-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TQerYdWSSeQHA0vR+E45iE+GI9yNXcdwczB4XF6zKpSJ8iPrrphmTcwX4KfDzHCL W6r91+PDPWfBQqejhT7/xw== 0001011438-07-000340.txt : 20070614 0001011438-07-000340.hdr.sgml : 20070614 20070614170556 ACCESSION NUMBER: 0001011438-07-000340 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20070331 FILED AS OF DATE: 20070614 DATE AS OF CHANGE: 20070614 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VALENCE TECHNOLOGY INC CENTRAL INDEX KEY: 0000885551 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS ELECTRICAL MACHINERY, EQUIPMENT & SUPPLIES [3690] IRS NUMBER: 770214673 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-20028 FILM NUMBER: 07920586 BUSINESS ADDRESS: STREET 1: 12201 TECHNOLOGY BOULEVARD, SUITE 150 CITY: AUSTIN STATE: TX ZIP: 78727 BUSINESS PHONE: 5125272900 MAIL ADDRESS: STREET 1: 12201 TECHNOLOGY BOULEVARD, SUITE 150 CITY: AUSTIN STATE: TX ZIP: 78727 10-K 1 form_10k-valence.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the fiscal year ended March 31, 2007 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission file number 0-20028 VALENCE TECHNOLOGY, INC. (Exact name of Registrant as specified in its charter) DELAWARE 77-0214673 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 12201 TECHNOLOGY BOULEVARD, SUITE 150 AUSTIN, TEXAS 78727 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (512) 527-2900 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common stock, $.001 par value Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X] Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [ ] No [X] Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers, pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of "accelerated filer" or "large accelerated filer" in Rule 12b-2 of the Exchange Act. Large Accelerated Filer [ ] Accelerated Filer [X] Non-accelerated filer [ ] Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [X] The aggregate market value of the Registrant's common equity held by non-affiliates was $103,949,823 as of September 30, 2006, the last business day of the registrant's most recently completed second fiscal quarter and based upon the average bid and asked price of the Registrant's Common Stock. This calculation excludes approximately 54,331,258 shares of Common Stock held by directors, officers and holders of 5% or more of Registrant's outstanding Common Stock and such exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the Registrant, or that such person is controlled by or under common control with the Registrant. The number of shares outstanding of the Registrant's Common Stock as of June 1, 2007 was 108,160,489. VALENCE TECHNOLOGY, INC. ANNUAL REPORT ON FORM 10-K FISCAL YEAR ENDED MARCH 31, 2007
INDEX PAGE Forward-Looking Statements.........................................................................1 PART I Item 1. Business.................................................................................................1 Item 1A. Risk Factors ............................................................................................9 Item 1B. Unresolved Staff Comments...............................................................................20 Item 2. Properties..............................................................................................20 Item 3. Legal Proceedings.......................................................................................21 Item 4. Submission of Matters to a Vote of Security Holders.....................................................21 PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.............................................................................22 Item 6. Selected Financial Data.................................................................................23 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation....................25 Item 7A. Quantitative and Qualitative Disclosures About Market Risk..............................................35 Item 8. Financial Statements and Supplementary Data.............................................................36 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure....................65 Item 9A. Controls and Procedures.................................................................................65 Item 9B. Other Information.......................................................................................67 PART III Item 10. Directors and Executive Officers of the Registrant......................................................68 Item 11. Executive Compensation..................................................................................71 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters..........74 Item 13. Certain Relationships and Related Transactions..........................................................76 Item 14. Principal Accountant Fees and Services..................................................................78 PART IV Item 15. Exhibits and Financial Statement Schedules..............................................................80 Signatures.......................................................................................85
FORWARD-LOOKING STATEMENTS THIS ANNUAL REPORT ON FORM 10-K (THIS "FORM 10-K" OR 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 - "RISK FACTORS" AND "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION". WE UNDERTAKE NO OBLIGATION TO PUBLICLY REVISE THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES THAT ARISE AFTER THE DATE HEREOF. PART I 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 to 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(R) Power System into several channels for sales and distribution, including national and regional retailers, top tier computer manufacturers, and national resellers. o In February 2004, we also introduced a prototype of the U-Charge(R) Power System family of large-format products. The U-Charge(R) 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 availability of Saphion(R) powered batteries for Segway Inc.'s 2005 products. Our batteries doubled the range of Segway's Human Transporters compared to the nickel metal hydride batteries that were previously used. o In May 2005, we launched the industry's first commercially available phosphate-based lithium-ion power cell. Built with our proprietary Saphion(R) technology, this cell offers the 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. 1 o In January 2006, we announced availability of eight new models of our large-format lithium-ion U-Charge(R) XP Power System batteries which feature built in battery management electronics and power rates of 500 to 1700 continuous watts, depending on the model. As part of our low-cost manufacturing strategy, we have successfully transitioned our powder manufacturing from Las Vegas, Nevada to Suzhou, China. This transition allows us to capitalize on lower manufacturing costs. 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(R) 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 Ireland to China and other low-cost manufacturing centers, using both internal and contract manufacturing capabilities. We have a facility in China, for the manufacture of the base powder used in our Saphion(R) cells for the manufacture of the large-format battery packs. We also have arrangements with contract manufacturers for cell production. We believe this manufacturing strategy will allow us to directly control our intellectual property and operations management as well as deliver high-quality 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, now complete, focused on the first generation of our Saphion(R) technology in our patented polymer construction. During this phase, we introduced the N-Charge(R) Power System which has been sold through national and regional retailers, top-tier computer manufacturers and national resellers. 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 a large prismatic cell and introducing a power cell all utilizing our first generation of Saphion(R) material. Additionally, we have focused on 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 led to the launch of our U-Charge(R) Power System product 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) technology-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. 2 FISCAL 2007 HIGHLIGHTS AND RECENT EVENTS PRODUCT ACHIEVEMENTS o U-Charge(R) system trials were launched with approximately 80 corporations. o Five major customers actively marketed our products that include our U-Charge(R) or custom packs including Segway, Oxygen, Kegel, Energy CS, and Merlin Equipment. o N-Charge(R) continues to be marketed directly by Valence to education and medical customers and thru our reseller network including D & H and PC Connection. o Significant new customers for Valence's Saphion(R) battery products include: Oxygen, Enova, WrightBus, Marlin Submarine, Kegel, Merlin Equipment, and various Government & Military groups. OPERATIONAL ACHIEVEMENTS o In March 2007, we appointed Robert L. Kanode as our President, Chief Executive Officer, and Director for the Company. Mr. Kanode brings over 12 years of experience in the battery industry to Valence. He served as a senior partner for The Sales & Performance Group, a consulting group based in New York where he worked with Fortune 500 companies to commercialize their products and services, to develop manufacturing, marketing, sales and service functions, and to identify and develop global niche retail and OEM markets. Prior to his tenure there, Kanode served as president of OptiTec LLC and other companies where he guided the company through the product and service commercialization process, the development of manufacturing and marketing/sales functions, the identification of niche retail and OEM markets, and the securing of financial support for public and private companies. o In June 2006, Joel Sandahl joined as VP of Engineering and Product Development. Mr. Sandahl leads the worldwide engineering operations for Valence Technology. Mr. Sandahl brings over 30 years of engineering leadership to Valence, consistently developing teams that deliver leading products and technologies to the market. Prior to joining Valence, he founded and served as President of companies, Complex Systems, Inc. and Simulcomm LLP. Previously, Mr. Sandahl served as the Chief System Architect for E. F. Johnson; Director of Advanced Systems & Technology for Motorola; the Chief Scientist and Director of Advanced Development for Quintron Corporation; and a Product Manager, Engineering Manager, and Lead Engineer for Harris Corporation. Further, he has served as a principal consultant for numerous high-tech companies including Xerox, Eastman Kodak, and Rockwell International. He is a member of the Institute for Electrical Engineers (IEEE) and the Association for Computing Machinery (ACM). o China battery pack, powder, and engineering operations were consolidated into one Suzhou location. o Significant reductions were made in the manufacturing cost due to lower raw material costs, reduced scrap, and improved efficiency. SAPHION(R) TECHNOLOGY: 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. Valence believes its Saphion(R) technology, which utilizes an environmentally friendly phosphate-based cathode in place of other less stable and more costly cathode 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. Valence believes that its Saphion(R) technology significantly reduces the safety risks associated with oxide-based 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 3 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. Valence believes its 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 20m Ohms. 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(0)C to 70% of the battery's initial capacity, representing a longer life span. o NO MEMORY EFFECT AND MAINTENANCE-FREE. Saphion(R) technology does not exhibit the "memory effect" of nickel-cadmium and is maintenance-free. o LOWER COST. The phosphate material used in our Saphion(R) technology is estimated to be less expensive than the cobalt-oxide material used in competing lithium-ion technologies. As a result, Valence believes that as production volume increases due to greater demand for Saphion(R) batteries, material costs should decrease. 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 polymer and cylindrical construction. In the future, Valence plans to offer it in a prismatic construction. 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 an environmentally friendly, phosphate-based cathode material that reduces the disposal issues versus 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, Matshushita Industrial Co., Ltd. (Panasonic), SAFT, A123 Systems, Inc. and E-One Moli Energy among others. The performance characteristics of lithium-ion batteries, in particular, have consistently improved over time as the market leaders have improved 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, Valence is continually evolving its Saphion(R) technology to meet these and other competitive threats. Valence believes that it has important technological advantages over competitors in terms of ability to compete in the rechargeable battery market. Valence believes that our Saphion(R) phosphate battery chemistry, construction and manufacturing processes enable Valence to serve a wide range of markets that do not currently use lithium-ion batteries. Valence is uniquely positioned for growth due to the following: 4 o LEADING TECHNOLOGY. Phosphate-based Saphion(R) lithium-ion technology offers many performance advantages over competing battery technologies. Valence believes the safety advantages inherent to Saphion(R) technology enables the design of large-format lithium-ion energy systems. As the first company in the battery industry to commercialize phosphates, Valence believes it has a significant advantage in terms of time to market as well as chemistry and manufacturing expertise. o NEW MARKET OPPORTUNITIES. Valence believes 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, Saphion(R) technology energy and power systems can be designed in a wide variety of products in markets not served by current lithium-ion technology. Valence intends to expand the market opportunity for lithium-ion by designing our Saphion(R) 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 Valence research and development by strengthening sales and marketing efforts. Valence is expanding our vision to become an energy solutions company, and plan to enter markets previously not served by lithium-ion solutions. PRODUCTS THE N-CHARGE(R) POWER SYSTEM FAMILY The N-Charge(R) Power System Family includes two models 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(R) Power System is available in commercial quantities and is currently offered through resellers as well as through our own direct sales organization. THE U-CHARGE(R) POWER SYSTEM FAMILY The U-Charge(R) 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 12.8 and 19.2 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(R) Power Systems applications such as hybrid and full electric vehicles, wheelchairs, scooters, robotics, marine, remote power, military, back-up and many other devices. SALES AND MARKETING At June 1, 2007, Valence had a sales and marketing team consisting of eight persons, headed up by our President and Chief Executive Officer. Our sales and marketing staff are located in Austin, Texas; Tarzana, California; Atlanta, Georgia; Gainesville, Florida; Shropshire, United Kingdom; and Mallusk, Northern Ireland. The N-Charge(R) 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. The U-Charge(R) Power System is customized to a particular customer's application and can require a significant amount of attention and commitment, including potential capital outlays by prospective customers. The client evaluation and approval process is generally between six and twenty-four months. Valence anticipates sales will typically be made through separately negotiated supply agreements rather than standard purchase orders. Our U-Charge(R) 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. Valence provides pack level design and engineering services to assist the customer in configuring a product that meets its needs. Sales of products are typically denominated in United States dollars. Consequently, 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 Enterprises ("WFOE's") in Suzhou, China. Polymer batteries are manufactured for us by Amperex Technology, Ltd. ("ATL"), cylindrical batteries are manufactured for us by Tianjin Lishen Battery Joint-Stock Co., Ltd. ("Lishen"). Our products are assembled into complete systems using both contract 5 manufacturers in China and our own assembly facilities in Suzhou, China. With these relationships we believe that we will have sufficient capacity to meet or exceed expected demands in fiscal 2008. RESEARCH AND PRODUCT DEVELOPMENT We conduct materials research and development at our Las Vegas, Nevada facility and product development at our China facility. 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; anode, cathode, and electrolyte chemistry and physics; polymer and radiation chemistries; thin film technologies; coating technologies; 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 and in May 2005, we officially launched the industry's first commercially available phosphate-based power cell. We continue to develop prismatic cells and large format cells. o DEVELOPMENT OF SECOND GENERATION 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 potential applications for the energy cell include electric vehicles, motive applications, notebook computers, and consumer electronics. The potential 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 expected 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 a myriad of customers who are currently evaluating the product. o DEVELOPMENT OF THIRD GENERATION BATTERY PACKS. We are continuing our development of products including the development of our third generation of U-Charge(R) XP Power Systems (Gen 3) to improve battery management, reporting, fail soft, field serviceability and many other features. We are also developing a new proprietary "Core Technology" for our products that can be quickly and easily configured to a variety of custom applications. The development of the Core Technology is expected to dramatically reduce the level of effort and technical risk developing customized hardware and software for new product designs, thus reducing the development cycle time and expense. 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 improvements 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 revenues. During fiscal 2007, three customers, Segway Inc., D&H Distributing Co., Inc., and PC Connection, Inc. contributed 60%, 9%, and 7%, respectively of our total revenues. During fiscal 2006, three customers, Segway Inc., D&H Distributing Co., Inc., and PC Connection, Inc. contributed 53%, 12%, and 8%, respectively of our total revenues. During fiscal 2005, three customers, D&H Distributing Co., Inc., PC Connection, Inc., and Best Buy Co., Inc. accounted for approximately 46% of our revenue. 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. 6 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 140 United States patents, which have expiration dates through 2025 and have about 38 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 voluntarily determine 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, regulates 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(R) Power System (65) is exempt from Class 9 designation for transportation. Our N-Charge(R) Power System (130), and U-Charge(R) 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 or 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 operations of our Las Vegas, 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 Las Vegas, 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 the 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. EMPLOYEES At June 1, 2007, we had a total of 36 regular full-time employees in the United States at our Austin, Texas headquarters and our Las Vegas, Nevada research and development facility. At June 1, 2007, our Cayman subsidiary had 4 regular full-time employees in the areas of engineering and sales located in the United Kingdom. In addition, at June 1, 2007, our China operations, consisting of two Wholly Foreign Owned Enterprises ("WFOE's"), had 269 regular full-time employees and 2 ex-patriates. 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 7 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. 8 ITEM 1A. 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. 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 THERE IS DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN We have experienced significant operating losses in the current and prior years. At March 31, 2007, our principal sources of liquidity were cash and cash equivalents of $1.2 million. Historically, Mr. Carl Berg, our chairman of the board and principal shareholder, has funded our operations. Although Mr. Berg may continue to fund the Company's operations he is under no obligation to do so. We intend to improve our liquidity by the continued monitoring and reduction of manufacturing, facility and administrative costs. However, notwithstanding these efforts, we do not expect that our cash on hand and cash generated by operations will be sufficient to fund our operating and capital needs beyond the next three months. As a result of our limited cash resources and history of operating losses, our auditors have expressed in their report on our consolidated financial statements included herein that there is substantial doubt about our ability to continue as a going concern. We presently have no further commitments for financing by Mr. Berg or any other source. If we are unable to obtain financing from Mr. Berg or others on terms acceptable to us, or at all, we may be forced to cease all operations and liquidate our assets. WE HAVE ENCOUNTERED PROBLEMS IN OUR PRODUCTION PROCESSES THAT HAVE LIMITED OUR ABILITY AT TIMES TO PRODUCE SUFFICIENT BATTERIES TO MEET THE DEMANDS OUR CUSTOMERS. IF THESE ISSUES RECUR AND WE ARE UNABLE TO TIMELY RESOLVE THESE PROBLEMS, OUR INABILITY TO PRODUCE BATTERIES WILL HAVE A MATERIAL ADVERSE IMPACT ON OUR ABILITY TO GROW REVENUES AND MAINTAIN OUR CUSTOMER BASE. During fiscal 2006, we experienced problems in our production processes that limited our ability to produce a sufficient number of batteries to meet the demands of our customers. These production issues have had a negative impact on gross margins as manufacturing yields have suffered. Any inability to timely produce batteries may have a material adverse impact on our ability to grow revenues and maintain our customer base. OUR LIMITED FINANCIAL RESOURCES COULD MATERIALLY AFFECT OUR BUSINESS, OUR ABILITY TO COMMERCIALLY EXPLOIT OUR TECHNOLOGY AND OUR ABILITY TO RESPOND TO UNANTICIPATED DEVELOPMENT, AND COULD PLACE US AT A DISADVANTAGE TO OUR COMPETITORS. Currently, we do not have sufficient capital resources, sales and gross profit to generate the cash flows required to meet our operating and capital needs. As a consequence, one of our primary objectives has been to reduce expenses and overhead, 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 9 o place us at a disadvantage to our competitors that have greater financial resources than we have. WE HAVE A HISTORY OF LOSSES AND AN ACCUMULATED DEFICIT AND MAY NEVER ACHIEVE OR SUSTAIN SIGNIFICANT REVENUES OR PROFITABILITY. We have incurred operating losses each year since our inception in 1989 and had an accumulated deficit of $516.7 million as of March 31, 2007. We 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 anticipate that we will continue to incur operating losses and negative cash flows during fiscal 2008. 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 available to common stockholders of $22.4 million for fiscal year ended March 31, 2007, a net loss available to common stockholders of $32.9 million for the fiscal year ended March 31, 2006 and a net loss available to common stockholders of $32.2 million for the fiscal year ended March 31, 2005. 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 and may be required to liquidate our assets. 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 and will continue to have a significant amount of indebtedness and other obligations. As of March 31, 2007, we had approximately $70.9 million of total consolidated indebtedness. Included in this amount are $33.9 million of loans outstanding to an affiliate, $18.5 million of accumulated interest associated with those loans and $18.5 million of principal and interest outstanding with a third party finance company. 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 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 with Mr. Berg or related entities. If we fail to meet our obligations pursuant to these loan agreements, these 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. WE DEPEND ON A SMALL NUMBER OF CUSTOMERS FOR OUR REVENUES, AND OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION COULD BE HARMED IF WE WERE TO LOSE THE BUSINESS OF ANY ONE OF THEM. To date, our existing purchase orders in commercial quantities are from a limited number of customers. During the fiscal year ended March 31, 2007, Segway Inc., D&H Distributing Co., Inc., and PC Connection, Inc. contributed 60%, 9%, and 10 7%, of our revenues, respectively. 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. OUR BUSINESS WILL BE ADVERSELY AFFECTED IF OUR SAPHION(R) TECHNOLOGY BATTERIES ARE NOT COMMERCIALLY ACCEPTED. We are researching and developing batteries based upon phosphate chemistry. Our batteries are designed and manufactured as components for other companies and end-user customers. Our success depends on the acceptance of our batteries and the products using our batteries in their markets. Technical issues may arise that may affect the acceptance of our products by our customers. Market acceptance may also depend on a variety of other factors, including educating the target market regarding the benefits of our products. Market acceptance and market share are also affected by the timing of market introduction of competitive products. If we, or our customers, are unable to gain any significant market acceptance for Saphion(R) technology-based batteries, our business will be adversely affected. It is too early to determine if Saphion(R) technology-based batteries will achieve significant market acceptance. IF WE ARE UNABLE TO DEVELOP, MANUFACTURE AND MARKET PRODUCTS THAT GAIN WIDE CUSTOMER ACCEPTANCE, OUR BUSINESS WILL BE ADVERSELY AFFECTED. The process of developing our products is complex and failure to anticipate our 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. OUR FAILURE TO COST-EFFECTIVELY MANUFACTURE OUR TECHNOLOGICALLY COMPLEX BATTERIES IN COMMERCIAL QUANTITIES WHICH SATISFY OUR CUSTOMERS' PRODUCT SPECIFICATIONS AND THEIR EXPECTATIONS FOR PRODUCT QUALITY AND DELIVERY 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 technologically complex batteries that meet our customer specifications for quality and timely delivery. To facilitate commercialization of our products, we will need to further reduce our manufacturing costs, which we intend to do through the effective utilization of manufacturing partners and continuous improvement of our manufacturing and development operations in our wholly foreign owned enterprises in China. We currently manufacture our batteries and assemble our products in China. We are dependent on the performance of our manufacturing partners, as well as our own manufacturing operations to manufacture and deliver our products to our customers. We have experienced production process issues, which have limited our ability to produce a sufficient number of batteries to meet current demand. If we fail to correct these issues in a manner that allows us to meet customer demand, or if any of our manufacturing partners are unable to manufacture products in commercial quantities on a timely and cost-effective basis, we could lose our customers and adversely impact our ability to attract future customers. 