10-K 1 form_10-k.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, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ Commission file number 0-20028 VALENCE TECHNOLOGY, INC. (Exact Name of Registrant as Specified in Its Charter) DELAWARE 77-0214673 (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification Number) 6504 BRIDGE POINT PARKWAY, SUITE 415 AUSTIN, TEXAS 78730 (Address of Principal Executive (Zip Code) Offices) (512) 527-2900 (Registrant's Telephone Number, Including Area Code) Securities registered pursuant to Section 12(b) of the Exchange Act: Name of Each Exchange TITLE OF EACH CLASS ON WHICH REGISTERED None None Securities registered under Section 12(G) OF THE ACT: Common Stock, $.001 par value (Title of Class) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark 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 an accelerated filer (as define din Exchange Act Rule 12b-2). Yes [ ] No [X] The aggregate market value of the Registrant's voting stock held by non-affiliates on September 30, 2002 was $20,762,826.* As of June 17, 2003, there were 71,734,022 shares of common stock and 1,000 shares of preferred stock outstanding. *Excludes approximately 19,229,829 shares of common stock held by directors, officers and holders of 5% or more of registrant's outstanding common stock at september 30, 2002. 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. 1 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, TRENDS AFFECTING OUR MANUFACTURING CAPABILITIES AND TRENDS AFFECTING THE COMMERCIAL ACCEPTABILITY OF OUR PRODUCTS, AND (C) 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". 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. From 1989 through 2000, our efforts were focused on developing and acquiring our battery technologies. With the appointment of Stephan B. Godevais as our Chief Executive Officer and President in May 2001, we initiated the transition of our business by broadening our marketing and sales efforts to take advantage of our strengths in research and development, which has fostered an extensive and worldwide portfolio of issued and pending patents. With this strategic shift, our vision is to become a leader in energy storage systems by drawing on the numerous benefits of our latest battery technology, the extensive experience of our management team and the significant market opportunity available to us. In February 2002, we unveiled our Saphion(TM) 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). We believe that Saphion(TM) 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(TM) technology is able to offer greater thermal and electrochemical stability than traditional lithium-ion technologies. Our business strategy incorporates a balance of system sales and licensing and a manufacturing plan that leverages internal capabilities and partnerships with contract manufacturers. We plan to capitalize on our Saphion(TM) technology by designing solutions that differentiate end-users' products in both the large format and small format markets. In addition, we will seek to expand the fields of use of our Saphion(TM) technology through the licensing of our intellectual property related to our battery chemistries and manufacturing processes. We introduced our first product based on our Saphion(TM) technology, the N-Charge(TM) Power System, in February 2002. The N-Charge(TM) Power System is a rechargeable battery system that provides supplemental battery power for a wide variety of portable electronic devices. Since the introduction of the N-Charge(TM) Power System, we have focused our efforts on marketing the N-Charge(TM) Power System to top tier companies in an effort to validate our Saphion(TM) technology. We have successfully developed various channels for the sale and distribution of the N-Charge(TM) system, including resellers, Tier One companies, and national retailers. In February 2003, we introduced our first large format energy storage system powered by our Saphion(TM) technology, the K-Charge(TM) Power System (previously announced as the Pure Po4wer Pack). The K-Charge(TM) Power System is engineered specifically for large format applications such as those required by the telecommunications, industrial, vehicular and utility markets. It is currently in a prototype stage and is being offered to customers for evaluation and customization for specific product requirements. 2 Currently, our battery products are offered in a polymer construction. Our research and development efforts are focused on a new generation of our Saphion(TM) technology which, in addition to expected enhanced performance characteristics, will provide us the ability to manufacture batteries using the technology in a cylindrical construction, which we believe will greatly increase it potential in the marketplace. Our polymer batteries are manufactured at our manufacturing facility in Northern Ireland. We have recently entered into an OEM arrangement and have utilized the manufacturer's capabilities for certain cobalt-oxide based products during the year. We are in the process of qualifying the manufacturer for our Saphion(TM) products with the goal of transferring some of our manufacturing operations to China and other low-cost manufacturing regions. STRATEGY Our strategy is to leverage the benefits of our Saphion(TM) technology to capitalize on the significant opportunities in the energy solutions market. Key elements of our strategy include: o EXECUTE A BALANCED LICENSING AND SYSTEM SALES APPROACH. We intend to capitalize on our advanced Saphion(TM) technology to design solutions that differentiate end-users' products. Additionally, we plan to leverage our understanding of certain market segments to develop new, emerging markets for our Saphion(TM) lithium-ion technology solutions. Our systems sales strategy includes: o Developing the market for our Saphion(TM) technology through our own product launches, such as the N-Charge(TM) Power System and K-Charge(TM) Power System, and through products designed by others. With the completion of the next generation of the technology, we plan to maximize the adoption of Saphion(TM) technology by offering it in both polymer and cylindrical constructions. o In an effort to rapidly expand the fields of use of our technology, we intend to license intellectual property related to our patent-protected manufacturing processes and battery chemistries. Our polymer battery manufacturing process and our Saphion(TM) technology are our key offerings in the licensing arena. We intend to partner with large material producers to leverage their manufacturing capabilities and existing sales channels to facilitate the adoption of our Saphion(TM) technology. o Continuing sales of our cobalt-oxide based polymer battery solutions to small and mid-sized companies, where the flexibility of design and thinness of the stacked polymer is paramount. o IMPLEMENT A MANUFACTURING PLAN that utilizes contract manufacturing capabilities for the most competitive and low cost parts of our business, and focus our Northern Ireland facility on the high value-add portion. We have recently entered into an OEM arrangement with ATL and are in discussions to complete a manufacturing joint venture with FengFan. We intend to seek additional partners for cylindrical cell construction and worldwide material production. We believe this manufacturing strategy will allow us to deliver to a broad range of customer needs, from low cost, high volume to highly customized, higher value added solutions. o IMPLEMENT A PHASED APPROACH TO OUR BUSINESS STRATEGY. Our