27, 2002, the Company drew down $5.0 million from its equity line financing commitment from Berg & Berg and issued approximately 4.4 million shares of the Company's common stock.
On February 5, 2003, we drew down $5 million from our equity financing commitment with Berg & Berg Enterprises, LLC, an affiliate of Carl Berg, a director and stockholder of ours. Under the terms of the equity commitment Valence issued to Berg & Berg 3,190,342 shares of restricted Common Stock, in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act, at a 15% discount to the average closing price of the stock for the five days prior to the purchase date or approximately $1.56 per share.
On March 31, 2003, we drew down an additional $5 million from our equity financing commitment with Berg & Berg and issued to Berg & Berg 2,973,589 shares of our restricted common stock in a private placement transaction exempt from registration pursuant to Section 4(2) of the Securities Act. Berg & Berg purchased these shares at a 15% discount to the average closing price of the stock for the five days prior to the purchase date or approximately $1.68 per share.
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.
On December 22, 2003, the Company drew down $5 million from its equity line of credit with Berg & Berg. The proceeds will be used to fund corporate operating needs and working capital. Under the terms of the equity line of credit, the Company issued to Berg & Berg 1,525,506 shares of its restricted common stock at a discount of 15% to the average closing price of common stock for the last five days prior to the purchase date, or approximately $3.28 per share.
On March 5, 2004, we drew down $3 million from a commitment offered by Berg & Berg. The proceeds were used to fund corporate operating needs and working capital. Under the terms of the commitment, we issued Berg & Berg 594,766 shares at the then-current market value of $5.04 per share, determined by the average of the five prior days closing bid prices.
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, 910,746 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 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.
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.
On November 30, 2004, the Company entered into a securities purchase agreement and subsequently raised $7.5 million (net proceeds of $7.0 million) through the private placement of common stock. The Company sold 2,475,248 shares of its common stock under the agreement pursuant to a registration statement filed with the Securities and Exchange Commission on August 20, 2001.
On November 30, 2004, the Company entered into an amendment and exchange agreement to exchange all of the outstanding 861 shares of the Company's Series C Convertible Preferred Stock, representing $8.6 million of principal. The Series C Convertible Preferred Stock was exchanged for 431 shares of Series C-1 Convertible Preferred Stock, with a stated value of $4.3 million, and 430 shares of Series C-2 Convertible Preferred Stock, with a stated value of $4.3 million. Under the terms of the Company's new Series C-1 Convertible Preferred Stock and Series C-2 Convertible Preferred Stock, the preferred stock is convertible into common stock at $4.00 per share, carry a 2% annual dividend rate, payable quarterly in cash or shares of common stock, and mature on December 15, 2005. The new series of preferred stock are identical in all respects except that the holder of the Series C-2 Convertible Preferred Stock will have the right to require the Company to redeem the Series C-2 Convertible Preferred Stock at any time during the 30 days following June 15, 2005 and September 15, 2005. 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.
On February 14, 2005, 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, 981,033 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 March 15, 2005, 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, 1,055,594 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 April 27, 2005, 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, 1,251,042 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 26, 2005, 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, 645,577 shares of its restricted common stock at the average closing bid price of the stock for the five days prior to the purchase date.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
This section presents selected historical financial data of Valence Technology, Inc. You should read carefully the consolidated financial statements included in this report, including the notes to the consolidated financial statements. We derived the statement of operations data for the years ended March 31, 2003, 2004 and 2005 and balance sheet data as of March 31, 2004 and 2005 from the audited consolidated financial statements in this report. We derived the statement of operations data for the years ended March 31, 2001 and 2002 and the balance sheet data as of March 31, 2001, 2002, and 2003 from audited financial statements that are not included in this report.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
THIS REPORT CONTAINS STATEMENTS THAT CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 21E OF THE EXCHANGE ACT AND SECTION 27A OF THE SECURITIES ACT. THE WORDS "EXPECT," "ESTIMATE," "ANTICIPATE," "PREDICT," "BELIEVE" AND SIMILAR EXPRESSIONS AND VARIATIONS THEREOF ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS APPEAR IN A NUMBER OF PLACES IN THIS FILING AND INCLUDE STATEMENTS REGARDING THE INTENT, BELIEF OR CURRENT EXPECTATIONS OF VALENCE TECHNOLOGY, INC. (THE "COMPANY," "VALENCE," "WE," OR "US"), OUR DIRECTORS OR OFFICERS WITH RESPECT TO, AMONG OTHER THINGS (A) TRENDS AFFECTING OUR FINANCIAL CONDITION OR RESULTS OF OPERATIONS, (B) OUR PRODUCT DEVELOPMENT STRATEGIES, (C) TRENDS AFFECTING OUR MANUFACTURING CAPABILITIES, (D) TRENDS AFFECTING THE COMMERCIAL ACCEPTABILITY AND SALES OF OUR PRODUCTS AND,(E) OUR BUSINESS AND GROWTH STRATEGIES. OUR STOCKHOLDERS ARE CAUTIONED NOT TO PUT UNDUE RELIANCE ON SUCH FORWARD-LOOKING STATEMENTS. SUCH FORWARD-LOOKING STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE PROJECTED IN THIS REPORT, FOR THE REASONS, AMONG OTHERS, DISCUSSED IN THE SECTIONS -- "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," AND "RISK FACTORS." THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR FINANCIAL STATEMENTS AND RELATED NOTES, WHICH ARE PART OF THIS REPORT OR INCORPORATED BY REFERENCE TO OUR REPORTS FILED WITH THE COMMISSION. WE UNDERTAKE NO OBLIGATION TO PUBLICLY REVISE THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES THAT ARISE AFTER THE DATE HEREOF.
OVERVIEW
We have commercialized the first phosphate-based lithium-ion technology and have brought to market our initial 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 experience of our management team and the significant market opportunity available to us. The introduction of lithium-ion technology to the market was the result of consumer demand for high-energy, small battery solutions to power portable electronic devices. The battery industry, consequently, focused on high-energy solutions at the expense of safety. Additionally, due to safety concerns, lithium-ion technology has been limited in adoption to small format applications, such as notebook computers, cell phones, and personal digital assistant devices. Our Saphion(R) technology, a phosphate based cathode material, addresses the need for a safe lithium-ion solution, especially in large-format applications.
Our business plan and strategy focus on the generation of revenue from product sales, 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's) in China. These WFOE's initiated operations in late 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 end-users' products in both the large format and small format markets. In addition, we will seek to expand the fields of use of our Saphion(R) technology through the licensing of our intellectual property related to our battery chemistries and manufacturing processes.
To date, we have achieved the following successes in implementing our business plan:
o Proven the feasibility of our technology;
o Launched new Saphion(R) technology based products, including our N-Charge(TM) Power System family and our K-Charge(TM) Power System, 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 and serve emerging motive applications;
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 and sold 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(TM) 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. Tyco has initiated field trials of the K-Charge(TM) Power System with three separate telecommunications companies;
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. Product development is ongoing with Graham-Field and a product launch is expected during fiscal 2006;
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. Production of the Segway battery packs began in March, 2005 and they are currently available through Segway's distribution channel;
o Successfully launched our second generation N-Charge(TM) Power System;
o Announced an order by UQM Technologies, Inc. for our U-Charge(TM) Power System for U.S. Air Force electric truck applications. Fulfillment of this order is expected during the summer of 2005; and
o Established two WFOE's in China to serve as our powder production and assembly facilities.
o Launched a phosphate-based Lithium-ion power cell. Batteries designed with power cells can be discharged and charged more quickly than batteries designed with energy cells. This makes them ideal for applications that require powerful bursts rather than slow discharges of energy, such as portable appliances and future generations of hybrid and electric vehicles. Our new Saphion(R) power cell offers significant cycling, weight and longevity benefits over Nickel-Metal-Hydride (NiMH) and Nickel Cadmium (NiCad) battery technologies.
In fiscal 2005 we were able to achieve several important goals in support of our business strategy. Total revenue grew by 13% as compared to the prior year to $10.7 million with battery and system sales growing over 20%. We achieved improvement of our negative gross margin and expanded our development and channel launch of Saphion(R)-based products. We continued our efforts to transition our manufacturing and other operations to China through the establishment and commencement of initial operations of two wholly-owned subsidiaries in Suzhou, China.
Valence's business headquarters is located in Austin, Texas. Our materials research and development centers are in Henderson, Nevada and Oxford, England. Our European sales and OEM manufacturing support center is in
Mallusk, Northern Ireland. Our manufacturing and product development centers are in Suzhou and Shanghai, China.
BASIS OF PRESENTATION, CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our consolidated financial statements in conformity with generally accepted accounting principles in the United States. 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 the Notes to Consolidated Financial Statements, Note 3, Summary of Significant Accounting Policies. The following further describes the methods and assumptions we use in our critical accounting policies and estimates:
REVENUE RECOGNITION: We generate revenues from sales of products including batteries and battery systems, and from licensing fees and royalties per technology license agreements. Product sales are recognized when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, seller's price to the buyer is fixed and determinable, and collectibility is reasonably assured. Product shipments that are not recognized as revenue during the period shipped, primarily product shipments to resellers that are subject to right of return, are recorded as deferred revenue and reflected as a liability on our balance sheet. For reseller shipments where revenue recognition is deferred, we record revenue based upon the reseller-supplied reporting of sales to their end customers or their inventory reporting. For direct customers, we estimate a return rate percentage based upon our historical experience. We review this estimate on a quarterly basis. From time to time we provide sales incentives in the form of rebates or other price adjustments; these are recorded as reductions to revenue as incurred. Licensing fees are recognized as revenue upon completion of an executed agreement and delivery of licensed information, if there are no significant remaining vendor obligations and collection of the related receivable is reasonably assured. Royalty revenues are recognized upon licensee revenue reporting and when collectibility is reasonably assured.
IMPAIRMENT OF LONG-LIVED ASSETS: We perform a review of long-lived tangible and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of these assets is measured by comparison of their carrying amounts to future undiscounted cash flows that the assets are expected to generate. If long-lived assets are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds its fair value and is recorded in the period the determination was 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 Consolidated Financial Statements, Note 4, 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 consolidated financial statements. Costs associated with exit or disposal activities are included in restructuring charges.
CONTRACT SETTLEMENT CHARGE. Since 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 former manufacturing facility in Mallusk, Northern Ireland, totaling (pound)9.0 million. Under certain circumstances, INI had the right to reclaim a portion of these grants and had a security interest in the facility's land, building, and equipment. On December 21, 2004, we entered into a settlement agreement with INI pursuant to which INI agreed to release us
of all outstanding claims and other obligations owing to INI in connection with grants previously provided. Under the terms of the settlement agreement we agreed to pay INI (pound)3 million consisting of a (pound)2 million payment in cash and a (pound)1 million payment in common stock. On December 6, 2004, we funded an initial payment of (pound)150,000 and used the net proceeds from the sale of our Northern Ireland manufacturing facility to fund an additional (pound)1.54 million. During Q4 of fiscal 2005, we funded the remaining (pound)307,000 ($589,000) related to the cash portion of the settlement from the net proceeds from equipment sales. In addition, in order to fund the (pound)1 million common stock payment we issued 539,416 shares of common stock, equivalent to $3.60 per share. In connection with this final settlement we recorded an additional charge of $957,000 during the third quarter of fiscal 2005. See Notes to Consolidated Financial Statements, Note 12, Settlement Agreement.
JOINT VENTURE. On July 9, 2003, Baoding Fengfan - Valence Battery Company, a joint venture between us and Fengfan Group, Ltd., or 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, right to name the majority of the joint venture's board of directors and 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. However, during the first quarter of fiscal 2005, a dispute arose between us and our joint venture partner, resulting in a loss of control over the joint venture and our initiation of an action to enforce our rights under the joint venture agreement and, commencing with that quarter we accounted for our investment in the joint venture under the cost method with no further recognition of assets, liabilities, operating results, and cash flows.
On November 17, 2004, we entered into a settlement agreement, or the JV Settlement Agreement, with Baoding Fengfan Group Limited Liability Company, Ltd., or Fengfan, and Baoding Fengfan - Valence Battery Company, Ltd., or the JV Company. Under the terms of the JV Settlement Agreement, the parties agreed to liquidate and dissolve the JV Company, terminate the JV Company contracts and fully settle any and all remaining obligations among the parties. We agreed to make compensation payments to the JV Company and to Fengfan totaling $224,417 and to make equipment purchases from the JV Company totaling $275,583. To date, we have made compensation payments of $157,092 and completed all of the equipment purchases. The $67,325 final compensation payment will be made upon final dissolution of the JV legal entity by Fengfan. We recorded a contract settlement charge of $224,217 in the third quarter of fiscal 2005 for the compensation payments and capitalized equipment purchases as the payments were made.
RESULTS OF OPERATIONS
FISCAL YEARS ENDED MARCH 31, 2005 (FISCAL 2005), MARCH 31, 2004 (FISCAL 2004) AND MARCH 31, 2003 (FISCAL 2003)
The following table summarizes the results of our operations for the past three fiscal years:
REVENUES AND GROSS MARGIN
BATTERY AND SYSTEM SALES: Battery and system sales totaled $10.275 million for the year ended March 31, 2005, as compared to $8.483 million for the year ended March 31, 2004, and $2.432 for the year ended March 31, 2003. The year over year increases in revenue during both fiscal 2005 and 2004 were primarily driven by the establishment and growth of our retail, reseller and education channels for our N-Charge(TM) Power System product. We achieved the largest growth in fiscal 2005 sales in education channels accounting for almost $2 million of our total product sales. Product shipments to resellers that are subject to right of return or monies received for exclusivity or future obligations are recorded on the balance sheet as deferred revenue. We had $1.240 in deferred revenue on our balance sheet at March 31, 2005 as compared to $1.593 million on March 31, 2004. We expect sales of the N-Charge(TM) Power System to continue to grow moderately in fiscal 2006. We launched our large format products in late 2004 with the K-Charge system and U-Charge family during fiscal 2005. In fiscal 2006, we plan to launch our long range battery pack for use in Segway LLC's human transporter as well as further expansions of our U-Charge family of products. Fiscal 2005 was largely taken up by customer testing and evaluation of our K-Charge and U-Charge products and, as a consequence, we did not record material sales of large form at products during the fiscal year. We anticipate that many of these customers will complete their evaluation in fiscal 2006, at which time customers will begin to make final purchase decisions..