11 IN ADDITION TO BEING USED IN OUR OWN PRODUCT LINES, OUR BATTERY CELLS ARE INTENDED TO BE INCORPORATED INTO OTHER PRODUCTS. IF WE DO NOT FORM EFFECTIVE ARRANGEMENTS WITH OEMS TO COMMERCIALIZE THESE PRODUCTS, OUR PROFITABILITY COULD BE IMPAIRED. 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 systems 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 product by OEMs. If we are unable to design, develop, and introduce products that meet OEMs' requirements, we may lose opportunities to enter into additional purchase orders and our reputation may be damaged. As a result, we may not receive adequate assistance from OEMs or pack assemblers to successfully commercialize our products, which could impair our profitability. FAILURE TO IMPLEMENT AN EFFECTIVE LICENSING BUSINESS STRATEGY WILL ADVERSELY AFFECT OUR REVENUE, CASH FLOW AND PROFITABILITY. Our long-term business strategy anticipates achieving significant revenue from the licensing of our intellectual property assets, such as our Saphion(R) technology. We have not entered into any licensing agreements for our Saphion(R) technology. Our future operating results could be adversely affected by a variety of factors including: o our ability to secure and maintain significant licensees of our proprietary technology; o the extent to which our future licensees successfully incorporate our technology into their products; o the acceptance of new or enhanced versions of our technology; o the rate at which our licensees manufacture and distribute their products to OEMs; and o our ability to secure one-time license fees and ongoing royalties for our technology from licensees. Our future success will also depend on our ability to execute our licensing operations simultaneously with our other business activities. If we fail to substantially expand our licensing activities while maintaining our other business activities, our results of operations and financial condition will be adversely affected. 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. 12 OUR ONGOING MANUFACTURING AND DEVELOPMENT OPERATIONS IN CHINA ARE COMPLEX AND HAVING THESE REMOTE OPERATIONS MAY DIVERT MANAGEMENT'S ATTENTION, LEAD TO DISRUPTIONS IN OPERATIONS AND DELAY IMPLEMENTATION OF OUR BUSINESS STRATEGY. We have relocated most of our manufacturing and development operations to China. We may not be able to find or retain suitable employees in China and we may have to train personnel to perform necessary functions for our manufacturing, senior management and development operations. This may divert management's attention, lead to disruptions in operations and delay implementation of our business strategy, all of which could negatively impact our profitability. WE EXPECT TO SELL AN INCREASING 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 product 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 or 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, which may reduce the future profitability of foreign sales and royalties; o import and export licensing requirements in Europe and other regions, including China, where we intend to conduct business, which may reduce or eliminate our ability to sell or license in certain markets; and o political and economic instability in countries, including China, where we intend to conduct business, which may reduce the demand for our batteries and our technology or our ability to market our batteries and our technology in those countries. These risks may increase our costs of doing business internationally and reduce our sales and royalties or future profitability. WE MAY NEED TO EXPAND OUR EMPLOYEE BASE AND OPERATIONS IN ORDER TO EFFECTIVELY DISTRIBUTE OUR PRODUCTS COMMERCIALLY, WHICH MAY STRAIN OUR MANAGEMENT AND RESOURCES AND COULD HARM OUR BUSINESS. To implement our growth strategy successfully, we will have to increase our staff in China, with personnel in manufacturing, engineering, 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 13 financial resources than we do. We cannot be certain that we will be successful in attracting and retaining the skilled personnel necessary to operate our business effectively in the future. INTERNATIONAL POLITICAL EVENTS AND THE THREAT OF ONGOING TERRORIST ACTIVITIES COULD INTERRUPT MANUFACTURING OF OUR BATTERIES AND OUR PRODUCTS AT OUR OEM FACILITIES OR OUR OWN FACILITIES AND CAUSE US TO LOSE SALES AND MARKETING OPPORTUNITIES. The terrorist attacks that took place in the United States on September 11, 2001, along with the U.S. military campaigns against terrorism in Iraq, Afghanistan, and elsewhere, and continued violence in the Middle East have created many economic and political uncertainties, some of which may materially harm our business and revenues. International political instability resulting from these events could temporarily or permanently disrupt manufacturing of our batteries and products at our OEM facilities or our own facilities in Asia and elsewhere, and have an immediate adverse impact on our business. Since September 11, 2001, some economic commentators have indicated that spending on capital equipment of the type that use our batteries has been weaker than spending in the economy as a whole, and many of our customers are in industries that also are viewed as under-performing in the overall economy, such as the telecommunications, industrial, and utility industries. The long-term effects of these events on our customers, the market for our common stock, the markets for our products, and the U.S. economy as a whole are uncertain. Terrorist activities could temporarily or permanently interrupt our manufacturing, development, sales and marketing activities anywhere in the world. Any delays also could cause us to lose sales and marketing opportunities, as potential customers would find other vendors to meet their needs. The consequences of any additional terrorist attacks, or any expanded armed conflicts are unpredictable, and we may not be able to foresee events that could have an adverse effect on our markets or our business. 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 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 are issued or are published. Since publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries by several months, we cannot be certain that we are the first creator of inventions covered by pending patent applications or the first to file patent applications on these inventions. We also cannot be certain that our pending patent applications will result in issued patents or that any of our issued patents will afford protection against a competitor. In addition, patent applications filed in foreign countries are subject to laws, rules and procedures that differ from those of the United States, and thus we cannot be certain that foreign patent applications related to issued U.S. patents will be issued. 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 near 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 14 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. 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. We are currently engaged in one intellectual property proceeding alleging the Company's SAPHION(R) I cathode material infringes two patents owned by the University of Texas. While the Company believes it has strong defenses to such allegations, an adverse decision could force us to do one or more of the following: o stop selling, incorporating, or using our products that use the SAPHION(R) I cathode material challenged intellectual property; o pay damages for the use of SAPHION(R) I cathode material; o obtain a license to sell or use the SAPHION(R) I cathode material, which license may not be available on reasonable terms, or at all; or o redesign those products or manufacturing processes that use the SAPHION(R) I cathode material, which may not be economically or technologically feasible. We may become involved in more litigation and proceedings in the future. In the future we may be subject to claims or an inquiry regarding our alleged unauthorized use of a third party's intellectual property. An adverse outcome in such future litigation could result in similar risks as noted above with respect to the third party's intellectual property. 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 HAVE TRANSFERRED ADDITIONAL OPERATIONS TO CHINA, WE FACE RISKS IF CHINA LOSES NORMAL TRADE RELATIONS STATUS 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 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 ("NTR") status for China. The loss of NTR status for China, changes in current tariff structures or adoption in the United States of other trade policies adverse to China could have an adverse affect on our business. Furthermore, our business may be adversely affected by the diplomatic and political relationships between the United States and China. These influences may adversely affect our ability to operate in China. If the relationship between the United States and China were to materially deteriorate, it could negatively impact our ability to control our operations and relationships in China, enforce any agreements we have with Chinese manufacturers or otherwise deal with any assets or investments we may have in China. 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 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. 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 15 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. 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, substantially increase taxes on foreign businesses or 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 ("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. 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. 16 The business structure of China is, in some respects, different from the business culture in Western countries and may present some difficulty for Western investors reviewing contractual relationships among companies in China and evaluating the merits of an investment. Personal relationships among business principals of companies and business entities in China are very significant in the business culture. In some cases, because so much reliance is based upon personal relationships, written contracts among businesses in China may be less detailed and specific than is commonly accepted for similar written agreements in Western countries. In some cases, material terms of an understanding are not contained in the written agreement but exist as oral agreements only. In other cases, the terms of transactions which may involve material amounts of money are not documented at all. In addition, in contrast to Western business practices where a written agreement specifically defines the terms, rights and obligations of the parties in a legally-binding and enforceable manner, the parties to a written agreement in China may view that agreement more as a starting point for an ongoing business relationship which will evolve and require ongoing modification. As a result, written agreements in China may appear to the Western reader to look more like outline agreements that precede a formal written agreement. While these documents may appear incomplete or unenforceable to a Western reader, the parties to the agreement in China may feel that they have a more complete understanding than is apparent to someone who is only reading the written agreement without having attended the negotiations. As a result, contractual arrangements in China may be more difficult to review and understand. Also, despite legal developments in China over the past 20 years, adequate laws, comparable with Western standards, do not exist in all areas and it is unclear how many of our business arrangements would be interpreted or enforced by a court in China. OUR OPERATIONS COULD BE MATERIALLY INTERRUPTED, AND WE MAY SUFFER A LARGE AMOUNT OF LOSS, IN THE CASE OF FIRE, CASUALTY OR THEFT AT ONE OF OUR MANUFACTURING OR OTHER FACILITIES. Firefighting and disaster relief or assistance in China is substandard by Western standards. In the event of any material damage to, or loss of, the manufacturing plants where our products are or will be produced due to fire, casualty, theft, severe weather, flood or other similar causes, we would be forced to replace any assets lost in those disaster. Thus our financial position could be materially compromised or we might have to cease doing business. The Company has obtained insurance in China to minimize this risk. 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. IT IS UNCERTAIN WHETHER WE WILL BE ABLE TO RECOVER VALUE-ADDED TAXES IMPOSED BY THE CHINESE TAXING AUTHORITY. China's turnover tax system consists of value-added tax ("VAT"), consumption tax and business tax. Export sales are exempted under VAT rules and an exporter who incurs 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 ("SARS"), AVIAN FLU, OR ANOTHER WIDESPREAD PUBLIC HEALTH PROBLEM, COULD ADVERSELY AFFECT OUR BUSINESS AND RESULTS OF OPERATIONS. A renewed outbreak of SARS, avian flu, or another widespread public health problem in China, where we have moved our manufacturing operations and may move additional operations, could have a negative effect on our operations. Our operations may be impacted by a number of health-related factors, including the following: o quarantines or closures of some of our manufacturing or other facilities which would severely disrupt our operations, or o the sickness or death of key officers or employees of our manufacturing or other facilities. Any of the foregoing events or other unforeseen consequences of public health problems in China could adversely affect our business and results of operations. 17 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 who are seeking to enhance traditional battery technologies, such as lead-acid and nickel-cadmium, have recently introduced or are developing batteries based on nickel metal-hydride, liquid lithium-ion and other emerging and potential technologies. These competitors are engaged in significant development work on these various battery systems, and we believe that much of this effort is focused on achieving higher energy densities for low power applications such as portable electronics. One or more new, higher energy rechargeable battery technologies could be introduced which could be directly competitive with, or superior to, our technology. The capabilities of many of these competing technologies have improved over the past several years. Competing technologies that outperform our batteries could be developed and successfully introduced, and as a result, there is a risk that our products may not be able to compete effectively in our targeted market segments. We have invested in research and development of next-generation technology in energy solutions. If we are not successful in developing and commercially exploiting new energy solutions based on new materials, or we experience delays in the development and exploitations 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 cylindrical lithium-ion, nickel cadmium, nickel metal-hydride and in some cases, non-SLI lead-acid batteries. These suppliers include Sanyo, Matsushita Industrial Co., Ltd. (Panasonic), Sony, Toshiba, SAFT E-One Moli Energy, as well as numerous lead-acid manufacturers throughout the world. Most of these companies are very large and have substantial resources and market presence. We expect that we will compete against manufacturers of other types of batteries in our targeted application segments. There is also a risk that we may not be able to compete successfully against manufacturers of other types of batteries in any of our targeted applications. LAWS REGULATING THE MANUFACTURE OR TRANSPORTATION OF BATTERIES MAY BE ENACTED WHICH COULD RESULT IN A DELAY IN THE PRODUCTION OF OUR BATTERIES OR THE IMPOSITION OF ADDITIONAL COSTS THAT COULD HARM OUR ABILITY TO BE PROFITABLE. At the present time, international, federal, state or local laws do not directly regulate the storage, use and disposal of the component parts of our batteries. However, laws and regulations may be enacted in the future which could impose environmental, health and safety controls on the storage, use and disposal of certain chemicals and metals used in the manufacture of lithium polymer batteries. Satisfying any future laws or regulations could require significant time and resources from our technical staff and possible redesign which may result in substantial expenditures and delays in the production of our product, all of which could harm our business and reduce our future profitability. The transportation of lithium and lithium-ion batteries is regulated both domestically and internationally. Under recently revised United Nations recommendations and as adopted by the International Air Transport Association ("IATA"), our N-Charge(R) Power System (Model VNC-65) is exempt from a Class 9 designation for transportation, while our N-Charge(R) Power System (Model VNC-130), and U-Charge(R) Power System currently fall within the level such that they are not exempt and require a Class 9 designation for transportation. The revised United Nations recommendations are not U.S. law until such time as they are incorporated into the Department of Transportation ("DOT") Hazardous Material Regulations. However, DOT has proposed new regulations harmonizing with the U.N. guidelines. At present it is not known if or when the proposed regulations would be adopted by the United States. While we fall under the equivalency levels for the United States and comply with all safety packaging requirements worldwide, future DOT or IATA regulations or enforcement policies could impose costly transportation requirements. In addition, compliance with any new DOT and IATA approval process could require significant time and resources from our technical staff and, if redesign were necessary, could delay the introduction of new products. 18 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 1, 2007, our officers, directors and their affiliates as a group beneficially owned approximately 55.7% of our outstanding common stock. Carl Berg, our chairman of the board, beneficially owns approximately 47.3% of our outstanding common stock. As a result, these stockholders will be able to exercise significant control over all matters requiring stockholder approval, including the election of directors and the approval of significant corporate transactions, which could delay or prevent someone from acquiring or merging with us. The interest of our officers and directors, when acting in their capacity as stockholders, may lead them to: o vote for the election of directors who agree with the incumbent officers' or directors' preferred corporate policy; or o oppose or support significant corporate transactions when these transactions further their interest 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 1, 2007, the closing price of our common stock was $1.36. 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. 19 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 106,199,516 shares of common stock as of March 31, 2007. In addition, at March 31, 2007, we had 13,025,883 shares of our common stock reserved for issuance under warrants and stock options plans. In connection with the potential conversion of the Series C-1 Convertible Preferred Stock and Series C-2 Convertible Preferred Stock, issued on December 1, 2004, we may need to issue up to 2,174,242 and 1,454,392 shares, respectively, of our common stock (based on a conversion price of $1.98 and $2.96, respectively). WE DO NOT INTEND TO PAY DIVIDENDS ON OUR COMMON STOCK, AND THEREFORE STOCKHOLDERS WILL BE ABLE TO RECOVER THEIR INVESTMENT IN OUR COMMON STOCK, IF AT ALL, ONLY BY SELLING THE SHARES OF OUR STOCK THAT THEY HOLD. Some investors favor companies that pay dividends on common stock. We have never declared or paid any cash dividends on our common stock. We currently intend to retain any future earnings for funding growth and we do not anticipate paying cash dividends on our common stock in the foreseeable future. Because we may not pay dividends, a return on an investment in our stock likely depends on the ability to sell our stock at a profit. OUR BUSINESS IS SUBJECT TO CHANGING REGULATIONS RELATING TO CORPORATE GOVERNANCE AND PUBLIC DISCLOSURE THAT HAS INCREASED BOTH OUR COSTS AND THE RISK OF NONCOMPLIANCE. Because our common stock is publicly traded, we are subject to certain rules and regulations of federal, state and financial market exchange entities charged with the protection of investors and the oversight of companies whose securities are publicly traded. These entities, including the Public Company Accounting Oversight Board, the Commission, and NASDAQ, have recently issued new requirements and regulations and continue to develop additional regulations and requirements in response to recent laws enacted by Congress, most notably Section 404 of the Sarbanes-Oxley Act of 2002. Our efforts to comply with these new regulations have resulted in, and are likely to continue to result in, materially increased general and administrative expenses and a significant diversion of management time and attention from revenue-generating and cost-reduction activities to compliance activities. In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our required assessment of our internal controls over financial reporting and our independent registered public accounting firm's audit of that assessment has required, and continues to require, the commitment of significant financial and managerial resources. There is no assurance that these efforts will be completed on a timely and successful basis. Because these laws, regulations and standards are subject to varying interpretations, their application in practice may evolve over time as new guidance becomes available. This evolution may result in continuing uncertainty regarding compliance matters and additional costs necessitated by ongoing revisions to our disclosure and governance practices. In the event that our Chief Executive Officer, Chief Financial Officer, or independent registered public accounting firm determine that our internal controls over financial reporting are not effective as defined under Section 404 of the Sarbanes-Oxley Act of 2002, there may be a material adverse impact in investor perceptions and a decline in the market price of our stock. ITEM 1B. UNRESOLVED STAFF COMMENTS None. ITEM 2. PROPERTIES Our corporate offices are located in a leased facility in Austin, Texas. We also have a leased research and development facility in Las Vegas, Nevada. Our two Wholly-Owned Foreign Entities in China lease three separate facilities, totaling 151,000 square meters in Suzhou, China. 20 ITEM 3. LEGAL PROCEEDINGS On January 31, 2007, Valence filed a claim against Phostech Lithium Inc. in the Federal Court in Canada (Valence Technology, Inc. v. Phostech Lithium Inc. Court File No. T-219-07) alleging infringement of Valence Canadian Patent 2,395,115. Subsequently, on April 2, 2007, Valence filed an amended claim alleging infringement of its recently granted Canadian Patents 2,483,918 and 2,466,366. The action is in the initial pleading state. The Company is seeking monetary damages and injunctive relief for the acts of Phostech in manufacturing, using and selling phosphate cathode material that infringes the asserted Valence Canadian Patents. On February 14, 2006, Hydro-Quebec filed an action against us in the United States District Court for the Western District of Texas (Hydro-Quebec v. Valence Technology, Civil Action No. A06CA111). In its amended complaint filed April 13, 2006, Hydro-Quebec alleges that Saphion(R) Technology, the technology utilized in all of our commercial products, infringes U.S. Patent No. 5,910,382 and 6,514,640 exclusively licensed to Hydro-Quebec. Hydro-Quebec's complaint seeks injunctive relief and monetary damages. The action is in the initial pleading state and we have filed a response denying the allegations in the amended complaint. The action has been stayed by the Court until July 10, 2007, pending a review and update of the status of the USPTO reexaminations of the two University of Texas patents asserted in the case. The USPTO has stated in declaring the two reexaminations that there are serious questions as to the patentability of the two patents. Our management believes the action by Hydro-Quebec is without merit and intends to vigorously defend the lawsuit, as well as all of its available legal remedies. We are subject to, from time to time, 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. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 21 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 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:
FISCAL 2006: HIGH LOW Quarter ended June 30, 2005 $3.35 $1.96 Quarter ended September 30, 2005 $3.22 $2.42 Quarter ended December 31, 2005 $2.78 $1.38 Quarter ended March 31, 2006 $2.85 $1.38 FISCAL 2007: Quarter ended June 30, 2006 $2.78 $1.68 Quarter ended September 30, 2006 $2.25 $1.14 Quarter ended December 31, 2006 $2.27 $1.57 Quarter ended March 31, 2007 $1.94 $1.16 FISCAL 2008: Quarter ended June 30, 2008 (through June 1, 2007) $1.49 $1.00
On June 1, 2007, the last reported sale price of our common shares of the Nasdaq SmallCap Market was $1.36 per share. On that date, we had 108,160,489 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, 2007, information regarding common stock authorized for issuance under our equity compensation plans:
NUMBER OF SECURITIES TO BE ISSUED UPON NUMBER OF SECURITIES REMAINING AVAILABLE EXERCISE OF OUTSTANDING OPTIONS, WEIGHTED-AVERAGE EXERCISE PRICE OF FOR FUTURE ISSUANCE UNDER EQUITY OUTSTANDING OPTIONS, PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS COMPENSATION PLANS - ----------------------------------------- ----------------------------------- ------------------------ ----------------------- Equity compensation plans approved by 4,877,861 $4.58 2,943,379 security holders Equity compensation plans not approved by security holders (1) 1,875,000 $1.89 - ----------------------------- ----------------------- Total 6,752,861 $3.84 2,943,379 ============================= ======================= - ------------- (1) Options to purchase 1,500,000 shares were granted to Robert L. Kanode in March 2007 pursuant to his employment agreement. The exercise price of his options is $1.61 per share and they vest as follows: 250,000 shares vest on September 13, 2007, and the remaining 1,250,000 shares quarterly over the remaining two and one-half years. Dr. Jim Akridge's employment with the Company terminated on March 16, 2007. Of his original grant of 1,000,000 shares at an exercise price of $2.99 per share, 375,000 shares are vested and will expire on June 16, 2007.