business strategy will be implemented in three fluid phases, each building on the one previous, with its own specific technology and market focus. During the initial phase, which defines our current operations, the focus is on the first generation of our Saphion(TM)technology in our patented polymer construction. We have identified the notebook accessory, PDA and tablet markets as our key targets for our small format, polymer applications. During this phase, we also introduced Saphion(TM)technology in its large format application designed for the vehicular, network and utility markets. The second phase of the business strategy will encompass the introduction of our second generation Saphion(TM) technology in cylindrical and prismatic constructions. During this stage, we plan to target the power tool, internal notebook battery and consumer appliance sectors, in addition to the markets targeted in the first phase. We also will continue to develop our large format applications throughout this phase and focus additional efforts toward our field of use licensing strategy. The final phase of our business strategy will entail the commercial production of second generation Saphion(TM)energy solutions for the vehicular, network and utility industries, with a continued focus on marketing small format Saphion(TM)solutions through the developed sales channels and licensing our battery chemistry and manufacturing process. We believe our strategy will allow us to expand our market opportunity. Through the sales of our current technology and the licensing and market development of our Saphion(TM) technology, we believe we are equipped to serve existing lithium-ion technology markets as well as open doors to new market opportunities. 3 FISCAL 2003 HIGHLIGHTS AND RECENT EVENTS o THE N-CHARGE(TM) POWER SYSTEM o In May 2003, the N-Charge(TM) Power System was selected for sale in Best Buy stores and in that same month it was selected for sale in Brookstone airport stores. o In March 2003, the N-Charge(TM) Power System was selected by HP Compaq for use with its Compaq branded notebooks. o In December 2002, CDW, a leading provider of technology solutions nationwide, began to offer the N-Charge(TM) Power System to its customers. Since that time, we have formed additional vendor relationships with other resellers and distributors, including PC Connection, MCE Technologies LLC and Datavision-Prologix. o We introduced our first consumer product utilizing our Saphion(TM) technology, the N-Charge(TM) Power System in February 2002. Sales of the product in the third and fourth quarter of fiscal 2003 were $252,000 and $348,000, respectively. o THE K-CHARGE(TM) POWER SYSTEM o In February 2003, at DEMO 2003, we introduced our first large format energy storage system powered by our Saphion(TM)technology, the K-Charge(TM)Power System. The K-Charge(TM)Power System is engineered specifically for large format applications including those required by the telecommunications, industrial, vehicular and utility markets. It offers the superior performance and safety features inherent to Saphion(TM)technology. Additionally, with lower weight and less volume than traditional lead-acid systems, the K-Charge(TM)system provides the design flexibility and versatility these applications require. The K-Charge(TM)Power System is in a prototype stage and is being offered to our customers for evaluation and design of custom products to meet their requirements. The K-Charge(TM)Power System is currently being evaluated by Tyco Electronics Power Systems (telecommunications industry), Electric Vehicles International (EVI) (electric vehicles), and the United States Advanced Battery Consortium (USABC) (comprised of representatives from Ford Motor Company, DaimlerChrysler, and General Motors Corporation and charged with the evaluation of technologies for consideration in the development of advanced high-performance batteries for electric and hybrid vehicles). o MANUFACTURING RELATIONSHIPS o On May 29, 2002 we signed an OEM agreement with Hong Kong based, Amperex Technology Limited (ATL) for the manufacturing of our batteries. We utilized ATL's manufacturing capabilities for certain cobalt-oxide based products during the year, and we are currently qualifying ATL as a manufacturing source for our Saphion(TM) products. o On November 12, 2002, we entered into an agreement to form a joint venture with FengFan Group, Ltd., the manufacturer of the largest capacity rechargeable batteries in China. The agreement contemplates the formation of a joint venture company to be established in China to manufacture Saphion(TM) Lithium-ion batteries. The formation of the joint venture is subject to approval by the Chinese government. We are currently in discussions to complete the joint venture. SAPHION(TM): THE NEXT-GENERATION IN THE RECHARGEABLE BATTERY INDUSTRY 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. 4 We believe our Saphion(TM) technology, which utilizes a natural, phosphate-based cathode in place of other less stable and more costly materials, addresses the current challenges facing the rechargeable battery industry and provides us with several competitive advantages. Key attributes of our Saphion(TM) technology include: o INCREASED SAFETY. We believe that our Saphion(TM)technology significantly reduces the safety risks associated with cobalt-oxide based lithium-ion technology. Our Saphion(TM) technology utilizes less lithium than other lithium-ion technologies. The unique chemical properties of phosphates render them incombustible if mishandled during charging or discharging. As a result, we believe Saphion(TM)technology is more stable under overcharge or short circuit conditions than existing lithium-ion technology and has the ability to withstand higher temperatures and electrical stress. The thermal and chemical stability inherent in our Saphion(TM)technology enables the creation of large, high energy density lithium-ion solutions. o ENVIRONMENTAL FRIENDLINESS. Rechargeable batteries that contain nickel-metal-hydride, nickel-cadmium and lead-acid raise environmental concerns. Saphion(TM) technology incorporates a natural, environmentally friendly, phosphate-based cathode material. o FLEXIBILITY. Saphion(TM) technology is intended for use in stacked, wound, polymer or wet battery construction types. When combined with our polymer technology, we believe it offers increased design flexibility and stability. Saphion(TM) technology can be manufactured to fit small as well as large applications. Large cells are well suited for many high energy, high power applications such as back-up power systems and vehicles. o PERFORMANCE ADVANTAGES. We believe Saphion(TM) technology offers several performance advantages over the competing battery chemistries of nickel cadmium, nickel metal-hydride and traditional lithium-ion technologies. o HIGH ENERGY DENSITY. We believe that phosphate, in combination with different metals, can allow for greater energy density than the more currently prevalent oxide technologies, whether cobalt or manganese. We expect that at maturity, Saphion(TM) technology will exceed the energy density of premium cobalt cells. o INCREASED CYCLE LIFE. The phosphates in Saphion(TM) technology cycle similarly to conventional Lithium-ion cobalt-oxide cells, over the temperature range of -20(degree)C and 60(degree)C. We believe that the cycle life of our Saphion(TM) technology will be greater than 600 cycles at 23(degree)C to 70% of the battery's initial capacity. o NO MEMORY EFFECT AND MAINTENANCE FREE. Saphion(TM) technology