LICENSING AND ROYALTY REVENUE: For fiscal years 2003 through 2005, license and royalty revenue was primarily derived from license fees and royalties payments from Amperex Technology Limited, or ATL, including a one time license fee payment of $500,000 in fiscal 2004 and on-going royalty payments as sales are made by ATL using our technology. We expect to continue to pursue a licensing strategy as our Saphion(R) technology receives greater market acceptance.
GROSS PROFIT (LOSS): Gross profit (loss) as a percentage of revenue, or gross margin, was (53%) for the year ended March 31, 2005 as compared to gross margin of (69%) for the fiscal year ended March 31, 2004 and gross margin of (330%) for the year ended March 31, 2003. 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. Fiscal year 2005 margin improvements were offset by inventory valuation adjustments related to valuation of our work in process cell inventory and lower of cost or market tests for our early launch and US sourced large format products. We have successfully transitioned our battery manufacturing and N-Charge(TM) product assembly operations to contract manufacturers in Asia. As of April 2005, we completed the transition of our powder manufacturing to our WFOEs in Suzhou, China. We are transitioning additional manufacturing including pack assembly to our WFOE's in Suzhou, China in fiscal 2006. We expect cost of sales to continue to decrease during fiscal 2006 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 our operating expenses during each of the past three fiscal years:
We continued to focus on our operating expense management throughout fiscal 2005. Operating expenses as a percentage of revenue decreased to 207% in fiscal 2005 versus 473% in fiscal 2004 and 1004% in fiscal 2003. The decrease is the result of our focus on expense reductions during fiscal 2005, our final settlement with the INI, the gain on the sale of our Mallusk, Northern Ireland facility, and reduced impairment and depreciation expenses related to our assets as we finalized our transition plans. The decrease in operating expense as a percent of revenue was offset by increases in general and administrative expenses related to compliance with the Sarbanes-Oxley Act of 2002 and our relocation of manufacturing and development operations to China as well as settlements of other contracts. Of our operating expenses in fiscal 2005, 2004 and 2003, $2.1 million, $17.6 million and $258,000, respectively, related to the changes in our business plan and subsequent closure of our Northern Ireland facility and the sale of our Henderson, Nevada facility, representing 20%, 187% and 10% of revenue in each of these fiscal years. We expect to continue to improve our operating expenses as a percentage of sales during fiscal 2006 through the transfer of additional operations to Asia and continued revenue growth.
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 totaled $7.682 million in fiscal 2005, $8.638 million in fiscal 2004, and $9.293 million in fiscal 2003. We achieved year over year decreases in research and development in fiscal 2005 and fiscal 2004 of 11% and 7%, respectively. Decreases in research and development expenses were the result of cessation of process development work in our Northern Ireland facility and
reductions in research headcount, temporary staff, and consulting expenses and material costs in our Henderson, Nevada facility. These decreases were offset by increases in development spending to expand the Saphion(R) family of products. We expect to continue to achieve reductions in research and product development expenses as we improve our product development efficiency and transition portions of our development efforts to Asia.
MARKETING. Marketing expenses consist primarily of costs related to sales and marketing personnel, public relations and promotional materials. After expanding our marketing expenses in fiscal 2004 to increase staffing, advertising and promotions to support brand awareness and expansion of sales channels for our products, we eliminated the lower performing of these programs and achieved 12% decrease in marketing expenses in fiscal 2005 as compared to fiscal 2004 while achieving over 20% growth in product revenue. Specifically, in fiscal 2005, we reduced expenses related to our N-Charge Power system lead generation and media advertising as well as reduced consulting related to the European market development. We expect marketing expenses to grow modestly in fiscal 2006 as we continue to expand and develop our channels, grow our worldwide sales team, 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 $12.933 million in fiscal 2005 represented an increase of $1.518, or 13%, over general and administrative expenses in fiscal 2004. Fiscal year 2004 general and administrative expenses of $11.415 million represented a 13% increase over fiscal 2003 expenses. The year over year increases in general and administrative expense in fiscal 2005 and fiscal 2004 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: An impairment charge of $87,000 was recorded during the second quarter of fiscal 2005. 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 would 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 estimate that there will be no future cash flows from these assets.
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 and consequently determined that the carrying value of certain manufacturing assets at our Northern Ireland facility exceed expected future cash flows from these assets. Additionally, we determined that the future cash flows expected to be generated from certain technology we acquired from Telcordia 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%.
During the fourth quarter of fiscal 2003, we recorded an impairment charge of $258,000 on our property in Henderson, Nevada related to the planned sale of this facility. We estimated that the future cash flows expected from the sale of this facility were less than the asset carrying value and adjusted the assets to their fair value accordingly.
CONTRACT SETTLEMENT CHARGES:
During fiscal 2005, we recorded contract settlement charges totaling $1.456 million:
(Dollars in thousands) FISCAL 2005 INI Settlement $ 957 Joint Venture 224 Supplier Contract Terminations 275 ------------------ Total $ 1,456 ==================
INI SETTLEMENT: Since 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 former manufacturing facility located in Mallusk, Northern Ireland, totaling (pound)9.0 million. Under certain circumstances, INI had the right to reclaim a portion of these grants and had a security interest in the facility's land, building, and equipment. On December 21, 2004, we and INI entered into a settlement agreement pursuant to which INI agreed to release us of all outstanding claims and other obligations owing to INI in connection with grants previously provided to us. Under the terms of the settlement agreement we agreed to pay INI (pound)3 million consisting of a (pound)2 million payment in cash and a (pound)1 million payment in common stock. On December 6, 2004, we funded an initial payment of (pound)150,000 and used the net proceeds from the sale of our Northern Ireland manufacturing facility to fund an additional (pound)1.54 million. During Q4 of fiscal 2005, we funded the remaining (pound)307,000 ($589,000) related to the cash portion of the settlement from the net proceeds from equipment sales. In addition, in order to fund the (pound)1 million common stock payment, we issued 539,416 shares of common stock, equivalent to $3.60 per share. In connection with this final settlement, we recorded an additional charge of $957,000 during the third quarter of fiscal 2005.
JOINT VENTURE SETTLEMENT: On November 17, 2004, we entered into a settlement agreement with Baoding Fengfan Group Limited Liability Company, Ltd., or Fengfan and Baoding Fengfan - Valence Battery Company, Ltd., or the JV Company. Under the terms of the JV Settlement Agreement, the parties agreed to liquidate and dissolve the JV Company, terminate the JV Company contracts and fully settle any and all remaining obligations among the parties. We agreed to make compensation payments to the JV Company and to Fengfan totaling approximately $224,000 and to make equipment purchases from the JV Company of approximately $276,000. To date, we have made compensation payments of $157,092 and completed all of the equipment purchases. The $67,325 final compensation payment will be made upon final dissolution of the JV legal entity by Fengfan. We recorded a contract settlement charge of $224,217 in the third quarter of fiscal 2005 for the compensation payments and capitalized equipment purchases as the payments were made.
SUPPLIER CONTRACT TERMINATIONS: During the third quarter of fiscal 2005, as a result of our relocating our core operations to China and selection of lower-cost suppliers, we terminated two supplier contracts related to producing product and manufacturing capital equipment. In settlement of these contracts, we expect to pay these suppliers termination fees which include the settlement expenses accrued in fiscal 2005 of approximately $275,000.
RESTRUCTURING CHARGE. In the third fiscal quarter of 2004, we recorded restructuring charges of $926,000 related to the closing of our Northern Ireland facility. During the third quarter of fiscal 2004, we completed the transition of our battery production from our Northern Ireland manufacturing facility to our OEM supplier. All inventory remaining at the conclusion of manufacturing operations was determined to be obsolete and unusable by any of our battery manufacturing sources. Raw materials inventory obsolescence expense of approximately $178,000 and work in process inventory obsolescence expense of approximately $517,000 were recorded as restructuring charges during the quarter ended December 31, 2003. Remaining payment obligations for factory equipment operating leases that extended beyond December 31, 2003 were approximately $231,000. These lease payment obligations provide no economic benefit to us, and contractual lease costs of approximately $231,000 were recorded as restructuring charges during the quarter ended December 31, 2003.
GAIN ON SALE OF ASSETS: Gain on sales of the facility and production and development equipment from our former Mallusk, Northern Ireland facility was $5.257 million in fiscal 2005. The majority of the gain is related to the sales of our Northern Ireland facility completed on December 22, 2004. Additionally, we determined that the equipment was not required in our manufacturing and development operations in Suzhou, China, and was sold for fair value. See Notes to Consolidated Financial Statements, Note 8, Property, Plant and Equipment.
DEPRECIATION AND AMORTIZATION, INTEREST EXPENSE, AND OTHER EXPENSES
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense totaled $884,000, $2.109 million, and $2.790 million for fiscal years ended March 31, 2005, 2004, 2003, respectively. The decrease in depreciation expenses resulted from the assets in our Northern Ireland facility being classified as held for sale and not depreciated beginning in the third quarter of fiscal 2005, the impact of the impairment charges to intellectual property and property, plant, and equipment and the impact of 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. We completed the sale of our Northern Ireland facility and paid off the mortgages on December 22, 2004. Interest expense was $4.262 million, $4.059 million and $4.172 million for the fiscal years 2005, 2004, 2003, respectively.
COST OF WARRANTS. In November 2003, we agreed to extend the time period in which a warrant holder was able to exercise its warrants. The warrant exercise period originally ended on July 27, 2003, and was extended to July 27, 2004, at which time the warrants terminated unexercised. The non-cash expense related to the exercise period extension of $181,000 was determined using the Black-Scholes model, with risk free rate of 1.04%, expected life of 0.75 years, and volatility of 69.88.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
At March 31, 2005, our principal sources of liquidity were cash and cash equivalents of $2.5 million and $6 million remaining under the $20 million backup equity funding commitment entered into in June 2004 with Mr. Carl Berg. Subsequent to March 31, 2005 we have drawn down an additional $5 million of this prior commitment. On June 13, 2005 we entered into a new $20 million funding commitment with Mr. Berg to provide funding in the form of equity or a secured loan on terms to be negotiated. This new commitment can be reduced by Mr. Berg by the amount of net proceeds received in a debt or equity transaction with a third party.
At March 31, 2005, we had $4.3 million of Series C-1 Convertible Preferred Stock and $4.3 million of Series C-2 Convertible Preferred Stock outstanding. The Series C-1 Convertible Preferred Stock and Series C-2 Convertible Preferred Stock are convertible into common stock at $4.00 per share and are redeemable on December 15, 2005 (subject to an early right of redemption in the case of the Series C-2 Convertible Preferred Stock during the 30 days following June 15, 2005 and September 15, 2005). Applicable provisions of Delaware corporate law restrict our ability to redeem the preferred stock. If we do not redeem the shares when required by their terms, the conversion price will be reduced to an amount equal to 95% of the lowest closing bid price of our common stock during the three days ending on and including the conversion date.
Our current forecast projects that these sources of liquidity will be sufficient for at least the twelve months following March 31, 2005. This forecast assumes product sales during fiscal 2006 from the N-Charge(TM) Power System and the Segway pack, which are subject to seasonal fluctuations, of between $2.5 - $5.0 million per quarter, and expect additional revenues from the sale of the U-Charge(TM) Power System into large-format applications and direct cell sale activities. We also anticipate further cash benefits from continued reductions in operating expenses and manufacturing costs, offset by small increases to capital expenditures associated with continuing efforts 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. These events could have a negative impact on our available liquidity sources during fiscal 2006.
The following table summarizes our statement of cash flows for the fiscal years ended March 31, 2005, 2004, and 2003:
Our use of cash from operations during fiscal 2005, fiscal 2004, and fiscal 2003 was $33.125 million, $27.063, and 32.484 million, respectively. The cash used for operating activities during all periods was primarily for operating losses and working capital. Cash used for operating loss in fiscal 2005 was higher than in fiscal 2004 primarily from the impact of contract settlement agreements and increases in some of the operating expenses as described above in the section titled "Operating Expenses" offset by reductions in gross profit loss.
In fiscal 2005, we received net cash from investing activities of $7.021 million. The cash provided from investing activities during fiscal 2005 related primarily to the sale of our Northern Ireland facility as described in the Notes to Consolidated Financial Statements, Note 8, Property, Plant, and Equipment, and offset by purchases of property, plant and equipment, primarily for enterprise software and manufacturing fixtures and our investment in our China subsidiaries. During fiscal 2005, the effect of deconsolidation of our China joint venture, as described in Notes to Consolidated Financial Statements, Note 19, Joint Venture, 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. During fiscal 2004, purchases of property, plant and equipment in our joint venture were offset by our sale of the Henderson, Nevada facility resulting in $3.305 million using in investing activities.
We obtained net cash from financing activities of $25.625 million and $28.357 million during the fiscal 2005 and 2004, respectively. The 2005 financing included $25.0 million from our Berg & Berg equity lines, net proceeds from the sale common stock to a third party institutional investor, and less cash used for the payoff of long-term debt related to the sale of our Northern Ireland facility.
As a result of the above, we had a net decrease in cash and cash equivalents of $192,000 during fiscal 2005, a net decrease of $3.924 during fiscal 2004, and a net increase of $5.993 million during fiscal 2003.
RELATED PARTY TRANSACTIONS
In June of 2005, we entered into a $20 million funding commitment with Mr. Carl Berg. The commitment is to provide funding in the form of equity or a secured loan on terms to be negotiated. This new commitment can be reduced by Mr. Berg by the amount of net proceeds received in a debt or equity transaction with a third party.
In June of 2004, we entered into a $20 million backup equity funding commitment with Mr. Carl Berg. 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. Since June 2004, we have received net proceeds from these transactions in an aggregate amount equal to $16.6 million. As of the date hereof, Mr. Berg has not requested that his commitment be reduced by this amount. As of March 31, 2005, there was $6 million available on this commitment and we have subsequently drawn down $5 million of this remaining committed amount.
On June 10, 2003, Berg & Berg, an affiliate of Carl Berg, a director and principal shareholder of ours, committed to provide us $10 million in fiscal 2004, increasing its total available remaining financing commitments
to $14 million ($10 million under this new financing commitment and $4 million under a then-existing commitment). Berg & Berg agreed to fund the $14 million commitments by purchasing shares of common stock from time to time as requested by us at the then-current market price. At March 31, 2005, we had fully utilized this financing commitment.