RECENT SALES OF UNREGISTERED SECURITIES None, except as has been previously disclosed in our quarterly reports on Form 10-Q and current reports on Form 8-K filed with the Securities and Exchange Commission. 22 PERFORMANCE GRAPH The graph below compares the cumulative 5-year total return of holders of Valence Technology, Inc.'s common stock with the cumulative total returns of the NASDAQ Composite index and the NASDAQ Electronic Components index. The graph tracks the performance of a $100 investment in our common stock and in each of the indexes (with the reinvestment of all dividends) from 3/31/2002 to 3/31/2007. [GRAPHIC OMITTED]
- ------------------------------------------------------------------------------------------------------------------------------------ 3/02 3/03 3/04 3/05 3/06 3/07 - ------------------------------------------------------------------------------------------------------------------------------------ VALENCE TECHNOLOGY, INC. 100.00 70.49 146.56 100.66 81.64 38.69 NASDAQ COMPOSITE 100.00 71.63 109.32 109.98 131.49 138.22 NASDAQ ELECTRONIC COMPONENTS 100.00 51.88 87.71 72.78 80.12 72.63
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, 2005, 2006 and 2007 and balance sheet data as of 23 March 31, 2006 and 2007 from the audited consolidated financial statements in this report. We derived the statement of operations data for the years ended March 31, 2003 and 2004 and the balance sheet data as of March 31, 2003, 2004 and 2005 from audited financial statements that are not included in this report.
Year Ended March 31, --------------------------------------------------------------------------- 2003 2004 2005 2006 2007 ------------- ---------- ----------- ---------- -------------- (in thousands, except per share amounts) Statement of Operations Data: Revenue: Battery and system sales $ 2,432 $ 8,483 $ 10,274 $ 16,490 $ 15,971 Licensing and royalty revenue 125 963 391 724 703 ------------- ---------- ----------- ---------- -------------- Total revenues 2,557 9,446 10,665 17,214 16,674 Cost of sales 10,996 15,923 16,341 25,454 16,366 Gross margin loss (8,439) (6,477) (5,676) (8,240) 308 Operating expenses: Research and product development 9,293 8,638 7,682 5,112 3,478 Marketing 3,210 4,880 4,292 2,163 2,138 General and administrative 9,947 10,687 13,130 11,621 8,510 Depreciation and amortization 2,790 2,109 884 722 718 Share based compensation 193 729 (197) 173 1,596 (Gain)/loss on disposal of assets (20) (21) (5,257) (445) 62 Asset impairment charge 258 13,660 87 170 - Restructuring charge - 926 - - - Contract settlement charge, INI - 3,046 957 - - Contract settlement charge, other - - 499 (108) 24 ------------- ---------- ----------- ---------- -------------- Total operating expenses 25,671 44,654 22,077 19,408 16,526 ------------- ---------- ----------- ---------- -------------- Operating loss (34,110) (51,131) (27,753) (27,648) (16,218) Minority interest in joint venture - 69 - - - Cost of warrants - (181) - - - Interest and other income 381 345 585 475 834 Interest expense (4,172) (4,059) (4,262) (5,551) (6,867) ------------- ---------- ----------- ---------- -------------- Net loss (37,901) (54,957) (31,430) (32,724) (22,251) Dividends on preferred stock - 162 171 172 172 Preferred stock accretion - 940 578 28 0 ------------- ---------- ----------- ---------- -------------- Net loss available to common stockholders $ (37,901) $ (56,059) $ (32,179) $ (32,924) $ (22,423) ============= =========== ============ ========== ============== Net loss per share available to common stockholders $ (0.65) $ (0.77) $ (0.40) $ (0.37) $ (0.22) ============= =========== ============ ========== ============== Shares used in computing net loss per share available to common stockholders, basic and diluted 58,423 73,104 81,108 89,298 99,714 ============= =========== ============ ========== ============== March 31, --------------------------------------------------------------------------- 2003 2004 2005 2006 2007 ------------- ---------- ----------- ---------- -------------- (in thousands) BALANCE SHEET DATA: Cash and cash equivalents $ 6,616 $ 2,692 $ 2,500 $ 612 $ 1,168 Working capital (deficit) 4,023 (4,847) (1,651) (4,250) 7,382 Total assets 36,154 21,056 10,231 11,632 19,201 Long-term debt, principal 38,865 39,407 34,656 51,112 52,390 Redeemable convertible preferred stock - 8,032 8,582 8,610 8,610 Accumulated deficit (374,604) (429,724) (461,328) (494,224) (516,647) Total stockholders' deficit (17,518) (56,794) (54,642) (76,212) (67,918)
24 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION 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 several products utilizing this technology. Our mission is to drive the wide adoption of high-performance, safe, low-cost energy storage systems by drawing on the numerous benefits of our latest battery technology, Saphion(R), the extensive experience of our management team and the significant market opportunity available to us. The 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, because of 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 a combination of product sales and licensing activities, while minimizing costs through a manufacturing plan that utilizes partnerships with contract manufacturers, and internal manufacturing efforts through our wholly owned subsidiaries in China. These subsidiaries 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 customers' products in both the large-format and small-format markets. In addition, we will seek to expand the fields of use of our Saphion(R) technology through the licensing of our intellectual property related to our battery chemistries and manufacturing processes. To date, we have achieved the following successes in implementing our business plan: o Proven the commercial feasibility of our technology; o Launched new Saphion(R) technology-based products, including our N-Charge(R) Power System family and introduced our U-Charge(R) Power System family of products, intended to be a direct replacement for existing lead acid battery applications in the market today and to compete for 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 Announced a joint technology development program with Segway Inc. 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 Consolidated three China locations into one site to serve as our powder production, research and development, and assembly facility; 25 o Developed 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 (NiMeH) and nickel-cadmium (NiCd) battery technologies. Total revenue decreased 3% as compared to the prior year to $16.7 million. We achieved improvement in our 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 two wholly-owned subsidiaries in Suzhou, China. Our business headquarters is in Austin, Texas. Our materials research and development center is in Las Vegas, Nevada. Our European sales and OEM manufacturing support center is in Mallusk, Northern Ireland. Our manufacturing and product development center is in Suzhou, 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, exit costs, contract settlement charges, and joint venture dissolution. 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. 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. 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 terminated employees, inventory obsolescence, costs to prepare assets for disposal or sale, and other 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. 26 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 ("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)3.0 million consisting of a (pound)2.0 million payment in cash and a (pound)1.0 million payment in common stock. In order to fund the (pound)1.0 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 was 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. During 2006, we realized a credit of $108,075 related to the final dissolution of the Joint Venture. 27 RESULTS OF OPERATIONS FISCAL YEARS ENDED MARCH 31, 2007 (FISCAL 2007), MARCH 31, 2006 (FISCAL 2006) AND MARCH 31, 2005 (FISCAL 2005) The following table summarizes the results of our operations for the past three fiscal years:
Year Ended ------------------------------------------------------------------------ March 31, 2007 % Change March 31, 2006 % Change March 31, 2005 ------------ ---------- -------------- ----------- -------------- (dollars in thousands) Battery and system sales $ 15,971 (3)% $ 16,490 60% $ 10,274 Licensing and royalty revenue 703 (3)% 724 85% 391 ------------ ---------- -------------- ----------- -------------- Total revenues 16,674 (3)% 17,214 61% 10,665 ------------ ---------- -------------- ----------- -------------- Gross margin (loss) 308 104% (8,240) (45)% (5,676) % of total revenue 2% (48)% (53)% Other operating expenses 16,440 (17)% 19,791 (23)% 25,791 % of total revenue 99% 115% 242% (Gain)/loss on disposal of assets 62 (114)% (445) (91)% (5,257) % of total revenue 0% 3% 49% Impairment, restructuring, contract settlement charges 24 (61)% 62 (96)% 1,543 % of total revenue 0% 0% 14% ------------ ---------- -------------- ----------- -------------- Total operating expenses 16,526 (15)% 19,408 (12)% 22,077 ------------ ---------- -------------- ----------- -------------- % of total revenue 99% 113% 207% Operating loss (16,218) (41)% (27,648) 0% (27,753) % of total revenue (97)% (161)% (260)% ------------ ---------- -------------- ----------- -------------- Net loss $ (22,251) (32)% $ (32,724) 4% $ (31,430) ============ ========== ============== =========== ============== % of total revenue (133)% (190)% (295)%
REVENUES AND GROSS MARGIN BATTERY AND SYSTEM SALES: Battery and systems sales totaled $16.0 million for the year ended March 31, 2007, as compared to $16.5 million for the year ended March 31, 2006, and $10.3 million for the year ended March 31, 2005. The decrease in revenues in fiscal 2007 compared to fiscal 2006 was primarily attributable to decreased sales of N-Charge(R) Power Systems as a result of the Company ceasing sales through our retail channels. We continue to sell the N-Charge(R) product through our reseller channels with a continued emphasis on healthcare and education sectors. We had $500,000 in deferred revenue on our balance sheet at March 31, 2007 and at March 31, 2006 primarily related to sales shipping in the end of the fourth quarter. We expect sales of the N-Charge(R) Power System to continue to grow moderately in fiscal 2008. We launched our large-format products with the U-Charge family of products during fiscal 2005. In fiscal 2006, we launched our long range battery pack for use in Segway Inc. human transporter as well as further expansions of our U-Charge family of products. Segway accounted for 60% and 53% of our total product sales in 2007 and 2006. LICENSING AND ROYALTY REVENUE: For fiscal years 2005 through 2007, license and royalty revenue was primarily derived from license fees and royalty payments, relating to our battery construction, from Amperex Technology Limited ("ATL") including a one-time license fee payment of $0.5 million 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 MARGIN/(LOSS): Gross margin as a percentage of revenue was 2% for the year ended March 31, 2007 as compared to a gross margin loss of (48%) for the fiscal year ended March 31, 2006 and a gross margin loss of (53%) for the year ended March 31, 2005. Fiscal years 2006 and 2005 margin improvements were offset by inventory valuation adjustments of $5.3 million and $1.2 million as of March 31, 2006 and 2005, related to valuation of our work in process cell inventory and lower of cost or market tests for our early launch and U.S.-sourced large-format products. During fiscal 2006, we had significant expenses due to issues with our powder manufacturing. We expect cost of sales to continue to decrease during fiscal 2008, as a percentage of sales, as production volumes increase, as we continue to implement our lower-cost manufacturing strategy, and improved efficiency. 28 OPERATING EXPENSES The following table summarizes our operating expenses during each of the past three fiscal years:
Year Ended ---------------------------------------------------------------------- March 31, 2007 % Change March 31, 2006 % Change March 31, 2005 -------------- --------- --------------- -------- -------------- (dollars in thousands) Operating expenses: Research and product development $ 3,478 (32)% $ 5,112 (33)% $ 7,682 Marketing 2,138 (1)% 2,163 (50)% 4,292 General and administrative 8,510 (27)% 11,621 (11)% 13,130 Share based compensation 1,596 823% 173 188% (197) Depreciation and amortization 718 (1)% 722 (18)% 884 (Gain)/loss on disposal of assets 62 (114)% (445) (91)% (5,257) Asset impairment charge - (100)% 170 95% 87 Contact settlement charge, INI - - - (100)% 957 Contact settlement charge, other 24 (122)% (108) 122% 499 -------------- --------- --------------- -------- -------------- Total operating expenses $ 16,526 (15)% $ 19,408 (12)% $ 22,077 ============== ========= =============== ======== ============== % of total revenue 99% 113% 207%
We continued to focus on our operating expense management throughout fiscal 2007. Operating expenses as a percentage of revenue decreased to 99% in fiscal 2007 versus 113% in fiscal 2006 and 207% in fiscal 2005. The decrease is the result of increased revenues, as well as our focus on expense reductions during fiscal 2007. Of our operating expenses in fiscal 2005 $2.1 million 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% of revenue. 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 $3.5 million in fiscal 2007, $5.1 million in fiscal 2006 and $7.7 million in fiscal 2005. We achieved year over year decreases in research and development in fiscal 2007 and 2006 of 32% and 33%, 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. 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 2005 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 50% decrease in marketing expenses in fiscal 2006 as compared to fiscal 2005 while achieving a 60% growth in product revenue. In fiscal 2007 and 2006, we reduced expenses related to our N-Charge(R) Power System lead generation and media advertising as well as reduced consulting related to the European market development. We expect marketing expenses to remain the same in fiscal 2008. We plan to continue to develop our indirect channels, selectively 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, audit, insurance, and corporate-related expenses. General and administrative expenses of $8.5 million in fiscal 2007 represented a 27% decrease over fiscal 2006. This was largely due to reductions made in facilities, personnel, insurance, auditing related costs and administrative expenses. Fiscal 2006 general and administrative expenses of $11.6 million represented a decrease of $1.5 million, or 11%, over fiscal 2005 expenses. OTHER COSTS RELATED TO OUR MANUFACTURING TRANSITION IMPAIRMENT CHARGE: There were impairment charges of $170,000 and $87,000 recorded during fiscal years 2006 and 2005, respectively. In 2006, we reduced the carrying value of certain software related to our manufacturing cost and accounting processes. In 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 29 cash flows greater than their carrying value. Assets with 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. CONTRACT SETTLEMENT CHARGES: During fiscal 2005, we recorded contract settlement charges totaling $1.456 million relating to the following items: 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 ("INI") for our former manufacturing facility located in Mallusk, Northern Ireland, totaling (pound)9 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. 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. ("Fengfan") and Baoding Fengfan - Valance Battery Company, Ltd. (collectively 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 $224,417 and to make equipment purchases from the JV Company of approximately $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 was 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. In 2006, we realized a credit of $108,075 related to the final dissolution of the Joint Company. 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 paid 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. 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/LOSS ON SALE OF ASSETS: Loss on sales of assets amounted to $62,000 in fiscal year 2007 and resulted primarily from consolidating our China operations into one location. Gain on sales of the facility and production and development equipment from our former Mallusk, Northern Ireland facility was $445,000 and $5.257 million in fiscal years 2006 and 2005. The majority of the gain is related to the sales of our Northern Ireland facility completed in fiscal 2005. Additionally, we determined that some equipment was not required in our manufacturing and development operations in Suzhou, China and was sold for fair value. DEPRECIATION AND AMORTIZATION, INTEREST EXPENSE AND SHARE BASED COMPENSATION DEPRECIATION AND AMORTIZATION: Depreciation and amortization expense totaled $718,000, $722,000, and $884,000 for fiscal years ended March 31, 2007, 2006 and 2005, 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 our long-term debt with a stockholder and third party, as well as mortgages on our Northern Ireland facility. We completed the sale of our Northern Ireland facility and paid off the mortgages on December 22, 2004. Interest expense was $6.9 million, $5.6 million, and $4.3 million for the fiscal years 2007, 2006 and 2005, respectively. 30 SHARE BASED COMPENSATION: Share based compensation of $1.6 million for the fiscal year of 2007 represents compensation costs recognized for all share-based payments granted on or after April 1, 2006 and awards granted to employees prior to April 1, 2006 that remain unvested on that date. In 2006 and 2005 share based compensation amounted to $173,000 and ($197,000), respectively, and primarily related to modifications of options. LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY At March 31, 2007, the Company's principal sources of liquidity were cash and cash equivalents of $1.2 million. The Company expects our sources of liquidity will not be sufficient for the remaining fiscal year. The Company anticipates product sales during fiscal 2008 from the N-Charge(R) Power System and the battery pack for Segway, Inc., which are subject to seasonal fluctuations and the sale of the U-Charge(R) Power System will be insufficient to cover the Company's operating expenses. Management depends upon our ability to periodically arrange for additional equity or debt financing to meet our liquidity requirements. Unless our product sales are greater than management currently forecasts or there are other changes to our business plan, we will need to arrange for additional financing within the next three to six months to fund operating and capital needs. This financing could take the form of debt or equity. Given our historical operating results and the amount of our existing debt, as well as the other factors, we may not be able to arrange for debt or equity financing from third parties on favorable terms or at all. 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 remaining fiscal year. As a result of our limited cash resources and history of operating losses, our auditors have expressed in their report on our consolidated financial statements included in our audited March 31, 2007 consolidated financial statements that there is substantial doubt about our ability to continue as a going concern. We presently have no further commitments for financing by Mr. Berg or any other source. If we are unable to obtain financing from Mr. Berg or others on terms acceptable to us, or at all, we may be forced to cease all operations and liquidate our assets. 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 2008. The following table summarizes our statement of cash flows for the fiscal years ended March 31, 2006, 2005 and 2004 (in thousands):
Year Ended ------------------------------------------------------------ March 31, 2007 March 31, 2006 March 31, 2005 ---------------- ------------------- ----------------- Net cash flows provided by (used in): Operating activities $ (20,307) $ (33,149) $ (33,125) Investing activities (2,204) (1,205) 7,021 Financing activities 23,185 32,439 25,625 Effect of foreign exchange rates (118) 27 287 Net increase (decrease) in cash and cash equivalents $ 556 $ (1,888) $ (192)