does not exhibit the "memory effect" of nickel cadmium and nickel metal-hydride solutions and is maintenance free. o LOWER COST. The phosphate material used in our Saphion(TM) technology is less expensive than the cobalt-oxide material used in competing technologies. As a result, we believe that as we manufacture batteries utilizing our Saphion(TM) technology, we will be able to do so with lower material costs. In addition, due to the inherent safety associated with the phosphate-based materials used in our Saphion(TM) technology, we expect that batteries manufactured with our Saphion(TM) technology will not require the addition of several costly safety devices. COMPETITIVE STRENGTHS We believe we are uniquely positioned for growth due to the following competitive strengths: o LEADING TECHNOLOGY. We believe our latest technological advancement, our phosphate-based Saphion(TM) lithium-ion technology, offers many performance advantages over competing battery technologies and creates new market opportunities. We believe the safety advantages inherent to Saphion(TM) technology allow for the creation of large format energy systems. We believe this will enable us to target markets not previously served by lithium-ion technology, such as the vehicular, network and utility industries. o NEW MARKET OPPORTUNITIES. We believe that Saphion(TM) technology enables the production of high energy density, large format batteries without the safety concerns presented by cobalt-oxide based batteries. Consequently, we believe that Saphion(TM) technology energy systems can be designed in a wide variety of products in markets not served by current lithium-ion technology. 5 o EXPERIENCED MANAGEMENT TEAM. We have strengthened our management team with several key people who have a broad base of experience in the high technology industry. The leader of our team is Stephan Godevais, who has 18 years of management and marketing experience at Dell Computer Corporation, Digital Equipment Corporation and Hewlett-Packard Company. During his tenure at Dell, Mr. Godevais launched the company's Inspiron division, growing it into a multi-billion dollar business and introduced the first 15" notebook in the industry, sustaining its position as a market leader from 1998 to 2000. Terry Standefer, Vice President of Worldwide Operations is also a key member of the management team. Mr. Standefer has 23 years of operational experience at Dell and Apple Computer. With its extensive knowledge base and market experience, we believe our management team will be able to identify customer needs and drive the expansion of our technology into new markets. o REFINED STRATEGIC FOCUS. We have transitioned to a company capitalizing on the results of our research and development by strengthening our sales and marketing efforts. We are expanding our vision to become an energy solutions company, and in addition to competing in existing lithium-ion markets, plan to enter markets previously not served by lithium-ion solutions. o PRODUCT VERSATILITY. Our products are appropriate for use in a wide variety of applications for the computer, consumer appliance, vehicular and military markets. We intend to be able to expand these markets with our Saphion(TM) technology and believe that it can be designed into a wide variety of products in markets not served by current lithium-ion technologies. PRODUCTS THE N-CHARGE(TM) POWER SYSTEM The N-Charge(TM) Power System is a rechargeable battery system featuring our Saphion(TM) technology. It is a stand-alone tool that provides easy-to-use, anytime, anywhere power for a wide variety of portable electronic devices. The N-Charge(TM) Power System allows users to charge two portable devices, such as a notebook computer and a cell phone or PDA, simultaneously. We offer the N-Charge(TM) Power System in two models, with the following specifications: FEATURE MODEL VNC-130 MODEL VNC-65 High power port voltage 16-24 V DC 16-24 V DC Low power port voltage 5-12 V DC 5-12 V DC Capacity 10 Ah 5 Ah Energy 120-130 Wh 60-65 Wh Charge time (typical) 3-4 hours 2-3hours Thickness 13 mm 13 mm Length 300 mm 300 mm Width 230 mm 230 mm Weight 1.35 kg .866 kg Cycle Life > 600 to 70% capacity > 600 to 70% capacity THE K-CHARGE(TM) POWER SYSTEM The K-Charge(TM) Power System is a large format energy storage system designed for the vehicular, network and utility industries. It features our Saphion(TM) technology in a large format battery application. Our K-Charge(TM) Power System has the following specifications: OPERATING VOLTAGE 24V/ 48V Energy 2.87 KWH Cycle Life > 2000 Cycles (80% Depth of Discharge) Operating Temperature -20~60(degree)C (-4~140(degree)F) (charge & disch.) Dimensions 546mm x 295mm x 87.4mm (21.5in. x 11.61in. x 3.44in.) Weight 27.2 Kg (60 Lb.) 6 COBALT-OXIDE AND MANGANESE-OXIDE LITHIUM ION BATTERIES We continue to offer for sale lithium ion batteries using cobalt-oxide or manganese-oxide cathodes in stacked polymer battery configurations. These products are primarily offered to small and mid-size companies for applications where the flexibility of design and the thinness of the stacked polymer is paramount. These batteries can be manufactured to as thin a specification as 1 mm and in a large "footprint" or size. Our primary marketing focus is on our battery products that feature our Saphion(TM) technology. Sales of cobalt-oxide and manganese-oxide batteries are typically made to address specific customer requirements and are not being actively promoted or marketed by us. SALES AND MARKETING We sell our battery cells and systems through an internal sales force, resellers, distributors, independent sales representatives and direct to consumers via our website in the United States, Europe and Asia. We currently have an in-house sales and marketing team consisting of seven persons. Our Vice President of Sales resides in Chicago, Illinois. Other members of the team reside in New York, New York; San Jose, California, Mallusk, Northern Ireland and Austin, Texas. We market our products mainly to resellers, distributors, retail chains, and Tier one computer manufacturers. Our battery cells and systems are sold in standard and custom configurations to meet the requirements of our customers. Our N-Charge(TM) Power System product is sold in two standard configurations. Our K-Charge(TM) Power System is expected to be sold in both standard and custom configurations. We provide pack level design and engineering services to assist the customer in configuring a product that meets its needs. We typically sell our products pursuant to standard purchase orders and license our technology pursuant to separately negotiated license agreements. Sales are typically denominated in United States dollars. Consequently, the Company's sales historically have not been subject to currency fluctuation risk. MANUFACTURING We currently manufacture most of our battery products and systems at our vertically integrated manufacturing plant in Mallusk, Northern Ireland. The Northern Ireland factory began automated assembly in the first quarter of 1999 and is state-of-the-art in high-volume manufacturing equipment. We have the ability to manufacture a range of battery sizes and thicknesses, utilizing the following chemistries: phosphate, cobalt-oxide, and manganese-oxide. Our batteries are intended for use in multiple applications, including but not limited to, PDAs, computer accessories, cellular phones and military equipment. As of June 18, 2003, we employed approximately 92 manufacturing personnel at our Northern Ireland factory. These