In March 2002, we obtained a $30 million equity line of credit with Berg & Berg. At December 31, 2003, the equity line was fully drawn. This commitment was approved by stockholders at our 2002 annual meeting held on August 27, 2002. In exchange for the amounts funded pursuant to this agreement, we have issued to Berg & Berg restricted common stock at 85% of the average closing price of the Company's common stock over the five trading days prior to the purchase date. We agreed to register any shares we issued to Berg & Berg under this commitment.
On January 1, 1998, we granted options to Mr. Dawson, the Company's then Chairman of the Board, Chief Executive Officer and President, an incentive stock option to purchase 39,506 shares, which was granted pursuant to our 1990 Plan (the "1990 Plan"). Also, an option to purchase 660,494 shares was granted pursuant to our 1990 Plan and an option to purchase 300,000 shares was granted outside of any of our equity plans, 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. Our Compensation Committee approved the early exercise of the Nonstatutory Options on March 5, 1998. The options permitted exercise by cash, shares, full recourse notes or non-recourse notes secured by independent collateral. The Nonstatutory Options were exercised on March 5, 1998 with non-recourse promissory notes in the amounts of $3,343,750 ("Dawson Note One") and $1,518,750 ("Dawson Note Two") (collectively, the "Dawson Notes") secured by the shares acquired upon exercise plus 842,650 shares previously held by Mr. Dawson. As of March 31, 2004, amounts of $3,548,487 and $1,612,683 were outstanding under Dawson Note One and Dawson Note Two, respectively, and under each of the Dawson Notes, interest from the Issuance Date accrues on unpaid principal at the rate of 5.69% per annum, or at the maximum rate permissible by law, whichever is less.
In accordance with the Dawson Notes, interest is payable annually in arrears and has been paid through March 4, 2005.
CAPITAL COMMITMENTS AND DEBT
At March 31, 2005, we had commitments for capital expenditures for the next 12 months of approximately $100,000 relating to the implementation of our enterprise software system. We may require additional capital expenditures in order to meet greater demand levels for our products than are currently anticipated and/or to support our transition of operations to China.
Our cash obligations for short-term and long-term debt, net of unaccreted discount consisted of:
(Dollars in thousands) March 31, 2005 -------------------- 1998 long-term debt to Berg & Berg 14,950 2001 long-term debt to Berg & Berg 20,000 Interest on long-term debt 12,536 -------------------- Total long-term debt $ 47,486 ====================
Repayment obligations of short-term and long-term debt principal are:
If not converted to common stock prior to maturity, the redemption obligation for the Series C-1 and Series C-2 Preferred Stock is $8.6 million on December 15, 2005. If the shares are not redeemed in accordance with their terms, the holder of the preferred stock shall have the option to require that we convert all or part of the redeemed shares at a share price of 95% of the lowest closing bid price of our common stock during the three days ending on and including the conversion date.
If cash flow from operations is not adequate to meet debt obligations, additional debt or equity financing will be required. There can be no assurance that we could obtain the additional financing.
INFLATION
Historically, our operations have not been materially affected by inflation. However, our operations may be affected by inflation in the future.
RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 46 ("FIN 46"), Consolidation of Variable Interest Entities, an interpretation of ARB NO. 51, which addresses consolidation by business enterprises of variable interest entities ("VIEs") either: (1) that do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) in which the equity investors lack an essential characteristic of a controlling financial interest. In December 2003, the FASB completed deliberations of proposed modifications to FIN 46 (Revised Interpretations) resulting in multiple effective dates based on the nature as well as the creation date of the VIE. VIEs created after January 31, 2003, but prior to January 1, 2004, may be accounted for either based on the original interpretation or the Revised Interpretations. However, the Revised Interpretations must be applied no later than the first quarter of fiscal year 2004. VIEs created after January 1, 2004 must be accounted for under the Revised Interpretations. The adoption of these deferred provisions in 2004 had no effect on the Company's financial position, results of operations or cash flows.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. The standard requires that abnormal amounts of idle capacity and spoilage costs should be excluded from the cost of inventory and expensed when incurred. The provision is effective for fiscal periods beginning after June 15, 2005. The Company does not expect the adoption of this standard to have a material effect on its financial position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB No. 29, Accounting for Nonmonetary Transactions. SFAS No. 153 requires exchanges of productive assets to be accounted for at fair value, rather than at carryover basis, unless (1) neither the asset received nor the asset surrendered has a fair value that is determinable within reasonable limits or (2) the transactions lack commercial substance. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company does not expect the adoption of this standard to have a material effect on its financial position, results of operations or cash flows.
In December 2004, the FASB released its final revised standard, SFAS No. 123R, Share-Based Payment. SFAS No. 123R requires that an entity measure the cost of equity based service awards using the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award or the vesting period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. An entity will initially measure the cost of liability based service awards using its current fair value; the fair value of that award will be re-measured subsequently at each reporting date through the settlement date. Changes in fair value during the requisite service period will be recognized as compensation cost over that period. Adoption of SFAS No. 123R is required for fiscal periods beginning after June 15, 2005. The Company is evaluating SFAS 123R and believes that it will likely have a material effect on its financial position and results of operations.
TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The following table sets forth, as of March 31, 2005, our scheduled principal, interest and other contractual annual cash obligations due for each of the periods indicated below (in thousands):
RISK FACTORS
CAUTIONARY STATEMENTS AND RISK FACTORS
Several of the matters discussed in this Report contain forward-looking statements that involve risks and uncertainties. Factors associated with the forward-looking statements that could cause actual results to differ from those projected or forecasted in this Report are included in the statements below. In addition to other information contained in this Report, you should carefully consider the following cautionary statements and risk factors. The risks and uncertainties described below are not the only risks and uncertainties we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business, financial condition, and results of operations could suffer. In that event, the trading price of our common stock could decline, and you may lose all or part of your investment in our common stock. The risks discussed below also include forward-looking statements and our actual results may differ substantially from those discussed in these forward-looking statements.
RISKS RELATED TO OUR BUSINESS
WE MAY BE REQUIRED TO RAISE ADDITIONAL DEBT OR EQUITY FINANCING TO EXECUTE OUR BUSINESS PLAN.
At March 31, 2005, our principal sources of liquidity were cash and cash equivalents of $2.5 million and $6 million remaining under the $20 million backup equity funding commitment entered into in June 2004 with Mr. Carl Berg. Subsequent to March 31, 2005 we have drawn down an additional $5 million of this prior commitment. On June 13, 2005 we entered into a new $20 million funding commitment with Mr. Berg to provide funding in the form of equity or a secured loan on terms to be negotiated. This new commitment can be reduced by Mr. Berg by the amount of net proceeds received in a debt or equity transaction with a third party.
At March 31, 2005, we had $4.3 million of Series C-1 Convertible Preferred Stock and $4.3 million of Series C-2 Convertible Preferred Stock outstanding. The Series C-1 Convertible Preferred Stock and Series C-2 Convertible Preferred Stock are convertible into common stock at $4.00 per share and are redeemable on December 15, 2005 (subject to an early right of redemption in the case of the Series C-2 Convertible Preferred Stock during the 30 days following June 15, 2005 and September 15, 2005).
Applicable provisions of Delaware corporate law restrict our ability to redeem the preferred stock. If we do not redeem the shares when required by their terms, the conversion price will be reduced to an amount equal to 95% of the lowest closing bid price of our common stock during the three days ending on and including the conversion date.
Our current forecast projects that these sources of liquidity will be sufficient for at least the twelve months following March 31, 2005. This forecast assumes product sales during fiscal 2006 from the N-Charge(TM) Power System and the Segway pack, which are subject to seasonal fluctuations, of between $2.5 - $5.0 million per quarter, and expect additional revenues from the sale of the U-Charge(TM) Power System into large-format applications and direct cell sale activities. We also anticipate further cash benefits from continued reductions in operating expenses and manufacturing costs, offset by small increases to capital expenditures associated with continuing efforts 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. These events could have a negative impact on our available liquidity sources during the next 12 months..
OUR LIMITED FINANCIAL RESOURCES COULD MATERIALLY AFFECT OUR BUSINESS AND OUR ABILITY TO COMMERCIALLY EXPLOIT OUR TECHNOLOGY. LIMITED FINANCIAL RESOURCES CAN ADVERSELY AFFECT OUR ABILITY TO RESPOND TO UNANTICIPATED DEVELOPMENTS AND PLACE US AT A COMPETITIVE 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 twelve months. As a consequence, one of our primary objectives has been to reduce expenses and overhead and thus limiting the resources available to 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(R) 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 or 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, HAVE AN ACCUMULATED DEFICIT AND MAY NEVER ACHIEVE OR SUSTAIN SIGNIFICANT REVENUES OR PROFITABILITY.
We have incurred operating losses each year since our inception in 1989 and had an accumulated deficit of $461.3 million as of March 31, 2005. We had negative working capital of $1.6 million as of March 31, 2005, 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 2006. 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 $31.4 million for the fiscal year ended March 31, 2005 and a net loss of $55.0 million for the fiscal year ended March 31, 2004. If we cannot achieve a competitive cost structure, achieve profitability and access the capital markets on acceptable terms, we will be unable to fund our obligations and sustain our operations.
OUR WORKING CAPITAL REQUIREMENTS MAY INCREASE BEYOND THOSE CURRENTLY ANTICIPATED.
We have planned for an increase in sales and, if we experience sales in excess of our plan, our working capital needs and capital expenditures would likely increase from that currently anticipated. Our ability to meet this additional customer demand would depend on our ability to arrange for additional equity or debt financing since it is likely that cash flow from sales will lag behind these increased working capital requirements.
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 have now and will continue to have a significant amount of indebtedness and other obligations. As of March 31, 2005, we had approximately $47.2 million of total consolidated indebtedness. Our substantial indebtedness and other obligations could negatively impact our operations in the future. For example, it could:
o limit our ability to obtain additional financing for working capital, capital expenditures, acquisitions and general corporate purposes;
o require us to dedicate a substantial portion of our cash flow from operations to the payment of principal of, and interest on, our indebtedness, thereby reducing the funds available to us for other purposes;
o make us more vulnerable to failure to achieve our forecasted results, economic downturns, adverse industry conditions or catastrophic external events, limit our ability to withstand competitive pressures and reduce our flexibility in planning for, or responding to, changing business and economic conditions; and
o place us at a competitive disadvantage to our competitors that have relatively less debt than we have.
ALL OF OUR ASSETS ARE PLEDGED AS COLLATERAL UNDER OUR LOAN AGREEMENTS. OUR FAILURE TO MEET THE OBLIGATIONS UNDER OUR LOAN AGREEMENTS COULD RESULT IN FORECLOSURE OF OUR ASSETS.
All of our assets are pledged as collateral under various loan agreements. If we fail to meet our obligations pursuant to these loan agreements, our lenders may declare all amounts borrowed from them to be due and payable together with accrued and unpaid interest. If this were to occur, we would not have the financial resources to repay our debt and these lenders could proceed against our assets.
OUR BUSINESS WILL BE ADVERSELY AFFECTED IF OUR SAPHION(R) TECHNOLOGY BATTERIES ARE NOT COMMERCIALLY ACCEPTED.
We are researching and developing batteries based upon phosphate chemistry. Our batteries are designed and manufactured as components for other companies and end-user customers. Our success depends on the acceptance of our batteries and the products using our batteries in their markets. We may have technical issues that arise that may affect the acceptance of our products by our customers. Market acceptance may also depend on a variety of other factors, including educating the target market regarding the benefits of our products. Market acceptance and market share are also affected by the timing of market introduction of competitive products. If our customers or we are unable to gain any significant market acceptance for Saphion(R) technology based batteries, our business will be
adversely affected. It is too early to determine if Saphion(R) technology based batteries will achieve significant market acceptance.
IF WE ARE UNABLE TO DEVELOP, MANUFACTURE AND MARKET PRODUCTS THAT GAIN WIDE CUSTOMER ACCEPTANCE, OUR BUSINESS WILL BE ADVERSELY AFFECTED.
The process of developing our products is complex and uncertain, and failure to anticipate customers' changing needs and to develop products that receive widespread customer acceptance could significantly harm our results of operations. We must make long-term investments and commit significant resources before knowing whether our predictions will eventually result in products that the market will accept. After a product is developed, we must be able to manufacture sufficient volumes quickly and at low costs. To accomplish this, we must accurately forecast volumes, mix of products and configurations that meet customer requirements, and we may not succeed.
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 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.
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.
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 2005, three customers, D&H Distributors, PC Connection, and Best Buy accounted for a combined 46% of our revenue. During fiscal 2004, Best Buy accounted for 30% of revenue. During fiscal 2003, two customers, Alliant Techsystems Inc. and Pabion Corporation, Ltd., each accounted for more than 10% of total revenues. We anticipate that sales of our products to a limited number of key customers will continue to account for a significant portion of our total revenues. We do not have long-term agreements with any of our customers and do not expect to enter into any long-term agreements in the near future. As a result, we face the substantial risk that one or more of the following events could occur:
o reduction, delay or cancellation of orders from a customer;
o development by a customer of other sources of supply;
o selection by a customer of devices manufactured by one of our competitors for inclusion in future product generations;
o loss of a customer or a disruption in our sales and distribution channels; or
o failure of a customer to make timely payment of our invoices.
If we were to lose one or more customers, or if we were to lose revenues due to a customer's inability or refusal to continue to purchase our batteries, our business, results of operations and financial condition could be harmed.
THE FACT THAT WE DEPEND ON A SOLE SOURCE SUPPLIER OR A LIMITED NUMBER OF SUPPLIERS FOR KEY RAW MATERIALS MAY DELAY OUR PRODUCTION OF BATTERIES.
We depend on a sole source supplier or a limited number of suppliers for certain key raw materials used in manufacturing and developing our 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 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:
o changes in foreign government regulations and technical standards, including additional regulation of rechargeable batteries, technology, or the transport of lithium and phosphate, which may reduce or eliminate our ability to sell or license in certain markets;
o foreign governments may impose tariffs, quotas, and taxes on our batteries or our import of technology into their countries;
o requirements or preferences of foreign nations for domestic products could reduce demand for our batteries and our technology;
o fluctuations in currency exchange rates relative to the U.S. dollar could make our batteries and our technology unaffordable to foreign purchasers and licensees or more expensive compared to those of foreign manufacturers and licensors;
o longer payment cycles typically associated with international sales and potential difficulties in collecting accounts receivable may reduce the future profitability of foreign sales and royalties;
o import and export licensing requirements in China or other countries where we intend to conduct business may reduce or eliminate our ability to sell or license in certain markets; and
o political and economic instability in China or other countries where we intend to conduct business may reduce the demand for our batteries and our technology or our ability to market our batteries and our technology in those countries.