Our use of cash from operations during fiscal 2007, fiscal 2006 and fiscal 2005 was $20.3 million, $33.1 million and $33.1 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 2007 was lower than in fiscal 2006 and 2005 primarily from the impact of decreases in some of the operating expenses as described above in the section titled "Operating Expenses." In fiscal 2007, we spent net cash from investing activities of $2.2 million primarily on property, plant, and equipment for our China facilities. We obtained net cash from financing activities of $23.2 million and $32.4 million during the fiscal 2007 and 2006, respectively. The 2007 financing includes $8.4 million in sales of common stock to private investors, 9.5 million in sales of common stock to a related party, and $5.0 million in short term convertible notes payable to a stockholder. The 2006 financing included $20 million from Berg & Berg Enterprises, LLC (Berg & Berg), an affiliate of Carl Berg, the Company chairman of the board and managing member of Berg & Berg in equity lines, including $6 million in convertible notes to shareholder, and approximately $5.9 million in common stock sales. The 2005 financing included $25.0 million from Berg & 31 Berg equity lines, net proceeds from the sale of common stock to a third party institutional investor, 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 increase in cash and cash equivalents of $556,000 during fiscal 2007, a net decrease of $1.9 million during fiscal 2006, and a net decrease of $192,000 during fiscal 2005. At March 31, 2007, we had $4.3 million of Series C-1 Convertible Preferred Stock and $4.3 million of Series C-2 Convertible Preferred Stock outstanding, all of which is currently held by Berg & Berg. 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 were redeemable on December 15, 2005. Applicable provisions of Delaware corporate law restrict our ability to redeem the preferred stock. Berg & Berg has agreed that our failure to redeem the Series C-1 Convertible Preferred Stock and the Series C-2 Convertible Preferred Stock does not constitute a default under the certificate of designations for either the Series C-1 Convertible Preferred Stock or the Series C-2 Convertible Preferred Stock and has waived the accrual of any default interest applicable. RELATED PARTY TRANSACTIONS On February 1, 2007, West Coast Venture Capital purchased 657,894 shares of the Company's common stock for $1.0 million. The purchase price of $1.52 per share equaled the closing bid price of the Company's common stock as of January 31, 2007. The issuance of these shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. On January 18, 2007, West Coast Venture Capital purchased 662,252 shares of the Company's common stock for $1.0 million. The purchase price of $1.51 per share equaled the closing bid price of the Company's common stock as of January 17, 2007. The issuance of these shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. On December 27, 2006, West Coast Venture Capital purchased 613,497 shares of the Company's common stock for $1.0 million. The purchase price of $1.63 per share equaled the closing bid price of the Company's common stock as of December 26, 2006. The issuance of these shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. On December 15, 2006, West Coast Venture Capital purchased 549,541 shares of the Company's common stock for $1.0 million. The purchase price of $1.82 per share equaled the closing bid price of the Company's common stock as of December 15, 2006. The issuance of these shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. On August 17, 2006, West Coast Venture Capital purchased 534,759 shares of the Company's common stock for $1.0 million. The purchase price of $1.87 per share equaled the closing bid price of the Company's common stock as of August 16, 2006. The issuance of these shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. On August 3, 2006, West Coast Venture Capital purchased 1,298,702 shares of the Company's common stock for $2.0 million. The purchase price of $1.54 per share equaled the closing bid price of the Company's common stock as of August 3, 2006. The issuance of these shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. On May 11, 2006, West Coast Venture Capital purchased 646,552 shares of the Company's common stock for $1.5 million. This represented a funding on the $20.0 million funding commitment previously made by Berg & Berg. The purchase price of $2.32 per share equaled the closing bid price of the Company's common stock as of May 10, 2006. The issuance of these 32 shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. On April 3, 2006, West Coast Venture Capital purchased 401,606 shares of the Company's common stock for $1.0 million. This represented a funding on the $20.0 million funding commitment previously made by Berg & Berg. The purchase price of $2.49 per share equaled the closing bid price of the Company's common stock as of March 31, 2006. The issuance of these shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. In June 2006, the Company issued convertible promissory notes in the aggregate principal amount of $2.0 million to Berg & Berg, which are due with interest in September 2006. These convertible promissory notes accrue interest at the annual rate of 8.0% and are convertible at any time prior to maturity, into shares of common stock of the Company at a conversion price equal to the closing bid price of the Company's common stock on the trading day immediately prior to the conversion date, provided that the conversion price cannot be lower than $1.70, the closing bid price of the Company's common stock on June 20, 2006. In June 2005, Mr. Carl Berg, our chairman of the board and principal stockholder, agreed to provide a funding commitment of $20.0 million. On June 30, 2005, the Company drew down $2.5 million of this commitment. This draw took the form of a loan at a 5.0% annual interest rate and was repaid with proceeds from a July 2005 loan from a third party finance company. This funding commitment was reduced by $4.3 million upon the purchase of the Series C-2 Convertible Preferred Stock on July 14, 2005 by Berg & Berg. On December 14, 2005, Mr. Berg's funding commitment was further reduced by $4.3 million in connection with the purchase of the Company's Series C-1 Convertible Preferred Stock by Berg & Berg. In February and March 2006, the Company issued convertible promissory notes in favor of Berg & in an aggregate principal amount of $6.0 million (the "Notes"). The Notes accrued interest at the annual rate of 8.0% and matured on March 30 and June 30, 2006. The principal amount of the Notes, together with accrued interest, was converted into 2,965,870 shares of common stock of the Company, in accordance with their terms on April 3, 2006. In June 2004, Mr. Berg 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, 2006, the Company has drawn down $19 million of this commitment. This commitment can be reduced by the amount of net proceeds received from the sale of the building or equipment from the Company's Mallusk, Northern Ireland facility or the amount of net proceeds in a debt or equity transaction, and may be increased if necessary under certain circumstances. As of the date of this report, Mr. Berg has not requested that his commitment be reduced. In October 2001, the Company entered into a loan agreement (the "2001 Loan") with Berg & Berg. Under the terms of the agreement, Berg & Berg agreed to advance the Company funds of up to $20.0 million between the date of the agreement and December 31, 2003. Interest on the 2001 Loan accrues at 8.0% per annum, payable from time to time. On July 13, 2005, Berg & Berg agreed to extend the maturity date for the loan from September 30, 2006, to September 30, 2008. In July 1998, the Company entered into an amended loan agreement (the "1998 Loan") with Berg & Berg that allows the Company to borrow, prepay and re-borrow up to $10.0 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 $15.0 million. As of March 31, 2007, the Company had an outstanding balance of $14.95 million under the 1998 Loan agreement. The loan bears interest at one percent over the lender's borrowing rate (approximately 9.0% at March 31, 2007). On July 13, 2005, the parties agreed to extend the loan's maturity date from September 30, 2006 to September 30, 2008. 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, 33 the "Dawson Notes") secured by the shares acquired upon exercise plus 842,650 shares previously held by Mr. Dawson. As of March 31, 2007, principal and interest amounts of $4.9 million and $300,000 were outstanding under Dawson Note One and Dawson Note Two, respectively, and under each of the Dawson Notes, interest from the issuance date accrues on unpaid principal at the rate of 5.77% per annum, or at the maximum rate permissible by law, whichever is less. On April 20, 2005, the Company's Board of Directors approved a resolution to extend the maturity dates of each of the Dawson Notes from September 5, 2005 to September 5, 2007. 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. As of March 31, 2007 and 2006, amounts of $3,550,313 and $1,613,458 were outstanding under Dawson Note One and Dawson Note Two, respectively. 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, 2007, we had commitments for capital expenditures for the next 12 months of approximately $300,000 relating to manufacturing equipment. 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. At March 31, 2007, our cash obligations for short-term and long-term debt (principal & interest) consisted of (in thousands): 1998 long-term debt to Berg & Berg Enterprises, LLC $ 25,094 2001 long-term debt to Berg & Berg Enterprises, LLC 28,330 2005 long-term debt to SFT I, Inc. 20,125 ------------------ Total debt obligations $ 73,549 ================== At March 31, 2007, our repayment obligations of short-term and long-term debt principal are (in thousands):
2008 2009 2010 2011 2011 Thereafter Total Principal repayments -------- ---------- --------- ---------- --------- ---------- ----------- $ - $ 34,950 $ - $ 20,000 $ - $ - $ 54,950
If not converted to common stock, the redemption obligation for the Series C-1 Convertible Preferred Stock and Series C-2 Convertible Preferred Stock is $8.6 million. The Series C-1 Convertible Preferred Stock may be converted, at any time, into shares of our common stock at the lower of $4.00 or the closing price of our common stock on the conversion date, provided the conversion price can be no lower than $1.98, the closing price of the common stock on December 13, 2005. The Series C-2 Convertible Preferred Stock may be converted, at any time, into shares of our common stock at the lower of $4.00 or the closing price of our common stock on the conversion date, provided the conversion price can be no lower than $2.96, the closing bid price of our common stock on July 13, 2005. The preferred shares are currently outstanding and subject to redemption or conversion at the holder's discretion. 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. CONTRACTUAL OBLIGATIONS At March 31, 2007, our contractual obligations and payments due by period are as follows (in thousands):
Payments Due by Period ------------------------------------------------------------------- Less than More than Total 1 Year 1-3 Years 3 - 5 Years 5 Years --------- ------------ --------- ------------ ------------- Long-term debt obligations $ 73,549 $ 125 $53,424 $20,000 $ - Operating lease obligations 1,021 441 521 59 - Purchase obligations 7,831 7,831 Redemption of convertible preferred stock 8,610 8,610 - - - --------- ------------ --------- ------------ ------------- Total $ 91,011 $ 17,007 53,945 20,059 $ - ========= ============ ========= ============ =============
34 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 February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115." SFAS No. 159 permits an entity to elect fair value as the initial and subsequent measurement attribute for many financial assets and liabilities. Entities electing the fair value option would be required to recognize changes in fair value in earnings. Entities electing the fair value option are required to distinguish, on the face of the statement of financial position, the fair value of assets and liabilities for which the fair value option has been elected and similar assets and liabilities measured using another measurement attribute. SFAS No. 159 is effective for the Company's fiscal year 2008. The adjustment to reflect the difference between the fair value and the carrying amount would be accounted for as a cumulative-effect adjustment to retained earnings as of the date of initial adoption. We are currently evaluating the impact, if any, of SFAS No. 159 on the Company's consolidated financial statements. In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. Specifically, this Statement sets forth a definition of fair value, and establishes a hierarchy prioritizing the inputs to valuation techniques, giving the highest priority to quoted prices in active markets for identical assets and liabilities and the lowest priority to unobservable inputs. The provisions of SFAS No. 157 are generally required to be applied on a prospective basis, except to certain financial instruments accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, for which the provisions of SFAS No. 157 should be applied retrospectively. The Company is still evaluating the effect, if any, on its financial position or results of operations. In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements" (SAB 108). SAB 108 was issued in order to eliminate the diversity in practice surrounding how public companies quantify financial statement misstatements. SAB 108 requires that registrants quantify errors using both a balance sheet and income statement approach and evaluate whether either approach results in a misstated amount that, when all relevant quantitative and qualitative factors are considered, is material. The adoption of this statement did not have a material impact on the Company's consolidated financial condition or results of operations. In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109 (FIN 48)." FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, and disclosure. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is in the process of evaluating the impact FIN48 will have on its results of operations and financial position, if any. In November 2004, the FASB, 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 inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of this standard does not have a material effect on the Company's financial position, results of operations or cash flows. 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." On July 13, 2005, in connection with a $20.0 million loan agreement with a third party finance company with an adjustable interest rate equal to the greater of 6.75% or the sum of the LIBOR rate plus 4.0% (9.375% at March 31, 2007), we entered into a rate cap agreement which caps the LIBOR rate at 5.5% (On May 8, 2007, the most recent adjustment date, the LIBOR rate was 5.32%) In addition, we are exposed to financial market risks, including changes in foreign currency exchange rates and interest rates. We are exposed to financial market risks, including changes in foreign currency exchange rates and interest rates. The following table presents the principal cash flows by year of maturity for our total debt obligations held at March 31, 2007 (in thousands):
Expected Maturity Date --------------------------------------------------------------------------------------- 2008 2009 2010 2011 2012 Thereafter Total ---------- --------- ---------- ----------- ---------- ----------- ---------- Fixed rate debt $ - $ 34,950 $ - $ - $ - $ - $ 34,950 Variable rate debt $ - $ - $ - $ 20,000 $ - $ - $ 20,000
35 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. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 36 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE Reports of Independent Registered Public Accounting Firms...............................................................38 Consolidated Balance Sheets as of March 31, 2007 and March 31, 2006.....................................................40 Consolidated Statements of Operations and Comprehensive Loss for the years ended March 31, 2007, 2006 and 2005 .........41 Consolidated Statements of Stockholders' Deficit for the years ended March 31, 2007, 2006 and 2005......................42 Consolidated Statements of Cash Flows for the years ended March 31, 2007, 2006 and 2005.................................43 Notes to Consolidated Financial Statements..............................................................................44
37 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, 2007, and the related consolidated statements of operations and comprehensive loss, stockholders' deficit, and cash flows for the fiscal year ended March 31, 2007. 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 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 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 audit provides 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, 2007, and the results of their operations and comprehensive loss and their cash flows for the fiscal year ended March 31, 2007, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 3 to the consolidated financial statements the Company adopted SFAS 123R during the year ended March 31, 2007. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company's recurring losses from operations, negative cash flows from operations and net stockholders' capital deficiency raise substantial doubt about its ability to continue as a going concern. Management's plans concerning these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. 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, 2007, 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 7, 2007, expressed an unqualified opinion on management's assessment of the effectiveness of the Company's internal control over financial reporting. PMB HELIN DONOVAN, LLP Austin, Texas June 7, 2007 38 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 sheet of Valence Technology, Inc., and subsidiaries (the "Company") as of March 31, 2006, and the related consolidated statements of operations and comprehensive loss, stockholders' deficit, and cash flows for each of the two years in the period ended March 31, 2006. 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, 2006 and the results of their operations and comprehensive loss and their cash flows for each of the two years in the period ended March 31, 2006, in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company's recurring losses from operations, negative cash flows from operations and net stockholders' capital deficiency raise substantial doubt about its ability to continue as a going concern. Management's plans concerning these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. DELOITTE & TOUCHE LLP Austin, Texas June 28, 2006 39
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS) March 31, 2007 March 31, 2006 ----------------- --------------- Assets Current assets: Cash and cash equivalents $ 1,168 $ 612 Trade receivables, net of allowance of $169 and $99, respectively 3,955 2,376 Inventory 7,915 2,738 Prepaid and other current assets 1,987 2,566 ----------------- --------------- Total current assets 15,025 8,292 Property, plant and equipment, net 3,997 3,052 Intellectual property, net 178 288 ----------------- --------------- Total assets $ 19,200 $ 11,632 ================= =============== Liabilities and Stockholders' Deficit Current liabilities: Convertible notes payable to stockholder $ - $ 6,000 Accounts payable 2,904 1,599 Accrued expenses 4,223 4,479 Deferred revenue 516 464 ----------------- --------------- Total current liabilities 7,643 12,542 Long-term interest payable to stockholder 18,475 15,580 Long-term debt, net of debt discount 18,484 17,942 Long-term debt to stockholder, net of debt discount 33,906 33,170 ----------------- --------------- Total liabilities 78,508 79,234 ----------------- --------------- Commitments and contingencies Redeemable convertible preferred stock, $0.001 par value, 10,000,000 shares authorized, 861 issued and outstanding at March 31, 2007 and 2006, respectively, liquidation value $8,610 8,610 8,610 Stockholders' deficit: Common stock, $0.001 par value, 200,000,000 shares authorized; 106,199,516 and 89,883,539 shares issued and outstanding as of March 31, 2007 and 2006, respectively 106 90 Additional paid-in capital 457,611 426,745 Notes receivable from stockholder (5,164) (5,164) Accumulated deficit (516,647) (494,224) Accumulated other comprehensive loss (3,824) (3,659) ----------------- --------------- Total stockholders' deficit (67,918) (76,212) ----------------- --------------- Total liabilities, preferred stock and stockholders' deficit $ 19,200 $ 11,632 ================= =============== The accompanying notes are an integral part of these consolidated financial statements.
40
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Year Ended ----------------- ------------------ ----------------- March 31, 2007 March 31, 2006 March 31, 2005 ----------------- ------------------ ----------------- Revenue: Battery and system sales $ 15,971 $ 16,490 $ 10,274 Licensing and royalty revenue 703 724 391 ----------------- ------------------ ----------------- Total revenues 16,674 17,214 10,665 Cost of sales 16,366 25,454 16,341 Gross margin/(loss) 308 (8,240) (5,676) Operating expenses: Research and product development 3,478 5,112 7,682 Marketing 2,138 2,163 4,292 General and administrative 8,510 11,621 13,130 Share based compensation 1,596 173 (197) Depreciation and amortization 718 722 884 (Gain)/loss on disposal of assets 62 (445) (5,257) Asset impairment charge - 170 87 Contract settlement charge, INI - - 957 Contract settlement charge, other 24 (108) 499 ----------------- ------------------ ----------------- Total operating expenses 16,526 19,408 22,077 ----------------- ------------------ ----------------- Operating loss (16,218) (27,648) (27,753) Interest and other income 834 475 585 Interest expense (6,867) (5,551) (4,262) ----------------- ------------------ ----------------- Net loss (22,251) (32,724) (31,430) Dividends on preferred stock 172 172 171 Preferred stock accretion - 28 578 ----------------- ------------------ ----------------- Net loss available to common stockholders, basic and diluted $ (22,423) $ (32,924) $ (32,179) ================= ================== ================= Other comprehensive loss: Net loss $ (22,251) $ (32,724) $ (31,430) Change in foreign currency translation adjustments (165) 234 148 Comprehensive loss $ (22,416) $ (32,490) $ (31,282) ================= ================== ================= Net loss per share available to common stockholders $ (0.22) $ (0.37) $ (0.40) ================= ================== ================= Shares used in computing net loss per share available to common stockholders, basic and diluted 99,714 89,298 81,108 ================= ================== ================= The accompanying notes are an integral part of these consolidated financial statements.
41 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT (IN THOUSANDS)
Accumulated Additional Notes Other Common Stock Paid-in Receivable from Accumulated Comprehensive Shares Amount Capital Stockholder Deficit Loss Totals ------- ------- --------- --------------- ----------- ------------- ------- Balances, March 31, 2004 75,961 $ 76 $382,056 $ (5,161) $ (429,724) $ (4,041) $(56,794) ------- ------- --------- --------------- ----------- ------------- ------- Sale of stock to private investors 10,243 10 31,890 31,900 Issuance of stock to INI 539 1 1,915 1,916 Exercise of stock options at 571 $0.63 to $4.56 per share 319 571 Accretion of preferred stock (578) (578) Stock compensation (197) (197) Modification of stock option (1) (1) Interest receivable from stockholder (304) (304) Payment of accrued interest on note receivable from stockholder 301 301 Dividends on preferred stock (174) (174) Net loss (31,430) (31,430) Change in translation adjustment 148 148 ------- ------- --------- --------------- ----------- ------------- ------- Balances, March 31, 2005 87,062 $ 87 $415,656 $ (5,164) $ (461,328) $ (3,893) $(54,642) ------- ------- --------- --------------- ----------- ------------- ------- Sale of stock to private investors 2,260 2 5,899 5,901 Exercise of stock options at 790 $0.63 to $4.56 per share 562 1 789 Issuance of common stock warrants 2,037 2,037 Extension of expiring common stock warrants 2,215 2,215 Accretion of preferred stock (28) (28) Stock compensation 287 287 Modification of stock option (110) (110) Interest receivable from stockholder (281) (281) Payment of accrued interest on note receivable from stockholder 281 281 Dividends on preferred stock (172) (172) Net loss (32,724) (32,724) Change in translation adjustment 234 234 ------- ------ --------- --------------- ----------- ------------- ------- Balances, March 31, 2006 89,884 $ 90 $426,745 $ (5,164) $ (494,224) $ (3,659) $(76,212) ======= ====== ========= =============== =========== ============= ======= Sale of stock to private investors 4,780 5 8,436 8,441 Sale of stock to related party 5,364 5 9,495 9,500 Conversion of short-term notes payable to 6,039 6 11,095 11,101 shareholder Exercise of stock options at 132 244 244 $0.63 to $1.69 per share Dividends on preferred stock (172) (172) Share based compensation 1,596 1,596 Net loss (22,251) (22,251) Change in translation adjustment (165) (165) -------- ------- --------- --------------- ----------- ------------- ------- Balances, March 31, 2007 106,199 $ 106 $457,611 $ (5,164) $ (516,647) $ (3,824) $(67,918) ======== ====== ========= =============== =========== ============= ======= The accompanying notes are an integral art of these consolidated financial statements.