employees include process engineers, chemists, supervisors and production personnel. Our manufacturing process is entirely vertically integrated. We begin the production process by mixing dry powders and solvents together to produce liquid slurries for the anode, cathode and separator. Each slurry is then cast into a film on one of our two 150 foot long coating lines. After coating, the material is stored in a roll of material, called films. These films are the raw materials that are later assembled through the lamination, assembly and packaging processes to become the battery. Our ability to produce our own films is critical in the following three aspects: o QUALITY CONTROL: We are able to carefully monitor and control all aspects of the film makeup to ensure that the films meet the quality standards and specifications for performance. Many of the technical characteristics of the final battery are directly determined by the characteristics of the base film. o DESIGN CONTROL: We customize the design of batteries in terms of desired performance and physical characteristics through our manipulation of physical and chemical properties of the films. o TECHNOLOGY CONTROL: We believe our strength lies in the ability to develop new battery materials and translate the new technology into high volume production. We have a strong relationship between our Research and Development and Manufacturing teams. We use a phased project approach in introducing new products into production. 7 On May 29, 2002, we entered into an OEM agreement with Amperex Technology Limited, or ATL, to complement our internal manufacturing capabilities. ATL, a Hong Kong based battery manufacturer, will provide us with additional production capacity in a low cost region of the world. With this agreement and the continuing expansion of our internal capabilities, we believe that we will have sufficient capacity to meet or exceed the expected demand in fiscal 2004. This agreement, which provides ATL with a right of first refusal to manufacture our non-Saphion(TM) based batteries (but no obligation to do so), expires in May 2007. We utilized ATL's manufacturing capabilities for certain cobalt-oxide based products during the year, and we are currently qualifying ATL as a manufacturer of our Saphion(TM) products. Once that process is complete, we intend to transfer a portion of our manufacturing requirements to ATL. On November 12, 2002, we entered into an agreement to form a joint venture with FengFan Group, Ltd., the manufacturer of the largest capacity rechargeable batteries in China. The agreement contemplates the formation of a joint venture company to be established in China to manufacture powders used in the manufacturer of our Saphion(TM) Lithium-ion batteries. The formation of the joint venture is subject to approval by the Chinese government. We are currently in discussions to complete the joint venture. RESEARCH AND PRODUCT DEVELOPMENT We conduct research and development and pilot production at our Henderson, Nevada 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; and anode, cathode and electrolyte chemistry and physics; polymer and radiation chemistries; thin film technologies; coating technologies; and analytical chemistry; and material science. 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. Ongoing improvement in the performance of our batteries allows us to maintain our competitive advantage. Currently, our battery products are offered in a polymer construction. Our research and development efforts are focused on a new generation of our Saphion(TM) technology which, in addition to expected enhanced performance characteristics, will provide us the ability to manufacture batteries using the technology in a cylindrical construction, which we believe will greatly increase it potential in the marketplace. COMPETITION Competition in the battery industry is intense. In the rechargeable battery market, the principal competitive technologies currently marketed are nickel cadmium, nickel metal hydride, liquid lithium ion and lithium-ion polymer batteries. We believe that our Saphion(TM) technology will compete in these traditional rechargeable battery markets and address other markets currently not being served by these technologies. 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 lithium-ion polymer type rechargeable battery products include Sony, Sanyo, Panasonic and Toshiba, among others. The performance characteristics of lithium-ion batteries, in particular, have consistently improved over time as the market leaders have matured the technology. Other contenders have recently emerged with a primary focus on price competition. In addition, a number of companies are undertaking research in other rechargeable battery technologies, including work on lithium-ion polymer technology. Nevertheless, we are continually evolving our technology to meet these and other competitive threats. We believe that we have important technological advantages over our competitors in terms of our ability to compete in the lithium-ion polymer battery market. We believe that our battery construction and manufacturing processes allow us to produce thinner, lighter and larger footprint batteries, thus enabling us to enter a wide range of markets that do not currently use lithium-ion polymer batteries. We believe that our next generation materials will provide additional advantages in the arenas of safety, cost, size and energy density relative to competing products. 8 INTELLECTUAL PROPERTY Our ability to compete effectively will depend 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 240 United States patents, which have a range of expiration dates from 2005 through 2022 and have about 51 patent applications pending in the United States. We continually prepare new patent applications for filing in the United States. We also actively pursue patent protection in certain foreign countries. In addition to potential patent protection, we rely on the laws of unfair competition and trade secrets to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information through agreements with customers and suppliers, proprietary information agreements with employees and consultants and other security measures. REGULATION Before we commercially introduce our batteries into certain markets, we may be required, or may decide to obtain approval of our materials and/or products from one or more of the organizations engaged in regulating product safety. These approvals could require significant time and resources from our technical staff and, if redesign were necessary, could result in a delay in the introduction of our products in those markets. The United States Department of Transportation, or DOT, and the International Air Transport Association, or IATA, regulate the shipment of hazardous materials. The United Nations Committee of Experts for the Transportation of Dangerous Goods has adopted amendments to the international regulations for "lithium equivalency" tests to determine the aggregate lithium content of lithium ion polymer batteries. In addition, IATA has adopted special size limitations for applying exemptions to these batteries. Under IATA, our N-ChargeTM system currently falls within the level such that it is no longer exempt and now requires a class 9 designation for transportation. The revised United Nations recommendations are not U.S. law until such time as they are incorporated into the DOT Hazardous Material Regulations. However, as a result of an incident during the summer of 1999, involving another supplier