These risks may increase our costs of doing business internationally and reduce our sales and royalties or future profitability.
WE MAY NEED TO EXPAND OUR EMPLOYEE BASE AND OPERATIONS IN ORDER TO EFFECTIVELY DISTRIBUTE OUR PRODUCTS COMMERCIALLY, WHICH MAY STRAIN OUR MANAGEMENT AND RESOURCES AND COULD HARM OUR BUSINESS.
To implement our growth strategy successfully, we will have to increase our staff, primarily with personnel in sales, marketing, and product support capabilities, as well as third party and direct distribution channels. However, we face the risk that we may not be able to attract new employees to sufficiently increase our staff or product support capabilities, or that we will not be successful in our sales and marketing efforts. Failure in any of these areas could impair our ability to execute our plans for growth and adversely affect our future profitability.
COMPETITION FOR PERSONNEL, IN PARTICULAR FOR PRODUCT DEVELOPMENT AND PRODUCT IMPLEMENTATION PERSONNEL, IS INTENSE, AND WE MAY HAVE DIFFICULTY ATTRACTING THE PERSONNEL NECESSARY TO EFFECTIVELY OPERATE OUR BUSINESS.
We believe that our future success will depend in large part on our ability to attract and retain highly skilled technical, managerial, and marketing personnel who are familiar with and experienced in the battery industry. If we cannot attract and retain experienced sales and marketing executives, we may not achieve the visibility in the marketplace that we need to obtain purchase orders, which would have the result of lowering our sales and earnings. We compete in the market for personnel against numerous companies, including larger, more established competitors who have significantly greater financial resources than we do. We cannot be certain that we will be successful in attracting and retaining the skilled personnel necessary to operate our business effectively in the future.
IF WE ARE SUED ON A PRODUCT LIABILITY CLAIM, OUR INSURANCE POLICIES MAY NOT BE SUFFICIENT.
Although we maintain general liability insurance and product liability insurance, our insurance may not cover all potential types of product liability claims to which manufacturers are exposed or may not be adequate to indemnify us for all liability that may be imposed. Any imposition of liability that is not covered by insurance or is in excess of our insurance coverage could harm our business.
OUR FAILURE TO COST-EFFECTIVELY MANUFACTURE BATTERIES IN COMMERCIAL QUANTITIES, WHICH SATISFY OUR CUSTOMERS' PRODUCT SPECIFICATIONS, COULD DAMAGE OUR CUSTOMER RELATIONSHIPS AND RESULT IN SIGNIFICANT LOST BUSINESS OPPORTUNITIES FOR US.
To be successful, we must cost-effectively manufacture commercial quantities of our batteries that meet customer specifications. To facilitate commercialization of our products, we will need to further reduce our manufacturing costs, which we intend to do through the effective utilization of manufacturing partners. We currently manufacture our batteries and assemble our products in China and Taiwan. We intend to transition additional operations to Asia over the course of fiscal 2006. 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 product 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 were the first creator of inventions covered by pending patent applications or the first to file patent applications on these inventions. We also cannot be certain that our pending patent applications will result in issued patents or that any of our issued patents will afford protection against a competitor. In addition, patent applications filed in foreign countries are subject to laws, rules and procedures that differ from those of the United States, and thus we cannot be certain that foreign patent applications related to issued U.S. patents will issue. Furthermore, if these patent applications issue, some foreign countries provide significantly less effective patent enforcement than in the United States.
The status of patents involves complex legal and factual questions and the breadth of claims allowed is uncertain. Accordingly, we cannot be certain that the patent applications that we file will result in patents being issued, or that our patents and any patents that may be issued to us in the future will afford protection against competitors with similar technology. In addition, patents issued to us may be infringed upon or designed around by others and others may obtain patents that we need to license or design around, either of which would increase costs and may adversely affect our operations.
IF WE CANNOT PROTECT OR ENFORCE OUR EXISTING INTELLECTUAL PROPERTY RIGHTS OR IF OUR PENDING PATENT APPLICATIONS DO NOT RESULT IN ISSUED PATENTS, WE MAY LOSE THE ADVANTAGES OF OUR RESEARCH AND MANUFACTURING SYSTEMS.
Our ability to compete successfully will depend on whether we can protect our existing proprietary technology and manufacturing processes. We rely on a combination of patent and trade secret protection, non-disclosure agreements and cross-licensing agreements. These measures may not be adequate to safeguard the proprietary technology underlying our batteries. Employees, consultants, and others who participate in the development of our products may breach their non-disclosure agreements with us, and we may not have adequate remedies in the event of their breaches. In addition, our competitors may be able to develop products that are equal or superior to our products without infringing on any of our intellectual property rights. We currently manufacture and export some of our products from China. The legal regime protecting intellectual property rights in China is weak. Because the Chinese legal system in general, and the intellectual property regime in particular, are relatively weak, it is often difficult to enforce intellectual property rights in China. In addition, there are other countries where effective copyright, trademark and trade secret protection may be unavailable or limited. Accordingly, we may not be able to effectively protect our intellectual property rights outside of the United States.
We have established a program for intellectual property documentation and protection in order to safeguard our technology base. We intend to vigorously pursue enforcement and defense of our patents and our other proprietary rights. We could incur significant expenses in preserving our proprietary rights, and these costs could harm our financial condition. We also 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 United States Senate voted to permanently normalize trade with China, which provides a favorable category of United States import duties. In addition, on December 11, 2001 China was accepted into the World Trade Organization (WTO), a global international organization of 144 countries that regulates international trade. As a result of opposition to certain policies of the Chinese government and China's growing trade surpluses with the United States, there has been, and in the future may be, opposition to the extension of Normal Trade Relations, or NTR, status for China. The loss of NTR status for China, changes in current tariff structures or adoption in the Unites States of other trade policies adverse to China could have an adverse effect on our business.
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. 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 such 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.
We currently have relationships with manufacturers in China for the production of our products and have transitioned our core operations to China.
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 in 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 were to 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;
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.
CHINA CURRENCY EXCHANGE ISSUES
We incur expenses and liabilities in both Chinese RMB and U.S. dollars. As a result, we are subject to the effects of exchange rate fluctuations with respect to any of these currencies. For example, the value of the Chinese RMB depends to a large extent on the PRC's domestic and international economic and political developments, as well as supply and demand in the local market. Since 1994, the official exchange rate for the conversion of Chinese RMB to U.S. dollars has generally been stable and the Chinese RMB has appreciated slightly against the U.S. dollar. However, given recent economic instability and currency fluctuations, we can offer no assurance that the Chinese RMB will continue to remain stable against the U.S. dollar or any other foreign currency.
Although Chinese governmental policies were introduced in 1996 to allow the convertibility of Chinese RMB into foreign currency for current account items, conversion of Chinese RMB into foreign exchange for capital items, such as foreign direct investment, loans or security, requires the approval of the State Administration of Foreign Exchange, or SAFE, which is under the authority of the People's Bank of China. These approvals, however, do not guarantee the availability of foreign currency. We cannot be sure that Chinese regulatory authorities will not impose greater restrictions on the convertibility of the Chinese RMB in the future. Because a significant amount of our operations are in China, any future restrictions on currency exchanges could have an adverse effect on our ability to do business in China.
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 the PRC 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.
IF THE RELATIONSHIP BETWEEN CHINA AND THE UNITED STATES DETERIORATES, THE GOVERNMENT OF CHINA COULD ADVERSELY CHANGE ITS POLICIES WITH RESPECT TO U.S. INVESTMENT IN COMPANIES IN CHINA.
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 affect 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.
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.
Our products are manufactured by Chinese manufacturers through contractual relationships. In addition, we are pursuing a strategy of expanding our operations in China. Firefighting and disaster relief or assistance in China is substandard by Western standards. Consistent with common practice in China for companies the size of us and 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 a loss of revenue or material damage to, or loss of, the manufacturing plants where our products are currently produced, or, in the future, where are other operations, including manufacturing, will occur, due to fire, casualty, theft, severe weather, flood or other cause, we would be forced to replace any assets lost in such disaster without the benefit of insurance and our financial position could be materially compromised or we might have to cease doing business. Also, consistent with customary business practices among enterprises 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 there is no assurance that such tax and other incentives will continue to be made available. Currently, China levies a 10% withholding tax on profit allocations (i.e., 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, such a 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.
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 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 Value Added Tax 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, OR ANOTHER WIDESPREAD PUBLIC HEALTH PROBLEM, COULD ADVERSELY AFFECT OUR BUSINESS AND RESULTS OF OPERATIONS.
A renewed outbreak of SARS 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 and 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 even obsolete. Other companies are seeking to enhance traditional battery technologies, such as lead acid and nickel cadmium or have recently introduced or are developing batteries based on nickel metal-hydride, liquid Lithium-ion and other emerging and potential technologies. These competitors are engaged in significant development work on these various battery systems, and we believe that much of this effort is focused on achieving higher energy densities for low power applications such as portable electronics. One or more new, higher energy rechargeable battery technologies could be introduced which could be directly competitive with, or superior to, our technology. The capabilities of many of these competing technologies have improved over the past several years. Competing technologies that outperform our batteries could be developed and successfully introduced, and as a result, there is a risk that our products may not be able to compete effectively in our targeted market segments.
We have invested in research and development of next-generation technology in energy solutions. If we are not successful in developing and commercially exploiting new energy solutions based on new materials, or we experience delays in the development and exploitation of new energy solutions, compared to our competitors, our future growth and revenues will be adversely affected.
OUR PRINCIPAL COMPETITORS HAVE GREATER FINANCIAL AND MARKETING RESOURCES THAN WE DO AND THEY MAY THEREFORE DEVELOP BATTERIES SIMILAR OR SUPERIOR TO OURS OR OTHERWISE COMPETE MORE SUCCESSFULLY THAN WE DO.
Competition in the rechargeable battery industry is intense. The industry consists of major domestic and international companies, most of which have financial, technical, marketing, sales, manufacturing, distribution and other resources substantially greater than ours. There is a risk that other companies may develop batteries similar or superior to ours. In addition, many of these companies have name recognition, established positions in the market, and long-standing relationships with OEMs and other customers. We believe that our primary competitors are existing suppliers of liquid Lithium-ion, competing polymer and, in some cases, nickel metal-hydride batteries. These suppliers include Sanyo, Matsushita Industrial Co., Ltd. (Panasonic), Sony, Toshiba, SAFT and Electrovaya. Most of these companies are very large and have substantial resources and market presence. We expect that we will compete against manufacturers of other types of batteries in our targeted application segments, which include laptops, cellular telephones, and personal digital assistant products, on the basis of performance, size and shape, cost, and ease of recycling. There is also a risk that we may not be able to compete successfully against manufacturers of other types of batteries in any of our targeted applications.
LAWS REGULATING THE MANUFACTURE OR TRANSPORTATION OF BATTERIES MAY BE ENACTED WHICH COULD RESULT IN A DELAY IN THE PRODUCTION OF OUR BATTERIES OR THE IMPOSITION OF ADDITIONAL COSTS THAT COULD HARM OUR ABILITY TO BE PROFITABLE.
At the present time, international, federal, state, or local law does not directly regulate the storage, use, and disposal of the component parts of our batteries. However, laws and regulations may be enacted in the future, which could impose environmental, health and safety controls on the storage, use, and disposal of certain chemicals and metals used in the manufacture of lithium polymer batteries. Satisfying any future laws or regulations could require significant time and resources from our technical staff and possible redesign which may result in substantial expenditures and delays in the production of our product, all of which could harm our business and reduce our future profitability. The transportation of lithium and lithium-ion batteries is regulated both internationally and domestically. Under recently revised United Nations recommendations and as adopted by the International Air Transport Association (IATA), our N-ChargeTM Power System (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 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 June 3, 2005, our officers, directors and their affiliates as a group beneficially owned approximately 42.6% of our outstanding common stock. Carl Berg, one of our directors, beneficially owns approximately 39.7% 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 PRICE OF OUR STOCK AND LIMIT THE PRICE THAT POTENTIAL ACQUIRERS MAY BE WILLING TO PAY FOR OUR COMMON STOCK.
Our board of directors has the authority, without any action by the outside stockholders, to issue additional shares of our preferred stock, which shares may be given superior voting, liquidation, distribution and other rights as compared to those of our common stock. The rights of the holders of our capital stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of additional shares of preferred stock could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. These provisions may have the effect of delaying, deferring or preventing a change in control, may discourage bids for our common stock at a premium over its market price, may decrease the market price, and may infringe upon the voting and other rights of the holders of our common stock.
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 June 3, 2005, the closing price of our common stock was $3.02. 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 87,061,639 shares of common stock as of March 31, 2005. In addition, at March 31, 2005, we had 13,068,000 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 2,152,500 shares of our common stock (based on a conversion price of $4.00) and up to 352,900 shares upon exercise of the related warrant issued on June 2, 2003.
WE DO NOT INTEND TO PAY DIVIDENDS ON OUR COMMON STOCK, AND THEREFORE STOCKHOLDERS WILL BE ABLE TO RECOVER THEIR INVESTMENT IN OUR COMMON STOCK, IF AT ALL, ONLY BY SELLING THE SHARES OF OUR STOCK THAT THEY HOLD.
Some investors favor companies that pay dividends on common stock. We have never declared or paid any cash dividends on our common stock. We currently intend to retain any future earnings for funding growth and we do not anticipate paying cash dividends on our common stock in the foreseeable future. Because we may not pay dividends, a return on an investment in our stock likely depends on the ability to sell our stock at a profit.
ITEM 7A.
ITEM 7A. 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 March 31, 2005. However, we are exposed to financial market risks, including changes in foreign currency exchange rates and interest rates.
Based on borrowing rates currently available to us for loans with similar terms, the carrying value of our debt obligations approximates fair value.
ITEM 8
ITEM 8 FINANCIAL STATEMENTS
The Company's Consolidated Financial Statements and notes thereto appear on pages through.
ITEM 9
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
None.