42
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) Year Ended ------------------------------------------------- March 31, 2007 March 31, 2006 March 31, 2005 Cash flows from operating activities: ----------------- -------------- -------------- Net loss $ (22,251) $ (32,724) $ (31,430) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 1,035 923 884 Gain on disposal of assets 62 (445) (5,257) Bad debt expense (recoveries) 154 - 17 Accretion of debt discount and other 1,278 1,074 909 Asset impairment charge - 170 87 Contract settlement payment to INI - - (3,211) Contract settlement charge, other - (108) 957 Reserve for obsolete inventory - - 741 Share based compensation 1,596 173 (197) Interest income on shareholder note receivable - (281) (3) Changes in operating assets and liabilities: Trade receivables (1,579) (912) (3) Inventory (5,177) (174) 13 Prepaid and other current assets 579 (1,647) (589) Accounts payable 1,305 (1,652) 987 Accrued expenses and long-term interest 2,639 3,230 3,322 Deferred revenue 52 (777) (352) ----------------- -------------- -------------- Net cash used in operating activities (20,307) (33,149) (33,125) ----------------- -------------- -------------- Cash flows from investing activities: Purchases of property, plant and equipment (2,230) (1,871) (1,838) Proceeds from disposal of property, plant and equipment 26 666 9,772 Effect of deconsolidation of joint venture - - (913) ----------------- -------------- -------------- Net cash provided by (used in) investing activities (2,204) (1,205) 7,021 ----------------- -------------- -------------- Cash flows from financing activities: Proceeds from convertible notes payable to stockholder 5,000 6,000 - Proceeds from long-term debt, net of issuance costs - 22,139 - Payments of short term loans - (2,500) - Payments of long-term debt - - (6,646) Dividends paid on preferred stock - (172) (172) Proceeds from issuance of preferred stock, net - - (28) Interest received on notes from shareholder - 281 - Proceeds from stock option exercises 244 789 571 Proceeds from issuance of common stock and warrants, net of issuance costs 17,941 5,902 31,900 ----------------- -------------- -------------- Net cash provided by financing activities 23,185 32,439 25,625 ----------------- -------------- -------------- Effect of foreign exchange rates on cash and cash equivalents (118) 27 287 ----------------- -------------- -------------- Increase/(decrease) in cash and cash equivalents 556 (1,888) (192) Cash and cash equivalents, beginning of year 612 2,500 2,692 ----------------- -------------- -------------- Cash and cash equivalents, end of year $ 1,168 $ 612 $ 2,500 ================= ============== ============== Supplemental Information: Interest paid $ 1,875 $ 1,070 $ 275 Conversion of notes payable to stockholder into common stock $ 11,101 - $ - The accompanying notes are an integral part of these consolidated financial statements.
43 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 Saphion(R) technology addresses the major weaknesses of existing technology while offering a solution that is competitive in cost and performance. 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, 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, the Company offers its Saphion(R) technology in both cylindrical and polymer construction and have initiated the design of a prismatic cell. The Company's business plan and strategy focuses 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 Wholly Foreign-Owned Enterprises ("WFOE's") in China. These WFOE's initiated operations in late 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(R) Power System and U-Charge(R) Power System, and through products designed by others. In addition, the Company expects to continue to pursue a licensing strategy as our Saphion(R) technology receives greater market acceptance. 2. GOING CONCERN AND LIQUIDITY AND CAPITAL RESOURCES: GOING CONCERN: The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has incurred operating losses each year since its inception in 1989 and had an accumulated deficit of $516.6 million as of March 31, 2007. For the years ended March 31, 2007 and 2006, the Company sustained net losses available to common shareholders of $22.4 and $32.9 million, respectively. These factors, among others, indicate that the Company may be unable to continue as a going concern for a reasonable period of time. The Company's ability to continue as a going concern is contingent upon its ability to meet its liquidity requirements. If the Company is unable to arrange for debt or equity financing on favorable terms or at all the Company's ability to continue as a going concern is uncertain. These financial statements do not give effect to any adjustments to the amounts and classifications of assets and liabilities which might be necessary should the Company be unable to continue as a going concern. LIQUIDITY AND CAPITAL RESOURCES: At March 31, 2007, the Company's principal sources of liquidity were cash and cash equivalents of $1.2 million. The Company expects our sources of liquidity will not be sufficient for the twelve months following March 31, 2007. The Company anticipates product sales during fiscal 2008 from the N-Charge(R) Power System and the Segway pack, which are subject to seasonal fluctuations and the sale of the U-Charge(R) Power System will be insufficient to cover the Company's operating expenses. The Company also anticipates some benefits from reductions in operating expenses and manufacturing costs; however, these benefits may not be sufficient to sustain the Company's operations and its ability to continue as a going concern. Management depends upon its ability to periodically arrange for additional equity or debt financing to meet our liquidity requirements. Unless the Company's product sales are greater than management currently forecasts or there are other changes to the Company's business plan, we will need to arrange for additional financing within the next three to six months to fund operating and capital needs. This financing could take the form of debt or equity. Given the Company's historical operating results and the amount of our existing debt, as well as the other factors, the Company may not be able to arrange for debt or equity financing from third parties on favorable terms or at all. 44 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. GOING CONCERN AND LIQUIDITY AND CAPITAL RESOURCES (CONTINUED): 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. The Company has made significant estimates in determining the amount of inventory reserves and inventory overhead absorption as discussed in Note 5, warranty liabilities as discussed in Note 13, and share based compensation as discussed in Note 15. Actual results could differ from those estimates. PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries. Intercompany balances and transactions are eliminated upon consolidation. 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. 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. 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 upon borrowing rates currently available to the Company for loans with similar terms, the carrying value of its debt obligations approximate fair value. 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. 45 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): PROPERTY, PLANT AND EQUIPMENT (CONTINUED): 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. 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. 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. 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 sales to ultimate customers. For direct customers, the Company estimates a return rate percentage based upon its historical experience. 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 sales of licensed products and when collectibility is reasonably assured. 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. 46 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): 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 2007, 2006 and 2005, were $87,000, $87,000 and $468,000, 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: Prior to April 1, 2006, the Company accounted for stock-based compensation under the recognition and measurement provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation. No employee compensation cost for stock options was recognized in the consolidated income statements for periods prior to April 1, 2006, as all stock options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment ("SFAS 123R"), which revises SFAS 123. SFAS 123R also supersedes APB No. 25 and amends SFAS No. 95, Statement of Cash Flows. SFAS 123R eliminates the alternative to account for employee stock options under APB No. 25 and requires the fair value of all share-based payments to employees, including the fair value of grants of employee stock options to be recognized in the statement of operations, generally over the vesting period. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 107, which provides additional implementation guidance for SFAS 123R. Among other things, SAB 107 provides guidance on share-based payment valuations, income statement classification and presentation, capitalization of costs and related income tax accounting. SFAS 123R provides for adoption using either the modified prospective or modified retrospective transition method. The Company adopted SFAS 123R on April 1, 2006 using the modified prospective transition method in which compensation cost is recognized beginning April 1, 2006 for all share-based payments granted on or after that date and for awards granted to employees prior to April 1, 2006 that remain unvested on that date. The Company uses the Black-Scholes option pricing model to determine the fair value of stock option awards. See Note 15 to the consolidated financial statements for disclosures required by SFAS 123R and related pronouncements. COMPREHENSIVE INCOME/LOSS: Comprehensive income/loss is the change in stockholder's equity (deficit) from foreign currency translation gains and losses. 47 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): 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 periods. 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 were as follows at:
MARCH 31, 2007 2006 2005 -------------------- --------------------------------------- Shares reserved for conversion of Series C preferred stock 3,628,634 3,629,470 2,152,500 Common stock options 10,070,240 9,045,276 9,264,000 Warrants to purchase common stock 2,955,643 2,955,643 1,889,000 -------------------- --------------------------------------- Total 16,654,517 15,630,389 13,305,500 ==================== =======================================
NEW ACCOUNTING STANDARDS: In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115." SFAS No. 159 permits an entity to elect fair value as the initial and subsequent measurement attribute for many financial assets and liabilities. Entities electing the fair value option would be required to recognize changes in fair value in earnings. Entities electing the fair value option are required to distinguish, on the face of the statement of financial position, the fair value of assets and liabilities for which the fair value option has been elected and similar assets and liabilities measured using another measurement attribute. SFAS No. 159 is effective for the Company's fiscal year 2008. The adjustment to reflect the difference between the fair value and the carrying amount would be accounted for as a cumulative-effect adjustment to retained earnings as of the date of initial adoption. We are currently evaluating the impact, if any, of SFAS No. 159 on the Company's consolidated financial statements. In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. Specifically, this Statement sets forth a definition of fair value, and establishes a hierarchy prioritizing the inputs to valuation techniques, giving the highest priority to quoted prices in active markets for identical assets and liabilities and the lowest priority to unobservable inputs. The provisions of SFAS No. 157 are generally required to be applied on a prospective basis, except to certain financial instruments accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, for which the provisions of SFAS No. 157 should be applied retrospectively. The Company is still evaluating the effect, if any, on its financial position or results of operations. In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements" (SAB 108). SAB 108 was issued in order to eliminate the diversity in practice surrounding how public companies quantify financial statement misstatements. SAB 108 requires that registrants quantify errors using both a balance sheet and income statement approach and evaluate whether either approach results in a misstated amount that, when all relevant quantitative and qualitative factors are considered, is material. The adoption of this statement did not have a material impact on the Company's consolidated financial condition or results of operations. 48 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): NEW ACCOUNTING STANDARDS (CONTINUED): In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109 (FIN 48)." FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, and disclosure. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is in the process of evaluating the impact FIN 48 will have on its results of operations and financial position, if any. 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 inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of this standard does not have a material effect on the company's financial position, results of operations or cash flows. 4. IMPAIRMENT CHARGE: An impairment charge of $170,000 was recorded during the 2006 fiscal year, pursuant to FASB Statement No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets." The charge relates to certain portions of the Company's information systems that are no longer in use. An impairment charge of $87,000 was recorded during the 2005 fiscal year, 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 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 at (in thousands):
MARCH 31, ---------------------------------------------------- 2007 2006 ---------------------------------------------------- Raw materials $ 2,210 $ 891 Work-in-process 3,116 1,422 Finished goods 2,589 425 ---------------------------------------------------- Inventory $ 7,915 $ 2,738 ====================================================
Included in inventory at March 31, 2007 and 2006 were valuation allowances of $4.4 million and $5.3 million, respectively, for scrap, obsolete inventory and to reduce their carrying values to lower of cost or market. Management has valued certain amounts of overhead absorption related to work-in-process based on estimates of completion at March 31, 2007. 6. PREPAID AND OTHER CURRENT ASSETS: Prepaid and other current assets consisted of the following at (in thousands):
MARCH 31, ----------------------------------------------------------- 2007 2006 ------------------------------- --------------------------- Other receivables $ 1,460 $ 897 Deposits 297 183 Prepaid insurance 78 268 Other prepaids 152 1,218 ------------------------------- --------------------------- Prepaids and other current assets $ 1,987 $ 2,566 =============================== ===========================
49 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment, net of accumulated depreciation and amortization and impairment, consisted of the following at (in thousands):
MARCH 31, ----------------------------------------------------------- 2007 2006 ------------------------------- --------------------------- Leasehold improvements $ 1,045 $ 738 Machinery and equipment 4,400 7,854 Office and computer equipment 2,001 2,032 Construction in progress 462 84 ------------------------------- --------------------------- Property, plant and equipment, gross 7,908 10,708 Less: accumulated depreciation and amortization (3,873) (5,624) Less: impairment (38) (2,032) ------------------------------- --------------------------- Property, plant and equipment, net $ 3,997 $ 3,052 =============================== ===========================
Depreciation expense was approximately $925,000 $810,000 and $770,000 for the fiscal years end March 31, 2007, 2006, and 2005, respectively. 8. INTELLECTUAL PROPERTY Intellectual property consisting primarily 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 at (in thousands):
MARCH 31, ----------------------------------------------------------- 2007 2006 ------------------------------- --------------------------- Intellectual property, gross $ 13,602 $ 13,602 Less: accumulated amortization (4,930) (4,820) Less: impairment (8,494) (8,494) ------------------------------- --------------------------- Intellectual property, net $ 178 $ 288 =============================== ===========================
Amortization expense was approximately $110, $113 and $114 for the fiscal years ended March 31, 2007, 2006 and 2005, respectively. Amortization expense on intellectual property at March 31, 2007 will be approximately $114 and $64 for fiscal years 2008 and 2009, respectively. 9. ACCRUED EXPENSES: Accrued expenses consisted of the following at (in thousands):
MARCH 31, ----------------------------------------------------------- 2007 2006 ------------------------------- --------------------------- Accrued compensation $ 494 $ 374 Professional services 189 431 Warranty reserve 1,139 1,509 Other accrued expenses 2,401 2,165 ------------------------------- --------------------------- Total Accrued expenses $ 4,223 $ 4,479 =============================== ===========================
50 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. CONVERTIBLE NOTES PAYABLE TO STOCKHOLDER: On July 10, 2006, the Company issued convertible promissory notes in favor of Berg & Berg Enterprises, LLC ("Berg & Berg"), an affiliate of Carl Berg, the Company's chairman of the board and managing member of Berg & Berg, in the principal amounts of $2.0 million. On July 20, 2006 the Company issued convertible promissory notes in favor of Berg & Berg in the principal amount of $1.0 million. These convertible promissory notes accrued interest at the annual rate of 8.0% and were convertible at any time prior to maturity, into shares of common stock of the Company at a conversion price equal to the closing bid price of the Company's common stock on the trading day immediately prior to the conversion date, provided that the conversion price cannot be lower than $1.73 and $1.33, respectively, the closing bid price of the Company's common stock on July 9 and 19, 2006. The notes and accrued interest were converted into a total of 1,885,302 common shares of the Company at $1.73 and $1.38, respectively. The issuance of these shares of common stock was exempt from registration pursuant to Section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. On June 21, 2006, the Company issued convertible promissory notes in favor of Berg & Berg in the principal amounts of $2.0 million. These convertible promissory notes accrued interest at the annual rate of 8.0% and were convertible at any time prior to maturity, into shares of common stock of the Company at a conversion price equal to the closing bid price of the Company's common stock on the trading day immediately prior to the conversion date, provided that the conversion price cannot be lower than $1.70, the closing bid price of the Company's common stock on June 20, 2006. The notes and accrued interest were converted into a total of 1,188,332 common shares of the Company on July 25, 2006. The issuance of these shares of common stock was exempt from registration pursuant to Section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. In February and March 2006, the Company issued convertible promissory notes in favor of Berg & Berg in an aggregate principal amount of $6.0 million (the "Notes"). The Notes accrued interest at the annual rate of 8.0% and matured on March 30 and June 30, 2006. The principal amount of the Notes, together with accrued interest, was converted into 2,965,870 shares of common stock of the Company, in accordance with their terms on April 3, 2006. The issuance of these shares of common stock was exempt from registration pursuant to Section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. 51 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. LONG-TERM DEBT: Long-term debt consisted of the following at (in thousands):
MARCH 31, ----------------------------------------------------------- 2007 2006 ------------------------------- --------------------------- 2005 Loan $ 20,000 $ 20,000 Less: unaccreted debt discount (1,516) (2,058) ------------------------------- --------------------------- Long-term debt, less current portion $ 18,484 $ 17,942 =============================== ===========================
Long-term debt to stockholder consisted of the following at (in thousands):
MARCH 31, ----------------------------------------------------------- 2007 2006 ------------------------------- --------------------------- 2001 Loan $ 20,000 $ 20,000 1998 Loan 14,950 14,950 Less: unaccreted debt discount (1,044) (1,780) ------------------------------- --------------------------- Long-term debt to stockholder $ 33,906 $ 33,170 =============================== ===========================
Principal payments of long-term debt are as follows (in thousands):
Fiscal -------------------------------------------------------------------------------------- 2008 2009 2010 2011 2012 Thereafter Total ----------- --------- --------- --------- --------- ------------ --------- 2005 loan $ - $ - $ - $ 20,000 $ - $ - $ 20,000 2001 loan - 20,000 - - - - 20,000 1998 loan $ - $ 14,950 $ - $ - $ - $ - $ 14,950 ----------- --------- --------- --------- --------- ------------ --------- Total debt to stockholder $ - $ 34,950 $ - $ 20,000 $ - $ - $ 54,950 =========== ========= ========= ========= ========= ============ =========
52 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. LONG-TERM DEBT (CONTINUED): In June 2005, the Company obtained a $20.0 million funding commitment from Mr. Carl Berg, the Company's chairman of the board and principal stockholder. On June 30, 2005, the Company drew down $2.5 million from this commitment in the form of a loan, which was repaid in full by the Company on July 13, 2005, including interest at an annual rate of 5.0%. The amount of Mr. Berg's funding commitment was reduced in connection with the purchase of the Series C-2 Convertible Preferred Stock in July 2005 by Berg & Berg Enterprises LLC ("Berg & Berg"), the purchase of the Series C-1 Convertible Preferred Stock in December 2005 by Berg & Berg, and the convertible notes payable to stockholder discussed in Footnote 10. On July 13, 2005, the Company secured a $20.0 million loan (the "2005 Loan") from a third party finance company, the full amount of which has been drawn down. The loan is guaranteed by Mr. Berg. The loan matures in a lump sum on July 13, 2010. Interest is due monthly based on a floating interest rate. The interest rate is calculated as the greater of 6.75% or the sum of LIBOR Rate, rounded to the nearest 1/16th of 1.0%, plus 4.0% (9.38% as of March 31, 2007). The loan may not be prepaid in whole or in part on or prior to July 12, 2007. The loan may be prepaid during the period beginning on July 13, 2007 through July 12, 2009, with a 1.0% prepayment premium, and on July 13, 2009 and thereafter with no prepayment premium. In connection with the loan, the Company purchased a rate cap agreement to protect against fluctuations in LIBOR for the full amount of the loan for a period of three years. The fair value of the LIBOR rate cap agreement is included in other assets and marked-to-market on a quarterly basis. The Company used $2.5 million of the proceeds from the loan to repay a June 30, 2005 draw from Mr. Berg's funding commitment. In connection with the loan both the third party finance company and Mr. Berg received warrants to purchase 600,000 shares of the Company's common stock at a price of $2.74 per share. The warrants are exercisable beginning on the date they were issued and will expire on July 13, 2008. The fair value assigned to these warrants, totaling approximately $2.037 million, has been reflected as additional consideration for the debt financing, recorded as a discount on the debt and will be accreted as interest expense over the life of the loan. The warrants were valued using the Black-Scholes valuation method using the assumptions of a life of 36 months, 96.45% volatility, and a risk free rate of 3.88%. Also in connection with the loan, the Company incurred a loan commitment fee and attorney's fees which has been recorded as a discount on the debt and will be accreted as interest expense over the life of the loan. Through March 31, 2007, a total of approximately $866,000 has been accreted and included as interest expense. Interest payments on the loan are currently being paid on a monthly basis. 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 July 13, 2005, Berg & Berg agreed to extend the maturity date for the loan principal and interest from September 30, 2006 to September 30, 2008. 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. 53 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. LONG-TERM DEBT (CONTINUED): 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 originally expired on August 30, 2005. In July 2005, the warrants were extended until September 30, 2008. The fair value assigned to these warrants, totaling approximately $5.1 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 (extended to 84 months), 100% volatility, and a risk-free rate of 5.5%. Through March 31, 2007, a total of $4.1 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, 2007, 2006 and 2005 were $1.6 million in each year. Interest payments on the loan are currently being deferred, and are recorded as long-term interest. The accrued interest amounts for the 2001 Loan were $8.3 million and $6.7 million as of March 31, 2007 and 2006, respectively. 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, 2007, 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, 2007). On July 13, 2005, Berg & Berg agreed to extend the maturity date for the loan principal and interest from September 30, 2006 to September 30, 2008. 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. The accrued interest amounts for the 1998 Loan were $10.1 million and $8.5 million as of March 31, 2007 and 2006, respectively. All of our assets are pledged as collateral under the 2001 Loan and the 1998 Loan to stockholder. 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 ("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 fiscal 2005. 54 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. COMMITMENTS AND CONTINGENCIES: LEASES: Total rent expense for the years ended March 31, 2007, 2006 and 2005 was approximately $674,000, $847,000 and $936,000, respectively. Future minimum payments on leases for fiscal years following March 31, 2007 are (in thousands): 2008 $ 441 2009 305 2010 216 2011 59 2012 - Thereafter - -------------------------- Total minimum payments $ 1,021 ========================== WARRANTIES: The Company has established a warranty reserve in connection with the sale of N-Charge(R) Power Systems covering a 12-month warranty period during which the Company would provide a replacement unit to any customers returning a purchased product because of a product performance issue. The Company has also established a warranty reserve in relation to the sale of U-Charge(R) Power Systems, and other large-format power systems. Product warranty liabilities are as follows at (in thousands):