of liquid button primary batteries that were mishandled at Los Angeles International Airport, DOT has proposed new regulations harmonizing with the UN regulations. At present it is not known if or when the proposed regulations would be adopted by the US. While we fall under the equivalency levels for the US 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. The Nevada Occupational Safety and Health Administration and other regulatory agencies have jurisdiction over the operation of our Henderson, Nevada manufacturing facility and similar regulatory agencies have jurisdiction over our Mallusk, Northern Ireland manufacturing facilities. Because of the risks generally associated with the use of flammable solvents and other hazardous materials, we expect rigorous enforcement of applicable health and safety regulations. In addition, we currently are regulated by the State Fire Marshall's office and local Fire Departments. Frequent audits or changes in their regulations may cause unforeseen delays and require significant time and resources from our technical staff. The Clark County Air Pollution Control District has jurisdiction over our Henderson, Nevada facility and annual audits and changes in regulations could impact current permits affecting production or time constraints placed upon personnel. Federal, state and local regulations impose various environmental controls on the storage, use and disposal of certain chemicals and metals used in the manufacture of lithium polymer batteries. Although we believe that our activities conform to current environmental regulations, any changes in these regulations may impose costly equipment or other requirements. Our failure to adequately control the discharge of hazardous wastes also may subject us to future liabilities. Recent analysis of our battery by Nevada Environmental Laboratories using the criteria required by local landfills classified them as non-hazardous waste. Other States and countries may have other criteria for their landfill requirements, which could impact cost and handling issues for end product users. 9 HUMAN RESOURCES As of June 18, 2003, we had a total of 95 regular full-time employees in the United States at our Austin, Texas headquarters and our Henderson, Nevada research and development facility. We have 36 total employees in the areas of administration, sales, legal, marketing, finance, management information systems, purchasing, quality control and shipping & receiving. We had 25 total employees in the areas of engineering, facilities maintenance and environmental health & safety. We had 34 total employees in the areas of research & development and product development; product development includes mixing, coating and assembly. In addition, as of June 18, 2003, our Dutch subsidiary had 92 regular full time employees located in Northern Ireland. None of our employees are covered by a collective bargaining agreement, and we consider our relations with our employees to be good. WEBSITE AVAILABILITY OF OUR REPORTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION We maintain a website with the address WWW.VALENCE.COM. We are not including the information contained on our website as a part of, or incorporating it by reference into, this annual report on Form 10-K. We make available free of charge through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file that material with, or furnish such material to, the Securities and Exchange Commission. ITEM 2. PROPERTIES Our corporate offices are located in a leased facility in Austin, Texas. In addition, we own a 55,000 square foot research and development facility in Henderson, Nevada. In December 2001 we paid the mortgage in full on the facility. We are considering selling the Henderson, Nevada facility. We currently contemplate that, if we sell the facility, we would continue to occupy the facility for a period of time pursuant to a lease arrangement. Our Dutch subsidiary owns a manufacturing facility in Mallusk, Northern Ireland, with approximately 155,000 square feet. As of March 31, 2003 we had mortgages on the manufacturing facility of approximately $4,411,000 and $2,022,000 that bear interest at an annual rate of 5.25% and 5.5%, respectively. We believe that our existing facilities will be adequate to meet the Company's needs for the foreseeable future. ITEM 3. LEGAL PROCEEDINGS We are subject to various claims and litigation in the normal course of business. In our opinion, all pending legal matters are either covered by insurance or, if not insured, will not have a material adverse impact on our consolidated financial statements. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 10 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock has been quoted on the Nasdaq SmallCap Market or the Nasdaq National Market under the symbol "VLNC" since May 7, 1992. 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 2002: HIGH LOW ----- ------ Quarter ended June 30, 2001 10.25 2.875 Quarter ended September 30, 2001 7.25 3.15 Quarter ended December 31, 2001 4.30 3.00 Quarter ended March 31, 2002 4.80 2.33 FISCAL 2003: Quarter ended June 30, 2002 3.17 1.28 Quarter ended September 30, 2002 1.86 0.45 Quarter ended December 31, 2002 2.49 0.50 Quarter ended March 31, 2003 2.20 1.20 FISCAL 2004: Quarter ended June 30, 2003 (through June 17, 2003) 4.65 2.16 On June 17, 2003, the last reported sale price of our common shares on the Nasdaq SmallCap Market was $3.57 per share. On that date, we had 71,734,022 shares of common stock outstanding held of record by approximately 673 record holders and an estimated over 15,000 beneficial owners. 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, 2003, information regarding common stock authorized for issuance under our equity compensation plans:
NUMBER OF NUMBER OF SECURITIES TO BE SECURITIES ISSUED UPON WEIGHTED-AVERAGE REMAINING AVAILABLE EXERCISE OF EXERCISE PRICE OF FOR FUTURE ISSUANCE OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, UNDER EQUITY PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS COMPENSATION PLANS Equity compensation plans approved by security holders 6,994,770 $5.47 122,589 Equity compensation plans not approved by security holders (1) 1,925,000 $6.45 - Total 8,919,770 $5.68 122,589 ----------- (1) Options to purchase 1,500,000 shares were granted to Stephan Godevais in May 2001 pursuant to his employment agreement. The exercise price of his options is $6.52 and they vest over four years. 25% of the options vested in May 2002 and the remainder vest in 12 equal quarterly installments during the term of his employment (750,000 shares vested as of June 17, 2003). The vesting accelerates and become immediately exercisable on the date of a change of control of the Company (or if he has been terminated without good cause or resigned for good reason). Options to purchase 225,000 shares were granted to Joseph Lamoreux in June 2001 pursuant to his employment offer letter. The exercise price of his options is $7.18 and they vest over four years. 25% of the options vested in June 2002 and the remainder vest in 12 equal quarterly installments during the term of his employment (112,500 shares vested as of June 17, 2003). Options to purchase 200,000 shares were granted to Terry Standefer in August 2001 pursuant to his employment offer letter. The exercise price of his options is $5.15 and they vest over four years. 25% of the options 11 vested in August 2002 and the remainder vest in 12 equal quarterly installments during the term of his employment (87,500 shares vested as of June 17, 2003).