ITEM 9A
ITEM 9A CONTROLS AND PROCEDURES
CONCLUSION REGARDING THE EFFECTIVENESS OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we have carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures are effective.
MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management does not expect that our control system 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 the company 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. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Our management's report on internal control over financial reporting, and the related report of our independent public accounting firm, are included in our annual report on Form 10-K under Management's Annual Report on Internal Control Over Financial Reporting and Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting , respectively, and are incorporated by reference.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the fourth quarter of 2005, in connection with our evaluation of internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002, we implemented or revised certain internal control procedures which affect financial reporting. The changes enhanced controls already in place or introduced new controls implemented to remove or reduce reliance on compensating controls. The most significant changes were made in the area of inventory and information technology systems.
ITEM 9B
ITEM 9B OTHER INFORMATION
On June 13, 2005 as part of the transition of our operations to China and the recent appointment of JR Hwang as President of Asia-Pacific Operations, Joseph Lamoreux resigned his position as Chief Operating Officer. Mr. Lamoreux will remain employed by the Company and will continue to assist in the transition of our operations to China and will perform other duties assigned to him by the Chief Executive Officer.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT.
DIRECTORS AND EXECUTIVE OFFICERS
The following persons serve as our directors:
Our executive officers are appointed by and serve at the discretion of the Board. There are no family relationships between any director and/or any executive officer.
CARL E. BERG. Mr. Berg helped found us and has served on the Board since September 1991. For more than 30 years, Mr. Berg has been a major Silicon Valley industrial real estate developer and a private venture capital investor. Mr. Berg also serves as the director of Mission West Properties, Inc., Monolithic Systems, Inc. and Focus Enhancements, Inc. Mr. Berg holds a Bachelor of Arts degree in Business Administration from the University of New Mexico.
STEPHAN B. GODEVAIS. Mr. Godevais joined us in May 2001 and is currently our Chairman of the Board of Directors, Chief Executive Officer, and President. From December 1997 to April 2001, Mr. Godevais served as a Vice President at Dell Computer Corporation where he led Dell's desktop and notebook product lines for consumers and small businesses. During his tenure at Dell, Mr. Godevais launched the company's Inspiron division, growing it into a multi-billion dollar business and introduced the first 15-inch notebook in the industry, sustaining its position as a market leader from 1998 to 2000. Prior to Dell, Mr. Godevais managed the worldwide notebook business of Digital Equipment Corporation. From December 1994 to November 1997, Mr. Godevais served in several positions, including General Manager and Vice President, at Digital. Mr. Godevais also spent ten years at Hewlett Packard Company, where he held positions in marketing for various product and field organizations. Mr. Godevais holds a business management degree from the Institut d'Etudes Politiques de Paris.
BERT C. ROBERTS, JR. Mr. Roberts originally joined us as a director in 1992 and served until 1993 prior to rejoining us as a director in 1998. Mr. Roberts served as Chairman and Chief Executive Officer of MCI, a telecommunications company from 1992 until 1998, after having served as President and Chief Operating Officer since 1985. Mr. Roberts serves on the boards of Johns Hopkins University and CaPCURE (a cancer research funding organization). Mr. Roberts holds a Bachelor of Science in Engineering from Johns Hopkins University.
ALAN F. SHUGART. Mr. Shugart joined us as a director in March 1992. Mr. Shugart was the Chief Executive Officer and a director of Seagate Technology, Inc., a technology development and manufacturing company, since its inception in 1979 until July 1998. Mr. Shugart also served as Seagate's President from 1979 to 1983 and from September 1991 to July 1998. Additionally, Mr. Shugart served as Chairman of the Board of Seagate from 1979 until September 1991, and from October 1992 to July 1998. Mr. Shugart currently serves as a director of Sandisk Corporation (a manufacturer of digital flash memory chips) and Cypress Semiconductor Corporation. Mr. Shugart holds a Bachelor of Science in Engineering - Physics from the University of Redlands.
Vassilis G. Keramidas. Dr. Keramidas joined us as a directors in August 2004. Dr. Keramidas has extensive experience in the development and commercialization of intellectual property and new energy storage technologies and has served as the managing director of Keramidas International Associates LLC, a consulting firm in the area of intellectual property, research management and corporate collaborative research, since May 2003. From 1997 to 2003, Dr. Keramidas served as vice president and research scientist for Telcordia Technologies, an international energy storage and memory technologies company. Dr. Keramidas has authored or co-authored 165 technical publications and holds several patents.
JR HWANG. Mr. Hwang joined us in April 2005 and serves as President of Asia-Pacific Operations. From 1999 to 2005 he served as managing director of Pareto Co. Ltd., a chemical manufacturing company, where he led new product development and marketing and sales of chemicals and components to the electronics industry. Mr. Hwang also has more than a dozen years of direct experience in chemical & metallurgical engineering and research. Mr. Hwang holds several degrees, including a Doctorate in chemical metallurgy and materials processing from Stanford University and a Master of Business Administration from Case Western Reserve University.
DEAN BOGUES. Mr. Bogues joined us in December 2004 and serves as our Vice President of Sales and Marketing. From 1999 to 2004, Mr. Bogues served as Director of Enterprise Sales for Dell Inc., a computer and peripherals company, where he directed sales of server and storage products in the government, education, and healthcare markets. From 1993 to 1999 Mr. Bogues was General Manager of the Datacenter Solutions Division for American Power Conversion Corp., a manufacturer of uninterruptible power supplies, where he built and led a new worldwide business consisting of industry breakthrough modular, fault-tolerant, network-managed power protection systems. From 1979 to 1993 Mr. Bogues served in various positions with Hewlett-Packard, a computer and electronics company. Mr. Bogues holds a Bachelor of Science in Electrical Engineering from Worcester Polytechnic Institute..
KEVIN W. MISCHNICK. Mr. Mischnick joined us in July 2001 as our Vice President of Finance. From November 2000 to March 2001, he served as Vice President of Finance at CarOrder, Inc., an internet automobile dealership. From March 1997 to October 2000, he served as Vice President of Finance for AMFM, Inc., a radio broadcasting company, and one of its predecessor companies where he was responsible for all aspects of treasury and cash management systems. During other tenures at AMFM and one of its predecessor companies, Mr. Mischnick completed multiple public equity and debt offerings and gained experience in Securities and Exchange Commission reporting. From August 1990 to March 1997, he served in various positions at Ernst & Young LLP, including Audit Manager. He is a certified public accountant and holds a Bachelor of Business Administration degree in Accounting from Texas Tech University.
ROGER WILLIAMS. Mr. Williams joined us in April 2001 and serves as our General Counsel and Assistant Secretary. Mr. Williams has been a practicing intellectual property attorney for 30 years, having practiced in both private and corporate positions. From 1991 to 2001, Mr. Williams served as Chief Patent Counsel and Associate General Counsel for the pharmaceutical company G.D. Searle & Co. Mr. Williams has his Juris Doctorate degree from Drake University Law School and a Bachelor of Science in Chemistry from Western Illinois University. He is a member of the California and Indiana Bars.
AUDIT COMMITTEE FINANCIAL EXPERT
On behalf of the Board, the Audit Committee is responsible for providing an independent, objective review of our auditing, accounting and financial reporting process, public reports and disclosures, and system of internal controls regarding financial accounting. We currently do not have a financial expert on our audit committee.
CODE OF ETHICS
We have adopted a Code of Ethics and Business Conduct applicable to all of our employees, including our Chief Executive Officer, Principal Financial Officer, Principal Accounting Officer and all other senior financial executives, and to our directors when acting in their capacity as directors. Our Code of Ethics and Business Conduct is designed to set the standards of business conduct and ethics and to help directors and employees resolve ethical issues. The purpose of our Code of Ethics and Business Conduct is to ensure to the greatest possible extent that our business is conducted in a consistently legal and ethical manner. Employees may submit concerns or complaints regarding audit, accounting, internal controls or other ethical issues on a confidential basis by means of a toll-free telephone call or an anonymous email. We investigate all concerns and complaints. Copies of our Code of Business Conduct and Ethics are available to investors upon written request. Any such request should be sent by mail to Valence Technology, Inc., 6504 Bridge Point Parkway, Suite 415, Austin, Texas 78730, Attn: General Counsel or should be made by telephone by calling General Counsel at (888) 825-3623.
We intend to disclose on our website amendments to, or waivers from, any provision of our Code of Ethics and Business Conduct that apply to our Chief Executive Officer, Principal Financial Officer, Principal Accounting Officer and persons performing similar functions and amendments to, or waivers from, any provision which relates to any element of our Code of Ethics and Business Conduct described in Item 406(b) of Regulation S-K.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires our directors, officers (including a person performing a principal policy-making function) and persons who own more than 10% of a registered class of our equity securities to file with the Commission initial reports of ownership and reports of changes in ownership of our common stock and other equity securities of ours. Directors, officers and 10% holders are required by Commission regulations to send us copies of all of the Section 16(a) reports they file. Based solely upon a review of the copies of the forms sent to us and the representations made by the reporting persons to us, we believe that, other than as described below, during the fiscal year ended March 31, 2005, our directors, officers and 10% holders complied with all filing requirements under Section 16(a) of the Exchange Act.
The Form 4 filed by Mr. Carl Berg as an individual, as managing member of Berg & Berg Enterprises, LLC, and as President of West Coast Venture Capital, Inc. on June 30, 2004 inadvertantly disclosed a purchase of 910,746 shares of our common stock as 877,193 shares. This reporting error of 33,553 shares was corrected in subsequent filings.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
The following table sets forth, as to the Chief Executive Officer and as to each of the other four most highly compensated executive officers whose compensation exceeded $100,000 during fiscal 2005 (referred to as the named executive officers), information concerning all compensation paid for services to us in all capacities for each of the three years ended March 31 indicated below.
*Mr. Lamoreux resigned his position as COO on June 13, 2005.
OPTION GRANTS IN LAST FISCAL YEAR
The following table shows for the fiscal year ended March 31, 2005, certain information regarding options granted to, exercised by, and held at year-end by the named executive officers:
*Mr. Lamoreux resigned his position as COO on June 13, 2005.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR, AND FISCAL YEAR END OPTION VALUES
The following table shows (i) the number of shares acquired and value realized from option exercises by each of the named executive officers during the fiscal year ended March 31, 2005 and (ii) the number and value of the unexercised options held by each of the named executive officers on March 31, 2005:
*Mr. Lamoreux resigned his position as COO on June 13, 2005.
EMPLOYMENT AGREEMENTS
Effective May 2, 2001, and renewed in August 2003, we entered into an employment agreement with Stephan B. Godevais pursuant to which we retained Mr. Godevais as Chief Executive Officer and President at a salary of $500,000 per year. The Board reviews his salary on January 1 of each year and may (in its sole discretion) increase, but not decrease, his salary.
Under his employment agreement, we granted Mr. Godevais stock options to purchase an aggregate of 1,500,000 shares of common stock at an exercise price of $6.52 per share, vesting over a period of four years.
We agreed to nominate Mr. Godevais to the Board for the entire period of his employment as Chief Executive Officer and President and to use our best efforts to cause our stockholders to cast their votes in favor of his continued election to the Board. Mr. Godevais agreed to resign from the Board when he no longer serves as Chief Executive Officer and President.
Mr. Godevais is entitled to a lump sum payment of $500,000 and continued group health insurance coverage for one year following termination if within the first two years of the employment agreement renewal any of the following occurs:
o A liquidation or change in control occurred (excluding an acquisition by Carl Berg or his affiliated companies of more than 50% of our voting stock, which will not constitute a change of control);
o We terminated Mr. Godevais' employment for any reason other than for cause; or
o Mr. Godevais resigned for good reason.
Effective September 18, 2003, we entered into an employment agreement with Joseph Lamoreux pursuant to which we retained Mr. Lamoreux as Chief Operating Officer at a salary of $230,000 per year. The Board reviews his salary annually on January 1 and may, at its sole discretion, increase, but not decrease, his salary.
Mr. Lamoreux is entitled to a lump sum payment of $100,000 and continued group health insurance coverage for six months following termination if within the subsequent two years of his employment any of the following occurs:
o A liquidation or change in control occurs (excluding an acquisition by Carl Berg or his affiliated companies of more than 50% of our voting stock, which will not constitute a change of control);
o Termination of Mr. Lamoreux's employment for any reason other than for cause; or
o Mr. Lamoreux resigns for good reason.
On June 13, 2005 Joseph Lamoreux resigned his position as Chief Operating Officer for personal reasons. Mr. Lamoreux will remain employed by the Company and will continue to assist in the transition of our operations to China and will perform other duties assigned to him by the Chief Executive Officer.
We have employment offer letters with each of our named executive officers that stipulate the initial salaries of each officer and the number of options to which the officer was initially entitled. Each letter specifies that either the employee or we, with or without cause, may terminate the employment at any time.
DIRECTORS' COMPENSATION. Our non-employee directors receive no cash compensation, for board or committee meetings, but are eligible to receive a $1,000 fee for each official quarterly board meeting, which would be paid in the form of stock options at the market price of the Company's common stock. In addition, director's are eligible for reimbursement for their expenses incurred in connection with attendance at Board meetings in accordance with Company policy. Directors who are employees do not receive separate compensation for their services as directors, but are eligible to receive stock options under our 2000 Stock Option Plan.
Upon appointment to the Board of Directors, each non-employee director is entitled to receive $10,000 as a training fee. Each of our non-employee directors also receives stock option grants pursuant to the 1996 Non-Employee Directors' Stock Option Plan, which we refer to as the Directors' Plan, or the 2000 Stock Option Plan. Only non-employee directors or an affiliate of those directors as defined in the Internal Revenue Code (the "Code") are eligible to receive options under the Directors' Plan. New directors will receive initial stock options to purchase 100,000 shares of common stock upon election to the Board. The per share exercise price for these options will be the fair market value of a share of our common stock on the day prior to the option grant date. These options will vest one-fifth on the first and second anniversaries of the date of grant of the options, and equal quarterly installments over the next three years. A director who had not received options upon becoming a director, received stock options to purchase 100,000 shares on the date of the adoption of the Directors' Plan.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. During the fiscal year ended March 31, 2005, the Compensation Committee consisted of Messrs. Shugart and Berg.