MARCH 31, ----------------------------------------------------------- 2007 2006 ------------------------------- --------------------------- Beginning balance $ 1,509 $ 1,067 Less: claims (523) (748) Add: accruals 153 1,190 ------------------------------- --------------------------- Ending balance $ 1,139 $ 1,509 =============================== ===========================
LITIGATION: On January 31, 2007, Valence filed a claim against Phostech Lithium Inc. in the Federal Court in Canada (Valence Technology, Inc. v. Phostech Lithium Inc. Court File No. T-219-07) alleging infringement of Valence Canadian Patent 2,395,115. Subsequently, on April 2, 2007, Valence filed an amended claim alleging infringement of its recently granted Canadian Patents 2,483,918 and 2,466,366. The action is in the initial pleading state. The Company is seeking monetary damages and injunctive relief for the acts of Phostech in manufacturing, using and selling phosphate cathode material that infringes the asserted Valence Canadian Patents. On February 14, 2006, Hydro-Quebec filed an action against us in the United States District Court for the Western District of Texas (Hydro-Quebec v. Valence Technology, Civil Action No. A06CA111). In its amended complaint filed April 13, 2006, Hydro-Quebec alleges that Saphion(R) Technology, the technology utilized in all of our commercial products, infringes U.S. Patent No. 5,910,382 and 6,514,640 exclusively licensed to Hydro-Quebec. Hydro-Quebec's complaint seeks injunctive relief and monetary damages. The action is in the initial pleading state and we have filed a response denying the allegations in the amended complaint. The action has been stayed by the Court until July 10, 2007, pending a review and update of the status of the USPTO reexaminations of the two University of Texas patents asserted in the case. The USPTO has stated in declaring the two reexaminations that there are serious questions as to the patentability of the two patents. Our management believes the action by Hydro-Quebec is without merit and intends to vigorously defend the lawsuit, as well as all of its available legal remedies. We are subject to, from time to time, 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. 55 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO 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 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. When issued, the Series C-1 Convertible Preferred Stock and Series C-2 Convertible Preferred Stock were convertible into common stock at $4.00 per share. Each series carries a 2% annual dividend rate, payable quarterly in cash or shares of common stock, and were redeemable on December 15, 2005. The Company has the right to convert the preferred stock if the average of the dollar-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 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. The preferred shares are currently outstanding and subject to redemption or conversion at the holder's discretion. Pursuant to assignment agreements entered into between the Company and Berg & Berg Enterprises, LLC ("Berg & Berg") on July 14, 2005 and December 14, 2005, Berg & Berg purchased all of the outstanding Series C-1 Convertible Preferred Stock and Series C-2 Convertible Preferred Stock from its original holder. Pursuant to the terms of the assignment agreement, Berg & Berg agreed that the failure of the Company to redeem the preferred stock on December 15, 2005 did not constitute a default under the certificate of designations and has waived the accrual of any default interest applicable in such circumstance. In exchange, the Company has agreed (i) that the Series C-1 Convertible Preferred Stock may be converted, at any time, into the Company's common stock at the lower of $4.00 per share or the closing bid price of the Company's common stock on December 13, 2005 ($1.98) and (ii) that the Series C-2 Convertible Preferred Stock may be converted, at any time, into the Company's common stock at the lower of $4.00 per share or the closing bid price of the Company's common stock on July 13, 2005 ($2.96). At March 31, 2007 the Company was in arrears on the payment of $258,000 in preferred stock dividends. In connection with the issue of the original issuance of the Series C Convertible Preferred Stock, in June 2003, the Company issued to the Series C Convertible Preferred Stock original 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 $8.61 million was recorded over the eighteen-month period of the Series C Convertible Preferred Stock ending December 2, 2004. 15. SHARE BASED COMPENSATION: 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 56 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. SHARE BASED COMPENSATION (CONTINUED): 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 the first and second quarter of fiscal 2007, no shares were granted under this plan. At March 31, 2007, the Company had 87,928 shares available for grant under the 1996 Non-Employee Director's Stock Option 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 2007, no shares were granted under this plan. At March 31, 2007, the Company had 920,440 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 2007, 1,276,000 shares were granted under this plan. At March 31, 2007, the Company had 2,309,011 shares available for grant under the 2000 Plan. When options are exercised the Company issues new shares to the grantee. Aggregate option activity is as follows (shares in thousands):
Outstanding Options -------------------------------------------------------------------- Number of Weighted Average Shares Exercise Price ------------------------------ -------------------------------- Balance at March 31, 2004 8,605 $5.73 Granted 1,799 $3.12 Exercised (315) $1.72 Canceled (825) $7.99 ------------------------------ Balance at March 31, 2005 9,264 $5.17 Granted 1,978 $2.74 Exercised (542) $1.52 Canceled (1,655) $4.36 ------------------------------ Balance at March 31, 2006 9,045 $4.97 ------------------------------ Granted 2,776 $1.66 Exercised (174) $1.49 Canceled (4,894) $4.78 ------------------------------ Balance at March 31, 2007 6,753 $3.84 ============================== At March 31, 2007, 2006, and 2005 vested options to purchase 2,903,797, 6,812,207, and 6,869,531 shares, respectively, were unexercised.
57
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. SHARE BASED COMPENSATION (CONTINUED): The following table summarizes information about fixed stock options outstanding at March 31, 2007 (shares in thousands): Options Outstanding Options Exercisable ------------------------------------------------------------------------------------------------ Weighted Weighted Average Average Range of Number Remaining Contractual Weighted Average Number Exercise Exercise Prices Outstanding Life (years) Exercise Price Exercisable Price -------------------- --------------- --------------------- ----------------- -------------- ------------- $0.63 - $1.99 3,304 9.08 1.61 602 1.45 $1.99 - $4.62 1,777 7.37 3.06 674 3.40 $4.62 - $10.06 1,448 2.41 6.51 1,404 6.55 $10.06 - $15.75 10 3.50 13.84 10 13.84 $15.75 - $23.56 113 3.14 20.41 113 20.41 $23.56 - $34.62 101 2.92 32.93 101 32.93 -------------------- --------------- --------------------- ----------------- -------------- ------------- $ 0.63 - $34.62 6,753 7.00 3.84 2,904 6.24 --------------- --------------------- ----------------- -------------- -------------
Compensation expense for stock plans has been determined based on the fair value at the grant date for options granted in the current fiscal year. For the years ended March 31, 2007, $1.6 million, $173,000, and ($197,000) of share based compensation expense has been included in operating expenses in the condensed consolidated statements of operations and comprehensive loss. The aggregate intrinsic value of options exerciseable at March 31, 2007 is $19,000 and the intrinsic value of options exercised during 2007 is $187,000. For fiscal years 2005 and 2006, compensation expense was not recorded consistent with the provisions of SFAS 123, as amended by SFAS 148. Had compensation expense been recorded the pro forma net loss would have been reported as follows (in thousands):
FISCAL YEAR ENDING MARCH 31, 2006 2005 -------------------------- -------------------- Net loss available to stockholders - as reported $ (32,924) $(32,179) Add: stock-based compensation expense, net of related taxes (2,388) (4,117) -------------------------- -------------------- Net loss available to stockholders - pro forma $ (35,312) $(36,296) ========================== ==================== Net loss available to stockholders per share, basic and diluted - as reported $ (0.37) $ (0.40) Net loss available to stockholders per share, basic and diluted - pro forma $ (0.40) $ (0.45)
As of March 31, 2007 the Company had a total of $4.6 million in compensation costs related to stock-based compensation to recognize over a remaining service period of 2.6 years for non-vested options. 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 2007 and 2006: MARCH 31, 2007 2006 ------------------- ------------------ Risk-free interest rate 4.34% 4.17% Expected life 5.0 years 5.0 years Volatility 82.36% 92.73% Dividend yield None None 58 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 16. SIGNIFICANT CUSTOMERS: Revenues from three significant customers represented 60%, 9%, and 7% or a total of 78% of total revenues for the year ended March 31, 2007 and a total of 74% of the trade accounts receivable at March 31, 2007. Revenues from three significant customers represented a total of 73% of total revenues for the year ended March 31, 2006 and a total of 77% of the trade accounts receivable at March 31, 2006. Revenues from three significant customers represented a total of 46% of total revenues for the year ended March 31, 2005 and a total of 41% of the trade accounts receivable at March 31, 2005. 17. INCOME TAXES: There was no recorded income tax benefit related to the losses of fiscal years 2007, 2006 or 2005 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:
FISCAL YEAR ENDING MARCH 31, 2007 2006 2005 --------------- ---------------- ------------------- Federal tax benefit at statutory rate $ (7,565) $ (11,126) $ (10,665) Rate differential - foreign (1) (19) (74) Impact of foreign rate change - - 1,159 Impact of change in Texas tax law 1,292 - - State tax provision (4) (935) (96) Expenses not deductible for tax and other 383 (157) (61) Research and experimentation credit (277) (146) - Foreign losses not available as a carryfoward 4,766 4,893 3,924 Change in valuation allowance 1,406 7,490 5,813 --------------- ---------------- ------------------- Tax provision (benefit) $ - $ - $ - =============== ================ ===================
The components of the net deferred tax asset were as follows at (in thousands):
MARCH 31, -------------------------------------------------------- 2007 2006 ----------------------------- ------------------------- Deferred tax assets: Current deferred tax assets: Accrued liabilities and other $ 827 $ 2,641 Valuation allowance for current deferred tax assets (827) (2,641) ----------------------------- ------------------------- Net current deferred tax assets - - ----------------------------- ------------------------- Non-current deferred tax assets: Depreciation and amortization - 1,236 Stock compensation 195 103 Research and experimentation credit carryforwards 2,175 1,899 Net operating loss carryforwards - Federal and state 70,151 70,069 Net operating loss carryforwards - Foreign 49,203 46,108 Impairment reserve 740 865 Imputed interest 1,122 1,207 Valuation allowance for non-current deferred tax assets (123,457) (121,487) ----------------------------- ------------------------- Net non-current deferred tax assets 129 - ----------------------------- ------------------------- Deferred tax liabilities: Non-current deferred tax liabilities Depreciation and amortization (129) - ----------------------------- ------------------------- Total non-current deferred tax liabilities (129) - ----------------------------- ------------------------- Net current deferred tax asset (liability) $ - $ - ============================= ========================= Net noncurrent deferred tax asset (liability) $ - $ - ============================= =========================
59 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 17. INCOME TAXES (CONTINUED): At March 31, 2007, the Company had federal net operating loss carryforwards available to reduce future taxable income of approximately $205.6 million. The effect of the change in Texas tax law represents a decrease in the state rate applied to the temporary differences, and the exclusion of the deferred tax assets related to Texas loss carryforwards and research and development credit carryforwards. The state rate applied to the temporary difference has been reduced as the temporary differences do not affect the Company's Texas gross margin tax and thus, do not represent a future tax benefit or liability for the Texas tax. The valuation allowance increase by approximately $155,000 during the year ended March 31, 2007. The net increase resulted from a gross decrease of $1.3 million related to the an adjustment to the gross deferred tax assets, and a gross increase of $1.4 million due to operating losses not benefited. A portion of the valuation allowance relates to tax benefits for stock option deductions included in the net operating loss carryforward, which when realized, will be allocated directly to contributed capital. The carryforwards expire from 2008 to 2027, 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 $162.4 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 investments 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. 60 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 20. RELATED PARTY TRANSACTIONS: On February 1, 2007, West Coast Venture Capital purchased 657,894 shares of the Company's common stock for $1.0 million. The purchase price of $1.52 per share equaled the closing bid price of the Company's common stock as of January 31, 2007. On January 18, 2007, West Coast Venture Capital purchased 662,252 shares of the Company's common stock for $1.0 million. The purchase price of $1.51 per share equaled the closing bid price of the Company's common stock as of January 17, 2007. On December 27, 2006, West Coast Venture Capital purchased 613,497 shares of the Company's common stock for $1.0 million. The purchase price of $1.63 per share equaled the closing bid price of the Company's common stock as of December 26, 2006. On December 15, 2006, West Coast Venture Capital purchased 549,541 shares of the Company's common stock for $1.0 million. The purchase price of $1.82 per share equaled the closing bid price of the Company's common stock as of December 15, 2006 On August 17, 2006, West Coast Venture Capital purchased 534,759 shares of the Company's common stock for $1.0 million. The purchase price of $1.87 per share equaled the closing bid price of the Company's common stock as of August 16, 2006. On August 3, 2006, West Coast Venture Capital purchased 1,298,702 shares of the Company's common stock for $2.0 million. The purchase price of $1.54 per share equaled the closing bid price of the Company's common stock as of August 3, 2006. On May 11, 2006, West Coast Venture Capital purchased 646,552 shares of the Company's common stock for $1.5 million. This represented a funding on the $20.0 million funding commitment previously made by Berg & Berg. The purchase price of $2.32 per share equaled the closing bid price of the Company's common stock as of May 10, 2006. On April 3, 2006, West Coast Venture Capital purchased 401,606 shares of the Company's common stock for $1.0 million. This represented a funding on the $20.0 million funding commitment previously made by Berg & Berg. The purchase price of $2.49 per share equaled the closing bid price of the Company's common stock as of March 31, 2006. In June 2006, the Company issued convertible promissory notes in the aggregate principal amount of $2.0 million to Berg & Berg, which are due with interest in September 2006. These convertible promissory notes accrue interest at the annual rate of 8.0% and are convertible at any time prior to maturity, into shares of common stock of the Company at a conversion price equal to the closing bid price of the Company's common stock on the trading day immediately prior to the conversion date, provided that the conversion price cannot be lower than $1.70, the closing bid price of the Company's common stock on June 20, 2006. In June 2005, Mr. Carl Berg, our chairman of the board and principal stockholder, agreed to provide a funding commitment of $20.0 million. On June 30, 2005, the Company drew down $2.5 million of this commitment. This draw took the form of a loan at a 5.0% annual interest rate and was repaid with proceeds from a July 2005 loan from a third party finance company. This funding commitment was reduced by $4.3 million upon the purchase of the Series C-2 Convertible Preferred Stock on July 14, 2005 by Berg & Berg. On December 14, 2005, Mr. Berg's funding commitment was further reduced by $4.3 million in connection with the purchase of the Company's Series C-1 Convertible Preferred Stock by Berg & Berg. In February and March 2006, the Company issued convertible promissory notes in favor of Berg & in an aggregate principal amount of $6.0 million (the "Notes"). The Notes accrued interest at the annual rate of 8.0% and matured on March 30 and June 30, 2006. The principal amount of the Notes, together with accrued interest, was converted into 2,965,870 shares of common stock of the Company, in accordance with their terms on April 3, 2006. 61 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 20. RELATED PARTY TRANSACTIONS (CONTINUED): In June 2004, Mr. Berg 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, 2006, the Company has drawn down $19 million of this commitment. This commitment can be reduced by the amount of net proceeds received from the sale of the building or equipment from the Company's Mallusk, Northern Ireland facility or the amount of net proceeds in a debt or equity transaction, and may be increased if necessary under certain circumstances. As of the date of this report, Mr. Berg has not requested that his commitment be reduced. In October 2001, the Company entered into a loan agreement (the "2001 Loan") with Berg & Berg. Under the terms of the agreement, Berg & Berg agreed to advance the Company funds of up to $20.0 million between the date of the agreement and December 31, 2003. Interest on the 2001 Loan accrues at 8.0% per annum, payable from time to time. On July 13, 2005, Berg & Berg agreed to extend the maturity date for the loan from September 30, 2006, to September 30, 2008. In July 1998, the Company entered into an amended loan agreement (the "1998 Loan") with Berg & Berg that allows the Company to borrow, prepay and re-borrow up to $10.0 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 $15.0 million. As of March 31, 2007, the Company had an outstanding balance of $14.95 million under the 1998 Loan agreement. The loan bears interest at one percent over the lender's borrowing rate (approximately 9.0% at March 31, 2007). On July 13, 2005, the parties agreed to extend the loan's maturity date from September 30, 2006 to September 30, 2008. 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, 2007, principal and interest amounts of $4.9 million and $300,000 were outstanding under Dawson Note One and Dawson Note Two, respectively, and under each of the Dawson Notes, interest from the issuance date accrues on unpaid principal at the rate of 5.77% per annum, or at the maximum rate permissible by law, whichever is less. On April 20, 2005, the Company's Board of Directors approved a resolution to extend the maturity dates of each of the Dawson Notes from September 5, 2005 to September 5, 2007. 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. As of March 31, 2007 and 2006, amounts of $3,550,313 and $1,613,458 were outstanding under Dawson Note One and Dawson Note Two, respectively. 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. 62 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 21. SEGMENT AND GEOGRAPHIC INFORMATION: The Company's chief operating decision makers are its Chairman and Chief Executive Officers, who review operating results to make decisions about resource allocation and to assess performance. The Company's chief operating decision makers view results of operations as a single operating segment and the development and marketing of the Company's Saphion(R) technology. The Company's Chairman and Chief Executive Officer have organized the Company functionally to develop, market, and manufacture Saphion(R) products. The Company conducts its business in two geographic regions. Long-lived asset information by geographic area is as follows at (in thousands):
MARCH 31, ------------------------------------------------------- 2007 2006 --------------------------- -------------------------- United States $ 657 $ 648 International 3,518 2,692 --------------------------- -------------------------- Total $ 4,175 $ 3,340 =========================== ========================== Revenues by geographic area are as follows at (in thousands): FISCAL YEAR ENDING MARCH 31, -------------------------------------- ----------------- 2007 2006 2005 -------------------- ----------------- ----------------- United States $ 14,579 $ 15,796 $ 9,656 International 2,095 1,418 1,009 -------------------- ----------------- ----------------- Total $ 16,674 $ 17,214 $ 10,665 ==================== ================= =================
22. QUARTERLY FINANCIAL DATA (UNAUDITED): 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Fiscal Year Year Ended March 31, 2007 -------------- ------------- -------------- ----------- ------------ - -------------------------------------- Revenue $ 3,168 $ 6,376 $ 2,318 $ 4,812 $ 16,674 Gross margin/(loss) 22 1,079 (464) (329) 308 Operating loss (4,160) (3,142) (4,458) (4,458) (16,218) Net loss available to common stockholders (5,657) (4,768) (5,962) (6,036) (22,423) Basic and diluted EPS(1) (0.06) (0.05) (0.06) (0.05) (0.22) Year Ended March 31, 2006 - ------------------------------------- Revenue $ 3,405 $ 5,518 $ 4,819 $ 3,472 $ 17,214 Gross margin loss (1,922) (1,826) (1,152) (3,340) (8,240) Operating loss (7,260) (6,698) (5,670) (8,020) (27,648) Net loss available to common stockholders (8,196) (8,053) (7,106) (9,569) (32,924) Basic and diluted EPS(1) (0.09) (0.09) (0.08) (0.11) (0.37) - -------------- (1) The sum of Basic and Diluted EPS for the four quarters may differ from the annual EPS due to the required method of computing weighted average number of shares in the respective periods.