RECENT SALES OF UNREGISTERED SECURITIES On February 5, 2003, we drew down $5 million from our equity financing commitment with Berg & Berg Enterprises, LLC, an affiliate of Carl Berg, a director and stockholder of ours. Under the terms of the equity commitment Valence issued to Berg & Berg 3,190,342 shares of restricted Common Stock, in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act, at a 15% discount to the average closing price of the stock for the five days prior to the purchase date or approximately $1.56 per share. The commitment was approved by our stockholders on August 27, 2002. The net proceeds were used to fund working capital for the fourth fiscal quarter of 2003. On March 31, 2003, we drew down an additional $5 million from our equity financing commitment with Berg & Berg and issued to Berg & Berg 2,973,589 shares of our restricted common stock in a private placement transaction exempt from registration pursuant to Section 4(2) of the Securities Act. Berg & Berg purchased these shares at a 15% discount to the average closing price of the stock for the five days prior to the purchase date or approximately $1.68 per share. The commitment was approved by our stockholders on August 27, 2002. The net proceeds are being used to fund working capital for the first fiscal quarter of 2004. 12 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, 2001, March 31, 2002 and March 31, 2003 and balance sheet data as of March 31, 2002 and March 31, 2003 from the audited consolidated financial statements in this report. We derived the statement of operations data for the years ended March 28, 1999, and March 31, 2000 and the balance sheet data as of March 28, 1999, March 31, 2000, and March 31, 2001 from audited financial statements that are not included in this report.
FISCAL YEAR ENDED ----------------------------------------------------------------- MARCH 28, MARCH MARCH 31, MARCH MARCH 31, 31, 31, 1999 2000 2001 2002 2003 ----------- ---------- ---------- ---------- ----------- (in thousands, except per share data) STATEMENT OF OPERATIONS DATA: Revenue: License and royalty revenue $ --- $ --- $ 1,500 $ 3,203 $ 125 Battery and system sales --- 1,518 7,191 1,671 2,432 ----------- ---------- ---------- ---------- ----------- Total revenues --- 1,518 8,691 4,874 2,557 Cost of sales: Cost of sales --- --- 19,366 8,649 10,996 INI revenue grant --- --- (1,191) --- --- ----------- ---------- ---------- ---------- ----------- Net cost of sales --- --- 18,175 8,649 10,996 Research and product development 18,783 19,000 8,516 9,681 9,293 Marketing 105 297 1,080 1,957 3,210 General and administrative 6,753 6,795 11,676 11,971 10,140 Depreciation and amortization 3,388 9,510 11,309 7,927 2,790 Asset impairment charge --- --- --- 31,884 258 Factory start-up costs --- 3,171 --- --- --- ----------- ---------- ---------- ---------- ----------- Total operating expenses 29,029 38,773 32,581 63,420 25,691 ----------- ---------- ---------- ---------- ----------- Operating loss (29,029) (37,255) (42,065) (67,195) (34,130) Stockholder lawsuit --- (30,061) --- --- --- Interest and other income 2,980 804 1,256 2,049 381 Interest expense (643) (1,841) (2,332) (4,327) (4,172) Gain (loss) on disposal of assets --- (583) (15) (147) 20 Equity in earnings (loss) of Joint Venture 268 (210) (345) --- --- ----------- ---------- ---------- ---------- ----------- Net loss (26,424) (69,146) (43,501) (69,620) (37,901) Beneficial conversion feature and accretion to redemption value on preferred stock (2,865) (560) (591) --- --- ----------- ---------- ---------- ---------- ----------- Net loss available to common stockholders $ (29,289) $ (69,706) $ (44,092) $ (69,620) $ (37,901) =========== ========== ========== ========== =========== Net loss per share available to common stockholders $ (1.13) $ (2.28) $ (1.14) $ (1.53) $ (0.65) =========== ========== ========== ========== =========== Shares used in computing net loss per share available to common stockholders, basic and diluted 25,871 30,523 38,840 45,504 58,423 =========== ========== ========== ========== ===========
13
MARCH 298 MARCH 31, MARCH MARCH MARCH 31, 1999 2000 31, 2001 31, 2002 2003 (in thousands) BALANCE SHEET DATA: Cash and cash equivalents $ 2,454 $ 24,556 $ 3,755 $ 623 $ 6,616 Working capital (deficit) (7,784) 16,007 5,684 (2,696) 4,023 Total assets 38,401 58,516 86,884 30,531 36,154 Long-term debt 8,171 12,369 20,651 34,639 38,865 Accumulated deficit (154,436) (223,582) (267,083) (336,703) (374,604) Total stockholders' equity (deficit) 7,955 27,845 48,214 (15,863) (17,518)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. THIS REPORT CONTAINS STATEMENTS THAT CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 21E OF THE EXCHANGE ACT AND SECTION 27A OF THE SECURITIES ACT. THE WORDS "EXPECT", "ESTIMATE", "ANTICIPATE", "PREDICT", "BELIEVE" AND SIMILAR EXPRESSIONS AND VARIATIONS THEREOF ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS APPEAR IN A NUMBER OF PLACES IN THIS FILING AND INCLUDE STATEMENTS REGARDING THE INTENT, BELIEF OR CURRENT EXPECTATIONS OF VALENCE TECHNOLOGY, INC. (THE "COMPANY," "VALENCE," "WE," OR "US"), OUR DIRECTORS OR OFFICERS WITH RESPECT TO, AMONG OTHER THINGS (A) TRENDS AFFECTING OUR FINANCIAL CONDITION OR RESULTS OF OPERATIONS, (B) OUR PRODUCT DEVELOPMENT STRATEGIES, TRENDS AFFECTING OUR MANUFACTURING CAPABILITIES AND TRENDS AFFECTING THE COMMERCIAL ACCEPTABILITY OF OUR PRODUCTS, AND (C) 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. BUSINESS AND BUSINESS STRATEGY We were founded in 1989. From 1989 through 2000, our efforts were focused on developing and acquiring our battery technologies. With the appointment of Stephan B. Godevais as our Chief Executive Officer and President in May 2001, we initiated the transition of our business by broadening our marketing and sales efforts to take advantage of our strengths in research and development, which has fostered an extensive and worldwide portfolio of issued and pending patents. With this strategic shift, our vision is to become a leader in energy storage systems by drawing on the numerous benefits of our latest