In July 1990, we entered into a loan agreement with Baccarat Electronics, Inc. Baccarat subsequently assigned all of its rights, duties and obligations under that agreement, as the same has been amended from time to time, to Berg & Berg, a company controlled by Carl Berg, a principal stockholder and one of our directors. The loan agreement, as amended, allowed us to borrow, prepay and re-borrow up to $15.0 million under a promissory note on a revolving basis. The loan bears interest at one percent over the interest rate on the lender's principal line of credit each year (approximately 9% at March 31, 2004). Effective December 31, 2001, we further amended the loan agreement to provide that Berg & Berg has no further obligations to loan or advance funds to us under this loan agreement, as amended. As of March 31, 2005, the principal balance and accrued and unpaid interest owing under the July 1990 loan agreement, as amended, totaled $14.95 million and $7.45 million, respectively. By amendment dated February 11, 2002, Berg & Berg agreed to extend the maturity date of the loan from September 30, 2005 to September 30, 2006. In fiscal 1998 and 1999, we issued warrants to purchase 594,031 shares of our common stock to Berg & Berg in conjunction with the amended loan agreement. The fair value of these warrants, totaling approximately $2,158,679, has been reflected as additional consideration for the loan from Baccarat.
In October 2001, we entered into a loan agreement with Berg & Berg. Under the terms of the loan agreement, Berg & Berg agreed to advance us up to $20.0 million between the date of the loan agreement and September 30, 2003. Interest on the loans accrues at 8.0% per annum, and all outstanding amounts with respect to the loans are due and payable on September 30, 2005. As of March 31, 2005, the principal balance and accrued and unpaid interest owing under this loan agreement totaled $20.0 million and $5.1 million, respectively . In conjunction with the loan agreement, Berg & Berg received a warrant to purchase 1,402,743 shares of our common stock at an exercise price of $3.208 per share. The warrants are immediately exercisable and expire on October 5, 2005.
On June 10, 2003 Berg & Berg committed to provide an additional $10 million equity commitment to supplement an existing $4 million commitment. We drew down $3 million under this commitment on each of March 5, April 19, May 24 and June 28, 2004 and $2 million on July 27, 2004 at the then-current market value of our common stock.
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 was in the form of an equity line of credit and allowed 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. To date the Company has drawn down $19 million of this funding commitment.
On June 10, 2005 we entered into a new $20 million funding commitment with Mr. Berg to provide funding in the form of equity or a secured loan on terms to be negotiated. This new commitment can be reduced by Mr. Berg by the amount of net proceeds received in a debt or equity transaction with a third party.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
EQUITY COMPENSATION PLANS
The following table summarizes information about the equity securities authorized for issuance under our compensation plans as of March 31, 2004. For a description of these plans, please see Note 15, Stockholders' Equity (Deficit), in our consolidated financial statements.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information regarding beneficial ownership of our common stock as of June 3, 2005, by:
o Each of our directors;
o Each of the named executive officers;
o All directors and executive officers as a group; and
o All other stockholders known by us to beneficially own more than 5% of the outstanding common stock.
Beneficial ownership is determined in accordance with the rules of the Commission. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of common stock subject to options held by that person that are currently exercisable or exercisable within 60 days of the date as of which this
information is provided, and not subject to repurchase as of that date, are deemed outstanding. These shares, however, are not deemed outstanding for the purposes of computing the percentage ownership of any other person.
Except as indicated in the notes to this table, and except pursuant to applicable community property laws, each stockholder named in the table has sole voting and investment power with respect to the shares shown as beneficially owned by them. Percentage ownership is based on 89,152,479 shares of common stock outstanding on June 3, 2005. Unless otherwise indicated, the address for each of the stockholders listed below is c/o Valence Technology, Inc., 6504 Bridge Point Parkway, Suite 415, Austin, Texas 78730.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Other than as described in Item 11 and below, there were no related party agreements or business transactions in fiscal 2005 that would require disclosure under this Item 13.
On January 4, 2005, the company appointed Dean F. Bogues to serve as Vice President of Sales and Marketing. Under the terms of Mr. Bogues' employment agreement he will receive an annual salary of $200,000 per year and is eligible for a bonus under a sales incentive compensation program with a target bonus payment of 50% of his annual base salary. Mr. Bogues also received stock options to purchase 220,000 shares of the Company's common stock at an exercise price of $3.21 per share, vesting over a period of four years. Under the terms of his agreement, if within the first 24 months following his initial start date, any of the following events occur:
o liquidation or a change of control (excluding an acquisition by Carl Berg or an affiliate company of more than 50% of our voting stock, which will not constitute a change of control)
o the Company terminates Mr. Bogues's employment for any reason other than for Good Cause(as defined in the employment agreement), or
o Mr. Bogues resigns for Good Reason (as defined in the employment agreement)
Mr. Bogues is entitled to a lump sum payment of $100,000 and continued group health insurance coverage or paid COBRA coverage for six months following termination of resignation.
On April 4, 2005, the Company entered into an employment agreement with Mr. Jin-Rong (JR) Hwang. Mr. Hwang serves as the Company's President of Asia-Pacific Operations and is responsible for the day-to-day operation and management of the Company's Asia-Pacific Operations business and affairs. Mr. Hwang receives an annual salary of $250,000. In connection with his employment, Mr. Hwang was granted options to purchase 250,000 shares of the Company's common stock with an exercise price of $3.10 per share. The options vest 25% on the first anniversary of his employment with the Company with the remaining 75% to vest quarterly over the three years thereafter. Under the terms of the agreement, the Company has agreed to pay Mr. Hwang a lump sum payment of $125,000 and six months of COBRA benefit payments if Valence is acquired or dissolved during the 24 months following the date of his hire and as a result Mr. Hwang is terminated or forced to resign.
PART IV
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The following table sets forth the aggregate fees billed to the Company for fiscal 2005 and 2004 by Deloitte & Touche LLP:
"Audit Fees" billed during fiscal 2005 and 2004 were for professional services rendered for the audit of our financial statements. "Audit-Related Fees" for fiscal 2005 were for services related to reviews of a Form S-3 filed with the Securities and Exchange Commission. "Audit-Related Fees" in fiscal 2004 were for services related to accounting consultation and reviews of a Form S-3 filed with the Securities and Exchange Commission. "Tax Fees" consist of fees billed for professional services rendered for tax compliance, tax advice, and tax planning. "All Other Fees" in fiscal 2005 were for consulting related to preparation of the Company for documentation of its internal controls under the requirements Section 404 of the Sarbanes-Oxley Act of 2002..
The Audit Committee has adopted a policy for the pre-approval of all audit and non-audit services to be performed for the Company by its independent registered public accounting firm. The Audit Committee has considered the role of Deloitte & Touche LLP in providing audit, audit-related and tax services to the Company and has concluded that such services are compatible with Deloitte & Touche LLP's role as the Company's independent registered public accounting firm.
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) (1) FINANCIAL STATEMENTS - See Index to Consolidated Financial Statements of this Annual Report on Form 10-K.
(2) FINANCIAL STATEMENT SCHEDULES - All financial statement schedules have been omitted because they are not applicable or are not required, or because the information required to be set forth therein is included in the Consolidated Financial Statements or Notes thereto.
(3) EXHIBITS - See Exhibit Index on pages [53-58] of this Annual Report on Form 10-K.
(b) The Company filed the following reports on Form 8-K during the last quarter of the period for which this Annual Report on Form 10-K covers:
(i) Form 8-K filed January 10, 2005 reporting under Items 1.01 and 9.01.
(ii) Form 8-K filed January 12, 2005, reporting under Items 8.01 and 9.01.
(iii) Form 8-K filed January 20, 2005, reporting under Items 1.01 and 9.01.
(iv) Form 8-K filed February 9, 2005, reporting under Items 2.02 and 9.01.
(v) Form 8-K filed February 15, 2005, reporting under Items 8.01 and 9.01.
(vi) Form 8-K filed February 16, 2005, reporting under Item 3.02.
(vii) Form 8-K filed March 3, 2005, reporting under Items 8.01 and 9.01.
(viii) Form 8-K filed March 16, 2005, reporting under Item 3.02.
(ix) Form 8-K filed March 22, 2005, reporting under Items 8.01 and 9.01.
(c) See Exhibit Index on pages 42-44 of this Form 10-K Annual Report.
(d) None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
VALENCE TECHNOLOGY, INC.
/s/ Stephan B. Godevais Dated: June 14, 2005 --------------------------------------- Stephan B. Godevais Chief Executive Officer, President and Chairman of the Board
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints Stephan B. Godevais and Kevin W. Mischnick, and each of them, as his true and lawful attorneys-in-fact and agents with full power of substitution and resubstitution, for him and his name, place and stead, in any and all capacities, to sign any or all amendments to this Annual Report on Form 10-K and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the foregoing, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or either of them, or their substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of Registrant and in the capacities and on the dates indicated.
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements for external reporting purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management has carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Principal Financial Officer, of the effectiveness of our internal control over financial reporting as of March 31, 2005. In performing this evaluation, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework . Based on our assessment of internal control over financial reporting, our management has concluded that, as of March 31, 2005, our internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Deloitte & Touche LLP, the independent registered public accounting firm that audited the consolidated financial statements included in this annual report on Form 10-K, has issued an attestation report on management's assessment of our internal control over financial reporting.
June 14, 2005
/s/ Stephan B. Godevais - ---------------------------------------- Stephan B. Godevais Principal Executive Officer
/s/ Kevin W. Mischnick - ---------------------------------------- Kevin W. Mischnick Principal Financial Officer
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Valence Technology, Inc. and subsidiaries Austin, Texas
We have audited the accompanying consolidated balance sheets of Valence Technology, Inc. and subsidiaries (the "Company") as of March 31, 2005 and 2004, and the related consolidated statements of operations and comprehensive loss, stockholders' equity (deficit), and cash flows for each of the three years in the period ended March 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of March 31, 2005 and 2004, and the results of their operations and comprehensive loss and their cash flows for each of the three years in the period ended March 31, 2005, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of March 31, 2005, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 14, 2005 expressed an unqualified opinion on management's assessment of the effectiveness of the Company's internal control over financial reporting and an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
DELOITTE & TOUCHE LLP
Austin, Texas June 14, 2005
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Valence Technology, Inc. and subsidiaries Austin, Texas
We have audited management's assessment, included in the accompanying Management's Report on Internal Controls over Financial Reporting, that Valence Technology, Inc and subsidiaries (the "Company") maintained effective internal control over financial reporting as of March 31, 2005, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective internal control over financial reporting as of March 31, 2005, is fairly stated, in all material respects, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2005, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended March 31, 2005 of the Company and our report dated June 14, 2005 expressed an unqualified opinion on those financial statements.
DELOITTE & TOUCHE LLP
Austin, Texas June 14, 2005
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) for the years ended March 31, 2005, 2004, and 2003 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
1. BUSINESS AND BUSINESS STRATEGY:
Valence Technology, Inc. (with its subsidiaries, "the Company") was founded in 1989 and has commercialized the industry's first phosphate-based lithium-ion 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 Saphion(R) battery technology, the 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, but primarily in 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 product sales, 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 started operations during the third and fourth quarter 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 through the Company's own product launches, such as the N-Charge(TM) Power System, K-Charge(TM) Power System, and U-Charge(TM) Power System, and through products designed by others. In addition, the Company expect to continue to pursue a licensing strategy as our Saphion(R) technology receives greater market acceptance.
2. LIQUIDITY AND CAPITAL RESOURCES:
At March 31, 2005, the Company's principal sources of liquidity were cash and cash equivalents of $2.5 million and $6 million remaining under the $20 million backup equity funding commitment entered into in June 2004 with Mr. Carl Berg. Subsequent to March 31, 2005 the Company has drawn down an additional $5 million of this prior commitment. On June 10, 2005 the Company entered into a new $20 million funding commitment with Mr. Berg to provide funding in the form of equity or a secured loan on terms to be negotiated. This new commitment can be reduced by Mr. Berg by the amount of net proceeds received in a debt or equity transaction with a third party.
At March 31, 2005, the Company had $4.3 million of Series C-1 Convertible Preferred Stock and $4.3 million of Series C-2 Convertible Preferred Stock outstanding. The Series C-1 Convertible Preferred Stock and Series C-2 Convertible Preferred Stock are convertible into common stock at $4.00 per share and are redeemable on December 15, 2005 (subject to an early right of redemption in the case of the Series C-2 Convertible Preferred Stock during the 30 days following June 15, 2005 and September 15, 2005). Applicable provisionsof Delaware corporate law restrict the Company's ability to redeem the preferred stock. If the Company does not redeem the shares when required by their terms, the conversion price will be reduced to an amount equal to 95% of the lowest closing bid price of the Company's common stock during the three days ending on and including the conversion date.
The Company's current forecast projects that these sources of liquidity will be sufficient for at least the twelve months following March 31, 2005. This forecast assumes product sales during fiscal 2006 from the N-Charge(TM) Power System and the Segway pack, which are subject to seasonal fluctuations, of between $2.5 - $5.0 million per quarter, and expect additional revenues from the sale of the U-Charge(TM) Power System into large-format applications and direct cell sale activities. The Company also anticipate further cash benefits from continued reductions in operating expenses and manufacturing costs, offset by small increases to capital expenditures associated with continuing efforts in China.
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. These events could have a negative impact on the Company's available liquidity sources during the next 12 months.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
USE OF ESTIMATES:
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the revenues and expenses for the period. Actual results could differ from those estimates.
PRINCIPLES OF CONSOLIDATION:
The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, and its majority-owned joint venture. Significant intercompany balances and transactions are eliminated upon consolidation.
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 their inventory reporting. For direct customers, the Company estimates a return rate 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.
CONCENTRATION OF CREDIT RISK:
Financial instruments that potentially subject the Company to concentrations of credit risk are primarily accounts receivable and cash and cash equivalents. The Company provides an allowance for doubtful accounts based upon the expected collectibility of accounts receivable. Credit losses to date have been within the Company's estimates.
Cash and cash equivalents are invested in deposits with a major financial institution. The Company has not experienced any losses on its deposits of cash and cash equivalents. Management believes that the financial institution is financially sound and, accordingly, minimal credit risk exists.
CASH AND CASH EQUIVALENTS:
The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.
INVENTORY:
Inventory is stated at the lower of cost (determined using the first-in, first out method) or market.