63 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 23. SUBSEQUENT EVENTS: On May 17, 2007, Berg & Berg Enterprises, LLC purchased 990,099 shares of the Company's common stock for $1.0 million. The purchase price of $1.01 per share equaled the closing bid price of the Company's common stock as of May 16, 2007. On April 18, 2007, West Coast Venture Capital purchased 925,926 shares of the Company's common stock for $1.0 million. The purchase price of $1.08 per share equaled the closing bid price of the Company's common stock as of April 19, 2007. On April 5, 2007, West Coast Venture Capital purchased 970,874 shares of the Company's common stock for $1.0 million. The purchase price of $1.03 per share equaled the closing bid price of the Company's common stock as of April 4, 2007. 64 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On August 21, 2006 the Company dismissed Deloitte & Touche, LLP as the Company's independent registered public accounting firm. Effective, the same day the Company appointed Helin, Donovan, Trubee & Wilkinson, LLP to serve as its principal independent registered public accounting firm for the fiscal year ending March 31, 2007. On January 22, 2007, the Company was informed that its principal independent registered public accounting firm, Helin, Donovan, Trubee & Wilkinson, LLP (HDT&W) had consummated a merger with Pohl, McNabola, Berg & Co., LLP located in San Francisco, California. The name of the post merger firm is PMB Helin Donovan, LLP and the post-merger firm has succeeded HDT&W as our principal independent registered public accounting firm. ITEM 9A. CONTROLS AND PROCEDURES EVALUATION AND CONCLUSION OF DISCLOSURE CONTROLS AND PROCEDURES The Company conducted an evaluation, under the supervision and with the participation of the Company's principal executive officer and principal financial officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of March 31, 2007. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures as of the end of the period covered by this report were effective as of March 31, 2007. MANAGEMENT'S REPORT ON INTERNAL CONTROL Management is responsible for establishing and maintaining adequate internal control over financial reporting of the Company. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) 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. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Company's internal control over financial reporting was effective as of March 31, 2007. The Company is in the process of implementing a new accounting system in China during the fourth quarter. The final testing and documentation of the accounting system implementation was not complete in time to allow sufficient testing of certain controls. The Company believes that mitigating and compensating controls which exist at the date of this report reduce to a relatively low level the risks associated with implementing the new accounting system. Management's assessment of the effectiveness of the Company's internal control over financial reporting as of March 31, 2007 has been audited by PMB Helin Donovan, LLP, an independent registered public accounting firm, as stated in their report, which is included herein. /s/ Robert L.kanode - ----------------------------------- Robert L. Kanode Principal Executive Officer 65 /s/ Thomas F. Mezger - -------------------------------- Thomas F. Mezger Principal Financial Officer CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING In order to address and correct certain deficiencies identified in fiscal 2006, management has taken the following corrective actions: 1) strengthened the expertise and minimum competency requirements for critical accounting and financial reporting positions, and 2) replaced and added personnel with the appropriate expertise to our accounting and financial reporting functions in the Company's operating and corporate segments to review and monitor transactions, accounting processes and control activities more effectively. Other than the proceeding changes, there were no significant changes in our internal control over financial reporting that occurred during the fourth quarter of fiscal 2007 that has materially affected, or is reasonably likely to affect, our internal control over financial reporting. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERAL CONTROL OVER FINANCIAL REPORTING 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 Control, that Valence Technology, Inc. and its subsidiaries (the "Company") did maintain effective internal control over financial reporting as of March 31, 2007 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 consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. 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 did maintain effective internal control over financial reporting as of March 31, 2007, 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 has maintained, in all material respects, effective internal control over financial reporting as of March 31, 2007, based on the criteria 66 established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company was in the process of implementing a new accounting system for its Chinese subsidiaries during the fourth quarter of its fiscal year. The final testing and documentation of the accounting system implementation was not completed in time to allow sufficient testing of certain controls. The Company implemented compensating controls during this period. 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, 2007, of the Company and our report dated June 7, 2007 expressed an unqualified opinion on those consolidated financial statements and included an explanatory paragraph concerning substantial doubt about the Company's ability to continue as a going concern on those consolidated financial statements. PMB HELIN DONOVAN, LLP Austin, Texas June 7, 2007 ITEM 9B. OTHER INFORMATION None. 67 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following tables set forth certain information with respect to our directors, officers and significant employees as of June 1, 2007. The following persons serve as our directors:
DIRECTORS AGE PRESENT POSITION - --------- --- ---------------- Carl E. Berg (2)............................. 69 Director and Chairman of the Board Robert L. Kanode............................. 57 Director Vassilis G. Keramidas (1).................... 67 Director Bert C. Roberts (1).......................... 63 Director (1) Member of the Audit Committee (2) Member of the Compensation Committee The following persons serve as our executive officers: EXECUTIVE OFFICERS AGE PRESENT POSITION - ------------------ --- ---------------- Robert L. Kanode............................ 57 Chief Executive Officer and President Thomas F. Mezger............................ 55 Chief Financial Officer and Assistant Secretary Roger A. Williams........................... 59 General Counsel and Assistant Secretary Joel Sandahl................................ 55 VP of Engineering and Product Development Richard Hanna............................... 29 VP of Operations
Our executive officers are appointed by and serve at the discretion of the Board. There are no family relationships between any director and any executive officer. CARL E. BERG. Mr. Berg helped found us and has served on the Board since September 1991 and currently serves as the Chairman of the Board. Mr. Berg has been a major Silicon Valley industrial real estate developer and private venture capital investor. Mr. Berg also serves as the Chairman of the Board, Chief Executive Officer and director of Mission West Properties, Inc., a real estate investment company; and as a director of Monolithic Systems, Inc., and Focus Enhancements, Inc. Mr. Berg holds a Bachelor of Arts degree in Business Administration from the University of New Mexico, Albuquerque. ROBERT L. KANODE. In March 2007, we hired a new President and Chief Executive Officer, Robert L. Kanode. Mr. Kanode brings over 12 years of experience in the battery industry to Valence. He served as a senior partner for The Sales & Performance Group, a consulting group based in New Yorkwhere he has worked with Fortune 500 companies to commercialize their products and services, to develop manufacturing, marketing, sales and service functions, and to identify and develop global niche retail and OEM markets. Prior to his tenure there, Kanode served as president of OptiTec LLC and other companies where he guided the company through the product and service commercialization process, the development of manufacturing and marketing/sales functions, the identification of niche retail and OEM markets, and the securing of financial support for public and private companies. VASSILIS G. KERAMIDAS. Dr. Keramidas joined us as a director in August 2004. Dr. Keramidas currently serves as the Managing Director of Keramidas International Associates LLC, which provides consulting services in connection with the generation, management, commercialization and disposition of intellectual property, technology commercialization and strategic research planning, and as a director of Twenty First Century Battery, Ltd. From 1997 to 2003, Dr. Keramidas served as Vice President of Formative Technologies at Telcordia Technologies (formerly Bellcore) where he launched the company's first international commercialization effort, and from 1984 to 1997, he served in Director and Executive Director of Research positions with Bellcore. Prior to that, Dr. Keramidas worked as a Researcher and Research Director at Bell Laboratories from 1973 to 1983. Dr. Keramidas holds a Bachelor's Degree in Physics from Rockford College, a Bachelor's Degree in Electrical Engineering from the University of Illinois, A Master's Degree in Physics from John Carroll University and a Ph.D. in Solid State Science (Applied Physics) from the Materials Research Laboratory of Pennsylvania State University. For his 68 contributions to his field and his technical leadership, Dr. Keramidas has been elected a Fellow of the Institute of Electrical and Electronic Engineers. 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 the Outside Chairman of WorldCom, Inc. from 1998 until December 2002. On July 21, 2002, WorldCom, Inc. and substantially all of its active U.S. subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York. Mr. Roberts served as Chairman of MCI, a telecommunications company from 1996 until 1998, Chairman and Chief Executive Officer from 1992 to 1996, and Chief Executive Officer in 1991 after having served as President and Chief Operating Officer since 1985. Mr. Roberts serves on the board of the Prostate Cancer foundation and is on the advisory board of several high-technology companies. Mr. Roberts holds a Bachelor of Science in Engineering from Johns Hopkins University. THOMAS F. MEZGER. Mr. Mezger joined us in September 2005 and serves as our Chief Financial Officer and Assistant Secretary. From January 2003 to April 2005, he served as Controller-Asia Pacific for Precision Castparts Corporation/Cooper Cameron Corporation, a supplier for the aerospace, oil and gas, water treatment and chemical industry. Headquartered in Kuala Lumpur, Mr. Mezger was responsible for the accounting and finance of subsidiaries of Precision Castparts in Malaysia, Singapore and China including the implementation of Sarbanes-Oxley compliance programs. From January 2002 through June 2002, Mr. Mezger served as Vice President and Chief Financial Officer for MCK Communications, Inc., a company that sold and services equipment for the telecommunications industry. From 1998 to 2002, Mr. Mezger serviced as Vice President of Operations and Chief Financial Officer for Enhanced Messaging Systems., a wireless and satellite networking equipment manufacturer, where he was responsible for production and financial operations. Mr. Mezger started his career at Motorola, Inc., a mobility products company, where he spent over 18 years in the U.S. and Hong Kong, involved in or managing various aspects of accounting, finance, credit, collection, policies and procedures and sales order processing. 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 32 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. JOEL SANDAHL. Mr. Sandahl joined us in June 2006 and serves as our VP of Engineering and Product Development. Mr. Sandahl leads the worldwide engineering operations for Valence Technology. Mr. Sandahl has over 30 years of engineering leadership consistently developing teams that deliver leading products and technologies to the market. Prior to joining Valence, he founded and served as President of two companies, Complex Systems, Inc. and Simulcomm LLP. Previously, Mr. Sandahl served as the Chief System Architect for E. F. Johnson; Director of Advanced Systems & Technology for Motorola; the Chief Scientist and Director of Advanced Development for Quintron Corporation; and a Product Manager, Engineering Manager, and Lead Engineer for Harris Corporation. Further, he has served as a principal consultant for numerous high-tech companies including Xerox, Eastman Kodak, and Rockwell International. He is a member of the Institute for Electrical Engineers (IEEE) and the Association for Computing Machinery (ACM). RICHARD HANNA. Mr. Hanna has worked with us since 2000. In March 2007, we promoted Mr. Hanna to VP of Operations. Mr. Hanna served as General Manager of our China manufacturing operations since September 2006. From December 2005 to September 2006, Mr. Hanna served as our General Manager of China manufacturing at our Valence Technology Suzhou facility. From 2000 to December 2005, Mr. Hanna held various other positions with Valence, including Quality Manager, Software Development Coordinator, and Project Engineer. 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 69 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., 12201 Technology Boulevard, Suite 150, Austin, Texas 78727, 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 Regulations 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, 2007, our directors, officers and 10% holders complied with all filing requirements under Section 16(a) of the Exchange Act. Mr. Robert L. Kanode was appointed as an officer subject to Section 16(a) on March 13, 2007, and filed a delinquent Form 3 on March 28, 2007. Mr. Ricky Hanna was appointed as an officer subject to Section 16(a) on March 23, 2007, and filed a delinquent Form 3 on April 9, 2007. 70 *** ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 is included in our definitive proxy statement for our 2007 annual meeting to be filed pursuant to Section 14(a) of the Securities and Exchange Act of 1934 and is incorporated by reference into this Report. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. The information required by Item 121 is included in our definitive proxy statement for our 2007 annual meeting to be filed pursuant to Section 14(a) of the Securities and Exchange Act of 1934 and is incorporated by reference into this Report. 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 2007 that would require disclosure under this Item 13. On February 1, 2007, West Coast Venture Capital purchased 657,894 shares of the Company's common stock for $1.0 million. The purchase price of $1.52 per share equaled the closing bid price of the Company's common stock as of January 31, 2007. The issuance of these shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. On January 18, 2007, West Coast Venture Capital purchased 662,252 shares of the Company's common stock for $1.0 million. The purchase price of $1.51 per share equaled the closing bid price of the Company's common stock as of January 17, 2007. The issuance of these shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. On December 27, 2006, West Coast Venture Capital purchased 613,497 shares of the Company's common stock for $1.0 million. The purchase price of $1.63 per share equaled the closing bid price of the Company's common stock as of December 26, 2006. The issuance of these shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. On December 15, 2006, West Coast Venture Capital purchased 549,541 shares of the Company's common stock for $1.0 million. The purchase price of $1.82 per share equaled the closing bid price of the Company's common stock as of December 15, 2006. The issuance of these shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. On August 17, 2006, West Coast Venture Capital purchased 534,759 shares of the Company's common stock for $1.0 million. The purchase price of $1.87 per share equaled the closing bid price of the Company's common stock as of August 16, 2006. The issuance of these shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. On August 3, 2006, West Coast Venture Capital purchased 1,298,702 shares of the Company's common stock for $2.0 million. The purchase price of $1.54 per share equaled the closing bid price of the Company's common stock as of August 3, 2006. The issuance of these shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. On May 11, 2006, West Coast Venture Capital purchased 646,552 shares of the Company's common stock for $1.5 million. This represented a funding on the $20.0 million funding commitment previously made by Berg & Berg. The purchase price of $2.32 per share equaled the closing bid price of the Company's common stock as of May 10, 2006. The issuance of these 71 shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. On April 3, 2006, West Coast Venture Capital purchased 401,606 shares of the Company's common stock for $1.0 million. This represented a funding on the $20.0 million funding commitment previously made by Berg & Berg. The purchase price of $2.49 per share equaled the closing bid price of the Company's common stock as of March 31, 2006. The issuance of these shares of common stock was exempt from registration pursuant to section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act, these shares are restricted from trading by West Coast Venture Capital, an affiliate of Mr. Berg, for one year from the date of issuance, unless registered, and then may be traded only in compliance with the volume restrictions and other applicable restrictions. In June 2006, the Company issued convertible promissory notes in the aggregate principal amount of $2.0 million to Berg & Berg, which are due with interest in September 2006. These convertible promissory notes accrue interest at the annual rate of 8.0% and are convertible at any time prior to maturity, into shares of common stock of the Company at a conversion price equal to the closing bid price of the Company's common stock on the trading day immediately prior to the conversion date, provided that the conversion price cannot be lower than $1.70, the closing bid price of the Company's common stock on June 20, 2006. In June 2005, Mr. Carl Berg, our chairman of the board and principal stockholder, agreed to provide a funding commitment of $20.0 million. On June 30, 2005, the Company drew down $2.5 million of this commitment. This draw took the form of a loan at a 5.0% annual interest rate and was repaid with proceeds from a July 2005 loan from a third party finance company. This funding commitment was reduced by $4.3 million upon the purchase of the Series C-2 Convertible Preferred Stock on July 14, 2005 by Berg & Berg. On December 14, 2005, Mr. Berg's funding commitment was further reduced by $4.3 million in connection with the purchase of the Company's Series C-1 Convertible Preferred Stock by Berg & Berg. In February and March 2006, the Company issued convertible promissory notes in favor of Berg & in an aggregate principal amount of $6.0 million (the "Notes"). The Notes accrued interest at the annual rate of 8.0% and matured on March 30 and June 30, 2006. The principal amount of the Notes, together with accrued interest, was converted into 2,965,870 shares of common stock of the Company, in accordance with their terms on April 3, 2006. In June 2004, Mr. Berg 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, 2006, the Company has drawn down $19 million of this commitment. This commitment can be reduced by the amount of net proceeds received from the sale of the building or equipment from the Company's Mallusk, Northern Ireland facility or the amount of net proceeds in a debt or equity transaction, and may be increased if necessary under certain circumstances. As of the date of this report, Mr. Berg has not requested that his commitment be reduced. In October 2001, the Company entered into a loan agreement (the "2001 Loan") with Berg & Berg. Under the terms of the agreement, Berg & Berg agreed to advance the Company funds of up to $20.0 million between the date of the agreement and December 31, 2003. Interest on the 2001 Loan accrues at 8.0% per annum, payable from time to time. On July 13, 2005, Berg & Berg agreed to extend the maturity date for the loan from September 30, 2006, to September 30, 2008. In July 1998, the Company entered into an amended loan agreement (the "1998 Loan") with Berg & Berg that allows the Company to borrow, prepay and re-borrow up to $10.0 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 $15.0 million. As of March 31, 2007, the Company had an outstanding balance of $14.95 million under the 1998 Loan agreement. The loan bears interest at one percent over the lender's borrowing rate (approximately 9.0% at March 31, 2007). On July 13, 2005, the parties agreed to extend the loan's maturity date from September 30, 2006 to September 30, 2008. 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 72 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, 2007, principal and interest amounts of $4.9 million and $300,000 were outstanding under Dawson Note One and Dawson Note Two, respectively, and under each of the Dawson Notes, interest from the issuance date accrues on unpaid principal at the rate of 5.77% per annum, or at the maximum rate permissible by law, whichever is less. On April 20, 2005, the Company's Board of Directors approved a resolution to extend the maturity dates of each of the Dawson Notes from September 5, 2005 to September 5, 2007. 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. As of March 31, 2007 and 2006, amounts of $3,550,313 and $1,613,458 were outstanding under Dawson Note One and Dawson Note Two, respectively. 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. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The following table sets forth the aggregate fees billed to us for fiscal 2007 and 2006 by PMB Helin Donovan, LLP and Deloitte & Touche LLP, and certain other consultants:
March 31, Percentage of services -------------------------------------- ------------------------------------- 2007 2006 2007 2006 ---------------- ----------------- ----------------- ---------------- Audit fees $ 349,230 $ 592,271 62% 55% Audit-related fees 50,715 38,934 9% 3% Tax fees 34,030 31,467 6% 3% All other fees 126,328 406,063 23% 39% ---------------- ----------------- ----------------- ---------------- Total fees $ 560,303 $ 1,068,735 100% 100% ================ ================= ================= ================