battery technology, the extensive experience of our management team and the significant market opportunity available to us. In February 2002, we unveiled our Saphion(TM) 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). We believe that Saphion(TM) 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(TM) technology is able to offer greater thermal and electrochemical stability than traditional lithium-ion technologies. Our business strategy incorporates a balance of system sales and licensing and a manufacturing plan that leverages internal capabilities and partnerships with contract manufacturers. We plan to capitalize on our Saphion(TM) technology by designing solutions thaT differentiate end-users' products in both the large format and small format markets. In addition, we will seek to expand the fields of use of our Saphion(TM) technology through the licensing of our intellectual property related to our battery chemistries and manufacturing processes. We introduced our first product based on our Saphion(TM) technology, the N-Charge(TM) PowEr System, in February 2002. The N-Charge(TM) Power System is a rechargeable battery system thaT provides supplemental battery power for a 14 wide variety of portable electronic devices. Since the introduction of the N-Charge(TM) Power System, we have focused our efforts on marketing the N-Charge(TM) Power System to top tier companies in an effort to validate our Saphion(TM) technology. We have successfully developed various channels for the sale and distribution of the N-Charge(TM)system, including resellers, Tier One companies, and national retailers. In February 2003, we introduced our first large format energy storage system powered by our Saphion(TM) technology, the K-Charge(TM) Power System (previously announced as the Pure Po4wer Pack). The K-Charge(TM) Power System is engineered specifically for large format applications such as those required by the telecommunications, industrial, vehicular and utility markets. It is currently in a prototype stage and is being offered to customers for evaluation and customization for specific product requirements. Currently, our battery products are offered in a polymer construction. Our research and development efforts are focused on a new generation of our Saphion(TM) technology which, in addition to expected enhanced performance characteristics, will provide us the ability to manufacture batteries using the technology in a cylindrical construction, which we believe will greatly increase its potential in the marketplace. Our polymer batteries are manufactured at our manufacturing facility in Northern Ireland. We have recently entered into an OEM arrangement and have utilized the manufacturer's capabilities for certain cobalt-oxide based products during the year. We are in the process of qualifying the manufacturer for our Saphion(TM) products with the goal of transferring some of our manufacturing operations to China and other low-cost manufacturing regions. BASIS OF PRESENTATION, CRITICAL ACCOUNTING POLICIES AND ESTIMATES We prepare our consolidated financial statements in conformity with generally accepted accounting principles in the U.S. Our accounting policies are described in Note 3 of the Notes to Consolidated Financial Statements included in "Item 8 -- Financial Statements and Supplementary Data". 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 and impairment of long-lived assets. REVENUE RECOGNITION: Revenues are generated from licensing fees and royalties per technology license agreements and sales of products including batteries and battery systems. Licensing fees are recognized as revenue upon completion of an executed agreement and delivery of licensed information, if there are no significant remaining obligations and collection of the related receivable is reasonably assured. Royalty revenues are recognized as revenue upon receipt of cash payment from the licensee. Product sales are recognized when the sale is complete, generally upon shipment, 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. IMPAIRMENT OF LONG-LIVED ASSETS: SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," requires us to review long-lived tangible and intangible assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of these assets is measured by comparison of its carrying amount to future undiscounted cash flows 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 market value and is recorded in the period the determination was made. 15 RESULTS OF OPERATIONS FISCAL YEARS ENDED MARCH 31, 2003 (FISCAL 2003), MARCH 31, 2002 (FISCAL 2002) AND MARCH 31, 2001 (FISCAL 2001) REVENUE. The following table summarizes the Company's revenue (in thousands) by type for each of the past three fiscal years:
MARCH 31, PERCENTAGE MARCH 31, PERCENTAGE MARCH 31, 2003 CHANGE 2002 CHANGE 2001 Battery and system sales $ 2,432 46% $1,671 -77% $ 7,191 License and royalty revenue 125 -96% 3,203 114% 1,500 Total revenues $ 2,557 -48% $ 4,874 -44% $ 8,691
BATTERY AND SYSTEM SALES: In December 2000, we completed the acquisition of technology rights from Telcordia Technologies, Inc. and correspondingly completed a strategic shift away from expanding our battery sales pipeline to an emphasis on licensing and royalty revenue. During fiscal 2002, we implemented a balanced strategy leveraging revenues from both our licensing and battery lines of business. As a result of the strategic shifts, our revenue for battery sales decreased 77% to $1.7 million in fiscal 2002. Sales of battery and system products increased 46% to $2.4 million in fiscal 2003 largely due to the re-establishment of our customer pipeline for our battery products and launch of our N-Charge(TM) Power system product. LICENSING AND ROYALTY REVENUE: In December 2000, we completed the acquisition of technology rights from Telcordia Technologies, Inc. We recorded initial revenues from licensing totaling $1.5 million during fiscal 2001. During fiscal 2002, we expanded our licensee base, including the conversion of the Hanil Joint Venture to a license agreement, and began collecting royalties from our licensees resulting