FAIR VALUE OF FINANCIAL INSTRUMENTS:
Financial instruments that potentially subject the Company to an interest and credit risk consist of cash and cash equivalents, trade receivables, accounts payable, and accrued expenses, the carrying value of which are a reasonable
estimate of their fair values due to their short maturities. Based on borrowing rates currently available to the Company for loans with similar terms, the carrying value of its debt obligations and grant payable approximate fair value.
INVESTMENTS:
The Company accounts for its investments in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities". Under SFAS No. 115, the Company classifies its securities as held-to-maturity. Held to maturity securities are those investments in which the Company has the ability and intent to hold the security until maturity. Held to maturity securities are recorded at amortized cost, which approximates market value. As of March 31, 2005, the Company had no held to maturity securities. Dividend and interest income are recognized in the period earned.
PROPERTY, PLANT AND EQUIPMENT:
Property and equipment are stated at cost and depreciated on the straight-line method over their estimated useful lives, generally three to five years. Leasehold improvements are amortized over the lesser of their estimated useful life, generally five years, or the remaining lease term.
Expenditures for renewals and betterments are capitalized; repairs and maintenance are charged to expense as incurred. The cost and accumulated depreciation of assets sold or otherwise disposed of are removed from the accounts and any gain or loss thereon is reflected in operations.
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.
INTELLECTUAL PROPERTY:
Intellectual properties acquired consist of patents and are recorded at cost based on the market value of the common stock used in their acquisition. The costs are amortized over the estimated remaining life of the patents.
RESEARCH AND DEVELOPMENT:
Research and development costs are expensed as incurred.
WARRANTY:
The Company records warranty liabilities at the time of sale for the estimated costs that may be incurred under its basic limited warranty. The warranty terms and conditions generally provide for replacement of defective products. Factors that affect the Company's warranty liability include the number of units currently under warranty, historical and anticipated rates of warranty claims on those units, and cost per claim to satisfy the Company's warranty obligation. Each quarter, the Company re-evaluates its estimates to assess the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. See Note 13, Commitments and Contingencies.
SHIPPING AND HANDLING COSTS:
In accordance with Emerging Issues Task Force No. 00-10, "Accounting for Shipping and Handling Fees and Costs", the Company recognizes as revenue amounts billed to customers related to shipping and handling, with related expenses recorded as a component of cost of sales.
ADVERTISING COSTS:
Advertising costs are charged to expense as incurred. Advertising expenses for fiscal 2005, 2004, and 2003, were $468,000, $1.3 million, and $611,000, respectively.
FOREIGN CURRENCY:
The assets and liabilities of the Company's foreign subsidiaries have been translated to U.S. dollars using the exchange rate in effect at the balance sheet date. Results of operations have been translated using the average exchange rate during the year. Resulting translation adjustments have been recorded as a separate component of stockholders' equity (deficit) as accumulated other comprehensive loss. Foreign currency transaction gains and losses are included in the consolidated statement of operations as they occur.
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 2005, 2004, and 2003 consistent with the provisions of SFAS 123, as amended by SFAS 148, the pro forma net loss would have been reported as follows (in thousands):
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 fiscal years 2005, 2004, and 2003:
2005 2004 2003 -------------------------------------------- Risk-free Interest Rate 3.69% 2.84% 2.85% Expected Life 5.0 years 5.0 years 4.71 years Volatility 101.58% 106.74% 106.52% Dividend Yield - - -
COMPREHENSIVE INCOME/LOSS:
Comprehensive income/loss is the change in stockholder's equity (deficit) from foreign currency translation gains and losses.
NEW ACCOUNTING STANDARDS:
In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 46 ("FIN 46"), CONSOLIDATION OF VARIABLE INTEREST ENTITIES, AN INTERPRETATION OF ARB NO. 51, which addresses consolidation by business enterprises of variable interest entities ("VIEs") either: (1) that do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) in which the equity investors lack an essential characteristic of a controlling financial interest. In December 2003, the FASB completed deliberations of proposed modifications to FIN 46 (Revised Interpretations) resulting in multiple effective dates based on the nature as well as the creation date of the VIE. VIEs created after January 31, 2003, but prior to January 1, 2004, may be accounted for either based on the original interpretation or the Revised Interpretations. However, the Revised Interpretations must be applied no later than the first quarter of fiscal year 2004. VIEs created after January 1, 2004 must be accounted for under the Revised Interpretations. The adoption of these deferred provisions in 2004 had no effect on the Company's financial position, results of operations or cash flows.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. The standard requires that abnormal amounts of idle capacity and spoilage costs should be excluded from the cost of inventory and expensed when incurred. The provision is effective for fiscal periods beginning after June 15, 2005. The Company does not expect the adoption of this standard to have a material effect on its financial position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB No. 29, Accounting for Nonmonetary Transactions. SFAS No. 153 requires exchanges of productive assets to be accounted for at fair value, rather than at carryover basis, unless (1) neither the asset received nor the asset surrendered has a fair value that is determinable within reasonable limits or (2) the transactions lack commercial substance. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company does not expect the adoption of this standard to have a material effect on its financial position, results of operations or cash flows.
In December 2004, the FASB released its final revised standard, SFAS No. 123R, Share-Based Payment. SFAS No. 123R requires that an entity measure the cost of equity based service awards using the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award or the vesting period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. An entity will initially measure the cost of liability based service awards using its current fair value; the fair value of that award will be re-measured subsequently at each reporting date through the settlement date. Changes in fair value during the requisite service period will be recognized as compensation cost over that period. Adoption of SFAS No. 123R is required for fiscal periods beginning after June 15, 2005. The Company is evaluating SFAS 123R and believes that it will likely have a material effect on its financial position and results of operations.
INCOME TAXES:
The Company utilizes the liability method to account for income taxes where deferred tax assets or liabilities are determined based on the differences between the financial reporting and tax reporting bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
NET LOSS PER SHARE:
Net loss per share is computed by dividing the net loss by the weighted average shares of common stock outstanding during the period. The dilutive effect of the options and warrants to purchase common stock are excluded from the computation of diluted net loss per share, since their effect is antidilutive. The antidilutive instruments excluded from the diluted net loss per share computation at March 31 were as follows:
4. IMPAIRMENT CHARGE:
During the quarter ended March 31, 2003, the Company recorded an impairment charge of $258,000 on the property in Henderson, Nevada related to the planned sale of this facility. The Company estimated that the expected future cash flows related to the facility were less than the asset carrying value of $3 million and adjusted the assets to their fair value accordingly. Fair value was based upon quoted market price for the facility.
An impairment charge of approximately $13.7 million was recorded during the fiscal quarter ended September 30, 2003. The charge was recorded pursuant to FASB Statement No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets." During the second quarter of fiscal 2004 the Company completed qualification of its OEM manufacturer in China, ATL, for Saphion(R) products. In addition, the Company announced the formation of a manufacturing joint venture in China with Fengfan Group, Ltd. The Company has transitioned all manufacturing from its Northern Ireland
facility to China and other low-cost manufacturing regions as of December 31, 2003, and has ceased all manufacturing operations in its Northern Ireland facility as of the end of calendar 2003. The Company also experienced progress on the development of cylindrical battery construction technology and now expects greater emphasis on the licensing of cylindrical technology to the detriment of the licensing of stacked technology (which was the technology acquired from Telcordia in December 2000). As a result of these developments, the Company determined that the future cash flows expected to be generated from its Northern Ireland facility and stacked technology intellectual property acquired in the Telcordia transaction in December 2000 did not exceed their carrying value. This determination resulted in the net impairment charge against property, plant, and equipment and intellectual property to record these assets at their fair value. The Company determined that assets with a carrying amount of approximately $19.5 million should be written down by approximately $13.7 million to their fair value. Fair value was based on estimated future cash flows to be generated by these assets, discounted at the Company's market rate of interest of 8%.[You need to update disclosure as it relates to forward looking disclosures regarding licensing reveneue and manufacturing capability.]
An impairment charge of $87,000 was recorded during the fiscal quarter ended September 30, 2004 pursuant to FASB Statement No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets." 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.
5. INVENTORY:
Inventory consisted of the following (in thousands) at:
March 31, ---------------------------- 2005 2004 ------------ ------------ Raw materials $ 464 $ 317 Work in process 880 1,330 Finished goods 1,220 1,671 ------------ ------------ Total inventory $ 2,564 $ 3,318 ============ ============
6. PREPAID AND OTHER CURRENT ASSETS:
Prepaid and other current assets consisted of the following (in thousands) at:
March 31, ---------------------------- 2005 2004 ------------ ------------ Other receivables $ 9 $ 101 Deposits 124 73 Prepaid insurance 221 351 Other prepaids 566 312 ------------ ------------ Total other current assets $ 920 $ 837 ============ ============
7. INTELLECTUAL PROPERTY:
Intellectual property consisting of stacked battery construction technology acquired from Telcordia Technologies, Inc. in December 2000 is amortized over five years. Intellectual property, net of accumulated amortization and impairment, consisted of the following (in thousands) at:
Amortization expense was approximately $114, $781 and $1,450 for the fiscal years ended March 31, 2005, 2004 and 2003, respectively. Amortization expense on intellectual property at March 31, 2005 will be $114 for fiscal years 2006 through 2008 and $58 for fiscal year 2009.
8. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment, net of impairment, consisted of the following (in thousands) at:
9. ACCRUED EXPENSES:
Accrued expenses consisted of the following (in thousands) at:
March 31, ---------------------------- 2005 2004 ------------ ------------ Accrued compensation $ 664 $ 1,104 Professional services 167 243 Warranty reserve 1,067 490 Other accrued expenses 2,709 1,718 ------------ ------------ Total accrued expenses $ 4,607 $ 3,555 ============ ============
10. NOTE PAYABLE:
In January 2004, the Company's joint venture purchased a land permit for its facility for a price of approximately $3.2 million, consisting of approximately $1.1 million in cash and a $2.1 million in a note payable due sixty days from purchase. The obligation was retired as part of the settlement agreement. See Note 19, Joint Venture.
11. LONG-TERM DEBT:
Long-term debt consisted of the following (in thousands) at:
March 31, ---------------------------- 2005 2004 ------------ ------------ Facility loans $ - $ 6,425 Less amounts due within one year - (967) ------------ ------------ Long-term debt, less current portion $ - $ 5,458 ============ ============
On December 22, 2004, the Company completed the sale of its Northern Ireland manufacturing facility and retired the related facility loans.
DEBT TO STOCKHOLDER CONSISTED OF THE FOLLOWING (IN THOUSANDS):
March 31, ----------------------------- 2005 2004 ------------- ------------- 2001 loan balance $ 20,000 $ 20,000 1998 loan balance 14,950 14,950 Unaccreted debt discount (294) (1,001) ------------- ------------- Balance at year-end $ 34,656 $ 33,949 ============= =============
Principal payments of debt to stockholder are as follows (in thousands):
In October 2001, the Company entered into a loan agreement ("2001 Loan") with Berg & Berg. Under the terms of the agreement, Berg & Berg agreed to advance the Company funds of up to $20 million between the date of the agreement and September 30, 2003. Interest on the 2001 Loan accrues at 8.0% per annum, payable from time to time, 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 March 31, 2005, accrued interest on the loan totaled $5.086 million, which is included in long-term interest. In conjunction with the 2001 Loan, Berg & Berg received a warrant to purchase 1,402,743 shares of the Company's common stock at the price of $3.208 per share. The warrants were exercisable beginning on the date they were issued and expire on August 30, 2005. The fair value assigned to these warrants, totaling approximately $2.768 million has been reflected as additional consideration for the debt financing, recorded as a discount on the debt and accreted as interest expense over the life of the loan. The warrants were valued using the Black-Scholes method using the assumptions of a life of 47 months, 100% volatility, and a risk free rate of 5.5%. Through March 31, 2005, a total of $2.473 million has been accreted and included as interest expense. The amounts charged to interest expense on the outstanding balance of the loan for the fiscal years ended March 31, 2005, 2004, and 2003 were $1.622 million, $1.627 million, and $1.465 million, respectively. Interest payments on the loan are currently being deferred, and are recorded as long-term interest.
In July 1998, the Company entered into an amended loan agreement ("1998 Loan") with Berg & Berg that allows the Company to borrow, prepay and re-borrow up to $10 million principal under a promissory note on a revolving basis. In November 2000, the 1998 Loan agreement was amended to increase the maximum amount to $15 million. As of March 31, 2005, the Company had an outstanding balance of $14.95 million under the 1998 Loan agreement. The loan bears interest at one percent over lender's borrowing rate (approximately 9.0% at March 31, 2005). On October 21, 2004, the parties agreed to extend the loan's maturity date 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 March 31, 2005, accrued interest on the loan totaled $7.45 million, which is included in long-term interest. In fiscal 1999, the Company issued warrants to purchase 594,031 shares of common stock to Berg & Berg in conjunction with the 1998 Loan agreement, as amended. The warrants were valued using the Black Scholes
valuation method and had an average weighted fair value of approximately $3.63 per warrant at the time of issuance. The fair value of these warrants, totaling approximately $2.159 million, has been reflected as additional consideration for the debt financing, recorded as a discount on the debt and accreted as interest expense to be amortized over the life of the line of credit. As of March 31, 2005, a total of $2.159 million has been accreted. The amounts charged to interest expense for each of the fiscal years ended on March 31, 2005, 2004, and 2003 were $1.349 million. Interest payments on the loan are currently being deferred, and are recorded as long-term interest.
All of our assets are pledged as collateral under the 2001 Loan and the 1998 Loan.
12. SETTLEMENT AGREEMENT
Since 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, totaling (pound)9.0 million. Under certain circumstances, INI had the right to reclaim a portion of these grants and had a security interest in the facility's land, building, and equipment. On December 21, 2004, the Company and INI entered into a settlement agreement pursuant to which INI agreed to release the Company of all outstanding claims and other obligations owing to INI in connection with grants previously provided to the Company. Under the terms of the settlement agreement the Company agreed to pay INI (pound)3 million consisting of a (pound)2 million payment in cash and a (pound)1 million payment in common stock. In order to fund the (pound)1 million common stock payment the Company issued 539,416 shares of common stock, equivalent to $3.60 per share. In connection with this final settlement, the Company recorded an additional charge of $957,000 during the third quarter of fiscal year 2005.