"Audit Fees" billed during fiscal 2007 and 2006 were for professional services rendered for the audit of our financial statements. "Audit-Related Fees" billed during fiscal 2007 and 2006 were for services related to accounting consultation and reviews of a Form S-3 filed with the Securities and Exchange Commission. "Tax Fees" billed during fiscal 2007 and 2006 were for professional services rendered for tax compliance, tax advice and tax planning. "All Other Fees" billed in fiscal 2007 and 2006 were for testing internal controls under the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 and for consulting services related to the preparation of our documentation of internal controls under the requirements of 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 us by our independent registered public accounting firm. The Audit Committee has considered the role of PMB Helin Donovan, LLP in providing audit, audit-related services to us and has concluded that such services are compatible with PMB Helin Donovan, LLP's role as our independent registered public accounting firm. 73 PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) The following documents are filed as part of this report: (1) Financial Statements: The following consolidated financial statements of Valence Technology, Inc. and Subsidiaries contained under Item 8 of this Form 10-K are incorporated herein by reference: Consolidated Balance Sheets as of March 31, 2007 and 2006 Consolidated Statements of Operations and Comprehensive Loss for the years ended March 31, 2007, 2006 and 2005 Consolidated Statements of Stockholders' Deficit for the years ended March 31, 2007, 2006 and 2005 Consolidated Statements of Cash Flows for the years ended March 31, 2007, 2006 and 2005 (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:
EXHIBIT NO. DESCRIPTION 3.1 (1) Second Restated Certificate of Incorporation of the Company 3.2 (2) Amendment to the Second Restated Certificate of Incorporation of the Company 3.3 (3) Certificate of Designations, Preferences and Rights of Series C-1 Convertible Preferred Stock 3.4 (3) Certificate of Designations, Preferences and Rights of Series C-2 Convertible Preferred Stock 3.4 Third Amended and Restated Bylaws of the Company 4.1 (5) Warrant dated January 4, 2002 to Berg & Berg Enterprises, LLC 4.2 (6) Warrant to Purchase Common Stock, issued June 2, 2003 (to Riverview Group LLC) 4.3 (1) Loan Agreement between the Company and Baccarat Electronics, Inc., dated July 17, 1990 4.4 (1) Amendment No. 1 to Loan Agreement between the Company and Baccarat Electronics, Inc., dated March 15, 1991 (subsequently transferred to Berg & Berg Enterprises, LLC) 4.5 (1) Amendment No. 2 to Loan Agreement between the Company and Baccarat Electronics, Inc., dated March 24, 1992 (subsequently transferred to Berg & Berg Enterprises, LLC) 4.6 (1) Amendment No. 3 to Loan Agreement between the Company and Baccarat Electronics, Inc., dated August 17, 1992 (subsequently transferred to Berg & Berg Enterprises, LLC) 4.7 (7) Amendment No. 4 to Loan Agreement between the Company and Baccarat Electronics, Inc., dated September 1, 1997 (subsequently transferred to Berg & Berg Enterprises, LLC) 74 EXHIBIT NO. DESCRIPTION 4.8 (8) Amendment No. 5 to Loan Agreement between the Company and Baccarat Electronics, Inc., dated July 17, 1998 (subsequently transferred to Berg & Berg Enterprises, LLC) 4.9 (7) Amendment No. 6 to Loan Agreement between the Company and Baccarat Electronics, Inc., dated November 27, 2000 (subsequently transferred to Berg & Berg Enterprises LLC) 4.10 (9) Second Amended Promissory Note dated November 27, 2000 issued by the Company to Baccarat Electronics, Inc. (subsequently transferred to Berg & Berg Enterprises, LLC) 4.11 (4) Amendment No. 7 to Original Loan Agreement between the Company and Berg & Berg Enterprises, LLC (previously with Baccarat Electronics, Inc.), dated October 10, 2001 4.12 (9) Amendment No. 8 to Original Loan Agreement and Amendment to Second Amended Promissory Note between the Company and Berg & Berg Enterprises, LLC (previously with Baccarat Electronics, Inc.), dated February 11, 2002 4.13 (10) Loan Agreement dated October 5, 2001 between the Company and Berg & Berg Enterprises, LLC 4.14 (10) Security Agreement dated October 5, 2001 between the Company and Berg & Berg Enterprises, LLC 4.15 (10) Promissory Note dated October 5, 2001 issued by the Company to Berg & Berg Enterprises, LLC 4.16 (11) Amendment to Loan Agreements with Berg & Berg dated November 8, 2002 (Amendment No. 1 to October 5, 2001 Loan Agreement and Amendment No. 9 to 1990 Baccarat Loan Agreement) 4.17 (12) Amendment to Loan Agreements with Berg & Berg dated October 23, 2004 (Amendment No. 2 to October 5, 2001 Loan Agreement and Amendment No. 10 to 1990 Baccarat Loan Agreement) 4.18 (22) Warrant to Purchase Common Stock, issued July 13, 2005 (SFT I, Inc.) 4.19 (22) Warrant to Purchase Common Stock, issued July 13, 2005 (Berg & Berg Enterprises, LLC) 4.20 (24) Option Agreement, dated as of July 13, 2005, by and between Valence Technology, Inc. and James R. Akridge 10.1 (13) 1990 Stock Option Plan as amended on October 3, 1997 10.2 (14) 1996 Non-Employee Directors' Stock Option Plan as amended on October 3, 1997 10.3 (15) Valence Technology, Inc. Amended and Restated 2000 Stock Option Plan 10.4 (17) Form of Indemnification Agreement entered into between the Company and its Directors and Officers 10.5 (16) Registration Rights Agreement with West Coast Venture Capital, Inc. (the 1981 Kara Ann Berg Trust) dated January 13, 2001 10.6 (18) Joint Venture Contract with Fengfan Group Limited Liability Company dated July 8, 2003 10.7 (18) Contract for Technology Investment with Baoding Fengfan Group Limited Liability Company and Baoding Fengfan - Valence Battery Co., Ltd., Dated July 8, 2003 10.8 (18) Export Sales Contract with Baoding Fengfan-Valence Battery Co., Ltd., dated July 8, 2003 10.9 (18) Equipment Contribution Contract with Baoding Fengfan Group Limited Liability Company dated July 8, 2003 75 EXHIBIT NO. DESCRIPTION 10.10 (19) Purchase and Sale Agreement and Escrow Instructions between Valence Technology Nevada, Inc. and Mars Partners, dated August 8, 2003 10.11 (21) Equity Line of Credit Term Sheet, dated June 11, 2004 between the Company and Carl E. Berg 10.28 (3) Securities Purchase Agreement, dated November 30, 2004 10.29 (3) Amendment and Exchange Agreement, dated November 30, 2004 10.15 (22) Loan Agreement dated July 13, 2005, by and between Valence Technology, Inc. and SFT I, Inc. 10.16 (22) Registration Rights Agreement dated July 13, 2005 by and between Valence Technology, Inc. and SFT I, Inc. 10.17 (22) Amendment No. 12 and Amendment No. 4, to Loan Agreements, dated as of July 13, 205 10.18 (22) Assignment Agreement, dated July 14, 2005, by and between Valence Technology, Inc. and Berg & Berg Enterprises, LLC. 10.19 (23) Letter Agreement, dated March 13, 2007, by and between Valence Technology, Inc. and Robert L. Kanode 10.21 (24) Letter Agreement, effective September 9, 2005, by and between Valence Technology, Inc. and Thomas F. Mezger 10.22 (25) Assignment Agreement, dated December 14, 2005, by and between Valence Technology, Inc. and Berg & Berg Enterprises, LLC 10.23 (26) Employment Agreement between Valence Technology (Suzhou) Co., Ltd. And Mr. Guo Chuntai. 10.24 (27) Controlled Equity Offering Sales Agreement, dated April 13, 2006, by and between Valence Technology, Inc. and Cantor Fitzgerald & Co. 10.25 Summary of Board of Directors Compensation 10.26 Summary of Executive Officers' Compensation 21.1 List of subsidiaries of the Company 23.1 Consent of Deloitte & Touch, LLP, an Independent Registered Public Accounting Firm 23.2 Consent of PMB Helin Donovan, LLP, an Independent Registered Public Accounting Firm 24.1 (28) Power of Attorney 31.1 Certification of Robert L. Kanode, Principal Executive Officer, pursuant to Rule 13a-14 and 15d-14 of the Securities Exchange Act of 1934 31.2 Certification of Thomas F. Mezger, Principal Financial Officer, pursuant to Rule 13a-14 and 15d-14 of the Securities Exchange Act of 1934 32.1 Certification of Robert L. Kanode, Principal Executive Officer and Thomas F. Mezger, Principal Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.1 Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
76 FOOTNOTES (1) Incorporated by reference to the exhibit so described in the Company's Registration Statement on Form S-1 (File No. 33-46765), as amended, filed with the Securities and Exchange Commission on March 27, 1992 (2) Incorporated by reference to the exhibit so described in the Company's Schedule 14A filed with the Securities and Exchange Commission on January 28, 2000 (3) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K dated November 30, 2004, filed with the Securities and Exchange Commission on December 1, 2005 (4) Incorporated by reference to the exhibit so described in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2002, filed with the Securities and Exchange Commission on July 1, 2002 (5) Incorporated by reference to the exhibit so described in the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended December 31, 2001, filed with the Securities and Exchange Commission on February 19, 2002 (6) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K dated June 2, 2003, and filed with the Securities and Exchange Commission on June 3, 2003 (7) Incorporated by reference to the exhibit so described in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2003, filed with the Securities and Exchange Commission on June 30, 2003 (8) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K dated July 27, 1998, and filed with the Securities and Exchange Commission on August 4, 1998 (9) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K dated December 11, 1998, and filed with the Securities and Exchange Commission on December 21, 1998 (10) Incorporated by reference to the exhibit so described in the Company's Registration Statement on Form S-8 (File No. 333-74595) filed with the Securities and Exchange Commission on March 17, 1999 (11) Incorporated by reference to the exhibit so described in the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2002, filed with the Securities and Exchange Commission on November 14, 2002 (12) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K, dated November 3, 2004, filed with the Securities and Exchange Commission on November 5, 2004 (13) Incorporated by reference to the exhibit so described in the Company's Registration Statement on Form S-8 (File No 333-43203) filed with the Securities and Exchange Commission on December 24, 1997 (14) Incorporated by reference to the exhibit so described in the Company's Registration Statement on Form S-8 (File No. 333-74595) filed with the Securities and Exchange Commission on March 17, 1999 (15) Incorporated by reference to the exhibit so described in the Company's Registration Statement on Form S-8 (File No. 333-101708) filed with the Securities and Exchange Commission on December 6, 2002 77 FOOTNOTES (16) Incorporated by reference to the exhibit so described in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2001, filed with the Securities and Exchange Commission on July 2, 2001 (17) Incorporated by reference to the exhibit so described in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2000, filed with the Securities and Exchange Commission on June 29, 2000 (18) Incorporated by reference to the exhibit so described in the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003, filed with the Securities and Exchange Commission on November 14, 2003 (19) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K, dated December 12, 2003, filed with the Securities and Exchange Commission on December 17, 2003 (20) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K, dated November 9, 2004, filed with the Securities and Exchange Commission on November 12, 2004 (21) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K, dated December 2, 2004, filed with the Securities and Exchange Commission on January 10, 2005 (22) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K, dated July 13, 2005, filed with the Securities and Exchange Commission on July 15, 2005 (23) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K, dated March 14, 2007, filed with the Securities and Exchange Commission on July 18, 2005 (24) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K, dated September 9, 2005, filed with the Securities and Exchange Commission on September 14, 2005 (25) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K, dated December 14, 2005, filed with the Securities and Exchange Commission on December 16, 2005 (26) Incorporated by reference to the exhibit so described in the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended December 31, 2005, filed with the Securities and Exchange Commission on February 9, 2006 (27) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K, dated April 13, 2006, filed with the Securities and Exchange Commission on April 13, 2006 (28) Included in signature page 78 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. Dated: June 1, 2007 /s/ Robert L. Kanode ----------------------------------------- Robert L. Kanode President and Chief Executive Officer POWER OF ATTORNEY Each person whose signature appears below constitutes and appoints Robert L. Kanode and Thomas F. Mezger, 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.
Name Position Date - ---------------------------------------- ---------------------------------------------- ----------------------- President and Chief Executive Officer /s/ Robert L. Kanode (Principal Executive Officer) and Director June 1, 2007 - ---------------------------------------- Robert L. Kanode Chief Financial Officer (Principal Financial /s/ Thomas F. Mezger and Accounting Officer) June 1, 2007 - ---------------------------------------- Thomas F. Mezger /s/ Carl E. Berg Director and Chairman of the Board June 1, 2007 - ---------------------------------------- Carl E. Berg /s/ Vassilis G. Keramidas Director June 1, 2007 - ---------------------------------------- Vassilis G. Keramidas /s/ Bert C. Roberts, Jr. Director June 1, 2007 - ---------------------------------------- Bert C. Roberts, Jr.
EX-10 2 exhibit_10-25.txt EXHIBIT 10.25 VALENCE TECHNOLOGY, INC. SUMMARY OF BOARD OF DIRECTORS COMPENSATION 2007 Each director who is a non-employee receives compensation as set forth below, in accordance with the compensation program for non-employee directors approved by the Board of Directors.
Annual Retainer Not applicable In Person Board, Shareholder or Committee Meeting Reimbursement for reasonable travel and lodging Meeting expenses Audit Committee Chair Fee Not applicable Equity Compensation Upon appointment to the Board of Directors, each non-employee director is entitled to receive an option grant to purchase 100,000 shares of our common stock. 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 and are exercisable at the fair market value of the underlying stock on the grant date. In addition, members of the Board of Directors are eligible to receive a $2,000 fee for each official quarterly board meeting. Other Compensation Upon appointment to the Board of Directors, each non-employee director is entitled to receive $10,000 as a training fee.
EX-10 3 exhibit_10-26.txt EXHIBIT 10.26 VALENCE TECHNOLOGY, INC. EXECUTIVE OFFICERS' COMPENSATION FOR 2007 ANNUAL CASH COMPENSATION BASE COMPENSATION. Set forth below are the base salaries effective for 2007 of our named executive officers. These salaries are reviewed by the Compensation Committee of the Board of Directors annually and are subject to increase.
NAME TITLE BASE SALARY - ---- ----- ----------- Robert L. Kanode (1) Chief Executive Officer and President $250,000 James R. Akridge (1) Former Chief Executive Officer and $250,000 President Dean F. Bogus Former President of the Americas $200,000 And Europe ChunTai Guo Former President of the Asia $200,000 -Pacific Operations Thomas F. Mezger (1) Chief Financial Officer and Assistant $185,000 Secretary Roger A. Williams General Counsel and Assistant $180,000 Secretary Joel Sandahl VP of Engineering and Product $180,000 Development Richard Hanna VP of Operations $155,000 - ----------------- (1) Please refer to the employment agreements of these executive officers, each of which has been filed with the Securities and Exchange Commission, for the other terms and conditions of their employment.
Bonuses awarded for 2007 in accordance with the foregoing were as follows:
NAME TITLE 2007 BONUS - ---- ----- ---------- Robert L. Kanode Chief Executive Officer and President n/a James R. Akridge Former Chief Executive Officer and $156,875(2) President Dean F. Bogus Former President of the Americas $112,500(3) And Europe ChunTai Guo Former President of the Asia n/a -Pacific Operations Thomas F. Mezger Chief Financial Officer and Assistant n/a Secretary Roger A. Williams General Counsel and Assistant n/a Secretary Joel Sandahl VP of Engineering and Product n/a Development Richard Hanna VP of Operations n/a - ------------------ (2) Includes a one-time severance payment of $125,000. (3) Includes a one-time severance payment of $100,000.
LONG TERM INCENTIVES STOCK OPTIONS.. Executive officers, together with our other employees, are eligible to receive grants of awards under our 2000 Stock Option Plan and 1990 Stock Option Plan. These awards may be in the form of stock options. The number of options granted to an executive officer is based upon a number of factors, including, but not limited to, his or her position, salary and performance, the number and/or value of his or her in-the-money outstanding unexercisable options, as well as the performance and goals of the Company. EX-21 4 exhibit_21-1.txt EXHIBIT 21.1 VALENCE TECHNOLOGY, INC. LIST OF SUBSIDIARIES VALENCE TECHNOLOGY (NEVADA), INC,. a Nevada corporation wholly owned by Valence Technology, Inc. VALENCE TECHNOLOGY CAYMEN ISLANDS INC., a Cayman Islands corporation wholly owned by Valence Technology, Inc. VALENCE TECHNOLOGY N.V., a Dutch Antilles corporation wholly owned by Valence Technology Cayman Islands Inc. VALENCE TECHNOLOGY INTERNATIONAL, INC, a Cayman Islands corporation wholly owned by Valence Technology Cayman Islands Inc. VALENCE TECHNOLOGY B.V., a Dutch corporation wholly owned by Valence Technology N.V. VALENCE TECHNOLOGY (Suzhou) Co., Ltd., a China Corporation, wholly owned by Valence Technology, Inc. VALENCE ENERGY-TECH (Suzhou) Co., Ltd., a China Corporation, wholly owned by Valence Technology, Inc. EX-23 5 exhibit_23-1.txt EXHIBIT 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in Registration Statement Nos. 333-101708, 333-66398, 333-74595, 333-67693, 333-43203, 333-21669, 333-21671, 033-94522, 033-60562, 033-48982 and 333-127914 on Form S-8 and Registration Statement Nos. 333-107135, 333-67942, 333-122827, and 333-127885 on Form S-3 of our reports dated June 28, 2006, relating to the consolidated financial statements of Valence Technology, Inc. (which report expressed an unqualified opinion on the consolidated financial statements and included an explanatory paragraph concerning substantial doubt about the Company's ability to continue as a going concern on those consolidated financial statements) appearing in this Annual Report on Form 10-K of Valence Technology, Inc. for the year ended March 31, 2007. /s/ Deloitte & Touche LLP ------------------------------------------ Austin, Texas June 14, 2007 EX-23 6 exhibit_23-2.txt EXHIBIT 23.2 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in Registration Statement Nos. 333-101708, 333-66398, 333-74595, 333-67693, 333-43203, 333-21669, 333-21671, 033-94522, 033-60562, 033-48982, and 333-127914 on Form S-8 and Registration Statement Nos. 333-107135, 333-67942, 333-122827, and 333-127885 on Form S-3 of our reports dated June 7, 2007, relating to the consolidated financial statements of Valence Technology, Inc. (which report expressed an unqualified opinion on the consolidated financial statements and included an explanatory paragraph concerning substantial doubt about the Company's ability to continue as a going concern on those consolidated financial statements) and of our report on internal control over financial reporting appearing in this Annual Report on Form 10-K of Valence Technology, Inc. for the year ended March 31, 2007. /s/ PMB Helin Donovan, LLP ------------------------------------ Austin, Texas June 14, 2007 EX-31 7 exhibit_31-1.txt EXHIBIT 31.1 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER OF VALENCE TECHNOLOGY, INC. I, Robert L. Kanode, certify that: 1. I have reviewed this annual report on Form 10-K of Valence Technology, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Designed such internal control over financial reporting, or caused internal control over financial reporting to be designed under our supervision, 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; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this annual report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting , to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial data; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: June 1, 2007 /s/ Robert L. Kanode - -------------------------------- By: Robert L. Kanode Title: Principal Executive Officer EX-31 8 exhibit_31-2.txt EXHIBIT 31.2 CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER OF VALENCE TECHNOLOGY, INC. I, Thomas F. Mezger, certify that: 1. I have reviewed this annual report on Form 10-K of Valence Technology, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Designed such internal control over financial reporting, or caused internal control over financial reporting to be designed under our supervision, 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; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this annual report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting , to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial data; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: June 1, 2007 /s/ Thomas F. Mezger - ------------------------------------- By: Thomas F. Mezger Title: Principal Financial Officer EX-32 9 exhibit_32-1.txt EXHIBIT 32.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of Chapter 63 of Title 18 of the United States Code), each of the undersigned officers of Valence Technology, Inc. (the "Company") does hereby certify with respect to the Annual Report of the Company on Form 10-K for the period ended March 31, 2007 (the "Report") that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in this Report fairly presents, in all material respects, the financial condition and results of operation of the Company. Date: June 1, 2007 By: /s/ Robert L. Kanode ----------------------------------- Name: Robert L. Kanode Title: Chief Executive Officer, President and Chairman of the Board Date: June 1, 2007 By: /s/ Thomas F. Mezger ----------------------------------- Name: Thomas F. Mezger Title: Chief Financial Officer The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of Chapter 63 of Title 18 of the United States Code) and is not being filed as part of the Report or as a separate disclosure document. -----END PRIVACY-ENHANCED MESSAGE-----