13. COMMITMENTS AND CONTINGENCIES:
LEASES:
Total rent expense for the years ended March 31, 2005, 2004 and 2003 was approximately $936,000, $885,000, and $662,000, respectively. Future minimum payments on leases for years following March 31, 2005 (in thousands) are:
Fiscal Year ----------- 2006 $ 886 2007 614 2008 387 2009 122 2010 -
On December 12, 2003, the Company closed the sale of its Henderson, Nevada building and land with net book value of $2.664 million for net proceeds of $2.685 million. A gain of $21,000 was recorded on the sale. The Company is leasing the facility month-to-month for $20,000 per month.
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 also established a warranty reserve in relation to the sale of its K-Charge(TM) Power Systems and its U-Charge(TM) Power Systems, and its other large-format power systems. 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.
Product warranty liabilities at the years ended March 31, 2005 and March 31, 2004 are as follows (in thousands):
March 31, -------------------------------- 2005 2004 --------------- --------------- Beginning balance $ 490 $ 123 Less: claims (695) (445) Less: returns (33) (34) Plus: accruals 1,305 846 -------------------------------- Ending balance $ 1,067 $ 490 ================================
LITIGATION:
The Company is subject to various claims and litigation in the normal course of business. In the opinion of management, all pending legal matters are either covered by insurance or, if not insured, will not have a material adverse impact on the Company's consolidated financial statements.
14. REDEEMABLE CONVERTIBLE PREFERRED STOCK:
On June 2, 2003, the Company issued 1,000 shares of Series C Convertible Preferred Stock and warrants to purchase the Company's common stock for $10,000 per share, raising net proceeds of $9.416 million. On January 22, 2004, the holder of the Series C 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. On November 30, 2004, the Company entered into an amendment and exchange agreement to exchange all of the outstanding 861 shares of the Company's Series C Convertible Preferred Stock, representing $8.6 million of principal. The Series C Convertible Preferred Stock was exchanged for 431 shares of Series C-1 Convertible Preferred Stock, with a stated value of $4.3 million, and 430 shares of Series C-2 Convertible Preferred Stock, with a stated value of $4.3 million. Under the terms of the Company's new Series C-1 Convertible Preferred Stock and Series C-2 Convertible Preferred Stock, the preferred stock is convertible into common stock at $4.00 per share, carry a 2% annual dividend rate, payable quarterly in cash or shares of common stock, and mature on December 15, 2005. The new series of preferred stock are identical in all respects except that the holder of the Series C-2 Convertible Preferred Stock will have the right to require the Company to redeem the Series C-2 Convertible Preferred Stock at any time during the 30 days following June 15, 2005 and September 15, 2005. 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. If the preferred shares are not redeemed in accordance with their terms, the holder of the preferred stock shall have the option to require the Company to convert all or part of the redeemed shares at a share price of 95% of the lowest closing bid price of the Company's common stock during the three days ending on and including the conversion date.
In connection with the issue of the initial issuance of the Series C Convertible Preferred Stock, the Company issued to the Series C Convertible Preferred Stock 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 Convertible Preferred Stock at $933,000. Accretion to the remaining redemption value of $8.6 million was recorded over the eighteen-month period of the Series C Convertible Preferred Stock ending December 2, 2004.
15. STOCKHOLDERS' EQUITY (DEFICIT):
STOCK OPTIONS AND WARRANTS:
The Company has a stock option plan (the "1990 Plan") under which options granted may be incentive stock options or supplemental stock options. Options are to be granted at a price not less than fair market value (incentive options) or 85% of fair market value (supplemental options) on the date of grant. The options vest as determined by the Board of Directors and are generally exercisable over a five-year period. Unvested options are canceled and returned to the 1990 Plan upon an employee's termination. Generally, vested options, not exercised within three months of termination, are also canceled and returned to the Plan. The 1990
Plan terminated on July 17, 2000, and as such options may not be granted after that date. Options granted prior to July 17, 2000 expire no later than ten years from the date of grant.
In February 1996, the Board of Directors adopted a stock plan for outside Directors (the "1996 Non-Employee Director's Stock Option Plan"). The plan provides that new directors will receive an initial stock option of 100,000 shares of common stock upon their election to the Board. The exercise price for this initial option will be the fair market value on the day it is granted. This initial option will vest one-fifth on the first and second anniversaries of the grant of the option, and quarterly over the next three years. A director who had not received an option upon becoming a director will receive an initial stock option of 100,000 shares on the date of the adoption of the plan. During fiscal years 2004 and 2005, no shares were granted under this plan. As of March 31, 2005, a total of 21,260 shares remained available for grant under this plan.
In October 1997, the Board of Directors adopted the 1997 Non-Officer Stock Option Plan (the "1997 Plan"). The Company may grant options to non-officer employees and consultants under the 1997 Plan. Options are to be granted at a price not less than fair market value (incentive options) on the date of grant. The options vest as determined by the Board of Directors, generally quarterly over a three- or four-year period. The options expire no later than ten years from the date of grant. Unvested options are canceled and returned to the 1997 Plan upon an employee's termination. Vested options, not exercised within three months of termination, also are canceled and returned to the 1997 Plan. During fiscal year 2005, a total of 21,000 shares were granted under this plan. At March 31, 2005, the Company had 701,490 shares available for grant under the 1997 Plan.
In January 2000, the Board of Directors adopted the 2000 Stock Option Plan (the "2000 Plan"). The Company may grant incentive stock options to employees and non-statutory stock options to non-employee members of the Board of Directors and consultants under the 2000 Plan. Options are to be granted at a price not less than fair market value on the date of grant. In the case of an incentive stock option granted to an employee who owns stock possessing more than 10% of the total combined voting power of all classes of stock of the Company or any affiliate, the option is to be granted at a price not less than 110% of the fair market value on the date of grant. The options are exercisable as determined by the Board of Directors, generally over a four-year period. The options expire no later than ten years from the date of grant. Unvested options are canceled and returned to the 2000 Plan upon an employee's termination. Vested options, not exercised within three months of termination, also are canceled and returned to the 2000 Plan. During fiscal year 2005, a total of 1,778,000 shares were granted under this plan. At March 31, 2005, the Company had 1,192,259 shares available for grant under the 2000 Plan. At March 31, 2005, the Company had committed 364,000 shares for future options to its China-based employees.
Aggregate option activity is as follows (shares in thousands):
Outstanding Options --------------------------------- Number of Weighted Avg. Shares Exercise Price ----------- Balance, March 31, 2003 8,831 $5.68 ----------- Granted 626 $4.34 Exercised (246) $1.68 Canceled (606) $5.41 ----------- Balance, March 31, 2004 8,605 $5.73 ----------- Granted 1,799 $3.12 Exercised (315) $1.72 Canceled (825) $7.99 ----------- Balance, March 31, 2005 9,264 $5.17 ===========
At March 31, 2005, 2004, and 2003, vested options to purchase 6,869,531, 5,699,000, and 4,225,000, shares, respectively, were unexercised.
The following table summarizes information about fixed stock options outstanding at March 31, 2005 (shares in thousands):
At March 31, 2005, the Company has reserved approximately 13,068,000 shares of common stock for the exercise of stock options and warrants.
16. SIGNIFICANT CUSTOMERS:
In the year ended March 31, 2005, 46% of revenue and 41% of trade receivables were from three customers. Revenues from three significant customers represented a total of 26% of total revenues for the year ended March 31, 2003 and a total of 69% of the trade accounts receivable at March 31, 2003. For fiscal year 2002, six customers represented 83% of total revenues for the year and 65% of trade accounts receivable at March 31, 2002.
17. INCOME TAXES:
There was no recorded income tax benefit related to the losses of fiscal years 2005, 2004 or 2003 due to the uncertainty of the Company generating taxable income to utilize its net operating loss carryforwards. The provision for income taxes differs from the amount computed by applying the federal statutory rate of 34% to the loss before income taxes as follows:
Year Ended March 31, -------------------------------- 2005 2004 2003 --------- ---------- ---------- Federal tax benefit at statutory rate $ (10,665) $ (18,685) $12,886) Rate differential - foreign (74) 888 403 Impact of foreign rate change 1,159 - - State tax provision (96) (371) (435) Expenses not deductible for tax (61) (39) 20 Research and experimentation credit - (306) (175) Foreign losses not available as carryforward 3,924 6,001 4,247 Change in valuation allowance 5,813 12,512 8,826 --------- --------- ---------- Tax provision $ - $ - $ - ========= ========= ==========
The components of the net deferred tax asset as of March 31, 2005 and 2004 were as follows (in thousands):
At March 31, 2005 the Company had federal net operating loss carryforwards available to reduce future taxable income of approximately $189.0 million. The valuation allowance increased by approximately $5.8 million during the year ended March 31, 2005 primarily due to operating losses not benefited.
The carryforwards expire from 2008 to 2025, if not used before such time to offset future taxable income.
For federal tax purposes, the Company's net operating loss carryforwards are subject to certain limitations on annual utilization because of changes in ownership, as defined by federal tax law. The Company also has foreign operating loss carryforwards available to reduce future foreign income of approximately $152.9 million.
18. EMPLOYEE BENEFIT PLAN:
The Company has a 401(k) plan (the "Plan") as allowed under Section 401(k) of the Internal Revenue Code. The Plan provides for the tax deferral of compensation by all eligible employees. All United States employees meeting certain minimum age and service requirements are eligible to participate under the Plan.
Under the Plan, participants may voluntarily defer up to 25% of their paid compensation, subject to specified annual limitations. The Plan does not provide for, and the Company has not made, contributions under the Plan.
19. JOINT VENTURE:
On July 9, 2003, Baoding Fengfan - Valence Battery Company, a joint venture (the "JV Company") 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. However, during the first quarter of fiscal 2005, a dispute arose between us and our joint venture partner, resulting in a loss of control over the joint venture and our initiation of an action to enforce our rights under the joint venture agreement and, commencing with that quarter we accounted for our investment in the joint venture under the cost method with no further recognition of assets, liabilities, operating results, and cash flows.
On November 17, 2004, the Company, Fengfan and the JV Company entered into a settlement agreement (the "JV Settlement Agreement"). Under the terms of the JV Settlement Agreement, the parties agreed to liquidate and dissolve
the JV Company, terminate the JV Company contracts and fully settle any and all remaining obligations among the parties. The Company agreed to make compensation payments to the JV Company and to Fengfan totaling $224,417 and to make equipment purchases from the JV Company totaling $275,583. To date, the Company has made compensation payments of $157,092 and completed all of the equipment purchases. The $67,325 final compensation payment will be made upon final dissolution of the JV legal entity by Fengfan. The Company recorded a contract settlement charge of $224,417 in the third quarter of fiscal 2005 for the compensation payments and capitalized equipment purchases as the payments were made.
20. FACILITY CLOSING:
In the third quarter of fiscal 2003, the Company ceased production at its Northern Ireland facility and commenced the transfer of manufacturing to ATL and other third party manufacturers. All inventory remaining at the conclusion of manufacturing operations was determined to be obsolete and unusable by any of the Company's battery manufacturing sources. Raw materials inventory obsolescence expense of approximately $178,000 and work in process inventory obsolescence expense of approximately $517,000 were recorded as restructuring charges during the quarter ended December 31, 2003. Remaining payment obligations for factory equipment operating leases that extended beyond December 31, 2003 were approximately $231,000. These lease payment obligations provide no economic benefit to the Company, and contractual lease costs of approximately $231,000 were recorded as restructuring charges during the quarter ended December 31, 2003. When the Northern Ireland manufacturing transition was initiated, an incentive payment plan was established for certain employees. The employees earned the bonus, which was paid in January 2004, if they were in good standing on December 31, 2003. The cost of this bonus plan was $352,000 and was charged to general and administrative expense during the quarter ended December 31, 2003.
Liabilities related to restructuring at March 31, 2004 consisted of inactive operating leases of approximately $146,000.
21. RELATED PARTY TRANSACTIONS:
In June of 2005, the Company entered into a new $20 million funding commitment with Mr. Berg to provide funding in the form of equity or a secured loan on terms to be negotiated. This new commitment can be reduced by Mr. Berg by the amount of net proceeds received in a debt or equity transaction with a third party.
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 was in the form of an equity line of credit and allowed 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 March 31, 2005, the Company has drawn down $14 million of this commitment and subsequently drew down an additional $5 million. 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 the date of this report, Mr. Berg has not requested that his commitment be reduced.
On January 1, 1998, the Company granted options to Mr. Dawson, the Company's then Chairman of the Board, Chief Executive Officer and President, an incentive stock option to purchase 39,506 shares, which was granted pursuant to the Company's 1990 Plan (the "1990 Plan"). Also, an option to purchase 660,494 shares was granted pursuant to the Company's 1990 Plan and an option to purchase 300,000 shares was granted outside of any equity plan of the Company, neither of which were incentive stock options (the "Nonstatutory Options"). The exercise price of all three options is $5.0625 per share, the fair market value on the date of the grant. The Compensation Committee of the Company approved the early exercise of the Nonstatutory Options on March 5, 1998. The options permitted exercise by cash, shares, full recourse notes or non-recourse notes secured by independent collateral. The Nonstatutory Options were exercised on March 5, 1998 with non-recourse promissory notes in the amounts of $3,343,750 ("Dawson Note One") and $1,518,750 ("Dawson Note Two") (collectively, the "Dawson Notes") secured by the shares acquired upon exercise plus 842,650 shares previously held by Mr. Dawson. As of March 31, 2005, amounts of $3,550,313 and $1,613,458 were outstanding under Dawson Note One and Dawson Note Two, respectively, and under each of the Dawson Notes, interest from the Issuance Date accrues on unpaid principal at the rate of 5.69% per annum, or at the maximum rate permissible by law, whichever is less.
In accordance with the Dawson Notes, interest is payable annually in arrears and has been paid through March 4, 2005.
22. 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.
The Company conducts its business in two geographic segments.
Long-lived asset information by geographic area at March 31, 2005 and 2004 is as follows (in thousands):
March 31, ---------------------------- 2005 2004 ------------ ------------ United States $ 987 $ 1,656 International 1,796 11,076 ------------ ------------ Total $ 2,783 $ 12,732 ============ ============
Revenues by geographic area for the years ended March 31, 2005, 2004 and 2003 are as follows (in thousands):
2005 2004 2003 ------------ ------------ ------------ United States $ 9,656 $ 7,229 $ 1,726 International 1,009 2,217 831 ------------ ------------ ------------ Total $ 10,665 $ 9,446 $ 2,557 ============ ============ ============