in a 114% increase in license and royalty revenue. During fiscal 2003, we did not add any additional licensees and collected royalties totaling $125,000. We continue to pursue licensing of both our process and chemistry patent portfolios. TOTAL REVENUES: Revenues from three significant customers totaled 26% of total revenue for the fiscal year ended March 31, 2003 and 69% of trade accounts receivable at March 31, 2003. During fiscal 2003, revenue from two customers, Alliant Techsystems Inc. and Pabion Corporation, Ltd., each comprised more than 10% of total revenues. For fiscal 2002, revenues from six significant customers represented a total of 83% of total revenues for the fiscal year and a total of 65% of the trade accounts receivable at March 31, 2002. During fiscal 2002, revenue from four customers, Hanil Joint Venture, Amperex Technology Limited, Alliant Techsystems Inc., and Samsung Corporation, each comprised more than 10% of total revenues. For fiscal year 2001, five customers represented 98% of total revenues for the year ended March 31, 2001. For fiscal 2001, revenue from four customers, Alliant Techsystems Inc., MicroEnergy Technologies Inc., Moltech Corporation, and Qualcomm, each comprised more than 10% of total revenues. COST OF SALES. Cost of sales consists primarily of expenses incurred to manufacture battery products. We initiated the recording of costs of sales as we ramped production and began our transition from a research and development focused organization during fiscal 2001. During fiscal 2003 and 2002, we recorded cost of sales of $11 million and $8.6 million, respectively. Comparably, cost of sales totaled $18.2 million during fiscal 2001, net of grant funding of $1.2 million provided by the Northern Ireland Industrial Development Board, now known as Invest Northern Ireland or INI, as a reduction of labor costs. The increase in cost of sales from fiscal 2002 to 2003 is largely due to increased product sales, inventory write offs necessary as a result of the resolution of the technical issue announced in the second quarter of fiscal 2003, and higher initial product costs associated with the launch of our N-Charge(TM) Power system. We maintained a negative gross margin on our sales in all periods due to insufficient production and sales volumes to facilitate the coverage of our indirect and fixed costs. We expect cost of sales to decrease as a percentage of sales as production and product sales volumes continue to increase. RESEARCH AND PRODUCT DEVELOPMENT. Research and product development expenses consist primarily of personnel, equipment and materials to support the Company's battery and product research and development. Research and product development expense totaled $9.3 million, $9.7 million, and $8.5 million for the fiscal years ended March 31, 2003, 2002, and 2001 respectively. The $.4 million or 4% decrease in research and development expenses from fiscal 16 2002 to 2003 is due largely to the transfer of our initial Saphion(TM) chemistry and N-Charge(TM) power system from development to production and the reduction of headcount as a result of our reorganization which took place in the third quarter of fiscal 2003. The $1.2 million or 14% increase in research and product development expenses from fiscal 2001 to 2002 relates to the both additional engineering for development of end-user products such as the N-Charge(TM) Power system and expanded development and pilot production of our Saphion(TM) chemistry. MARKETING. Marketing expenses consist primarily of costs related to sales and marketing personnel, public relations and promotional materials. Marketing expenses were $3.2 million, $2.0 million, and $1.1 million for the fiscal years ended March 31, 2003, 2002, and 2001, respectively. The $1.2 million or 60% increase in marketing expenses during fiscal 2003 was due to increased staffing and promotions to support expansion of channels to sell our N-Charge(TM) power system and Saphion(TM) products. The $0.9 million or 82% increase in marketing expenses during fiscal 2002 resulted from increased personnel, the launch of a new corporate web site, the development of our on-line store, and the creation of promotional materials and sales tools. Our increased expenditures in all periods are in line with our continued focus on sales and marketing activities through expansion of our sales teams, sales channels, and promotional activities. GENERAL AND ADMINISTRATIVE. General and administrative expenses consist primarily of salaries and other related costs for finance, human resources, accounting, information technology, legal, and corporate related expenses. General and administrative expenses totaled $10.1 million, $12.0 million, and $11.7 million for the fiscal years ended March 31, 2003, 2002, and 2001 respectively. The 1.9 million or 16% decrease in general and administrative expenses from fiscal 2002 to 2003 relates to lower legal expenses and lower recruiting and relocation expenses with completion of relocation of the corporate office to Austin, Texas during fiscal 2002. The decrease is partially offset by an increase in insurance expense. The $0.3 million or 3% increase in general and administrative expenses from fiscal 2001 to fiscal 2002 relate primarily to increased recruiting efforts associated with completion of the management team and relocation of the corporate office to Austin, Texas. DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses were $2.8 million, $7.9 million, and $11.3 million for fiscal years ended March 31, 2003, 2002, and 2001, respectively. The $5.1 or 65% decrease in fiscal 2003 and the $3.4 million or 30% decrease during fiscal 2002 resulted primarily from the impact of an impairment charge taken during the third quarter of fiscal 2002 as described below. This decrease is partially offset by depreciation for capital assets acquired subsequent to the third quarter of fiscal 2002. IMPAIRMENT CHARGE: During the fourth quarter of fiscal 2003, we recorded an impairment charge of $258,000 on our property in Henderson, Nevada related to the planned sale of this facility. We estimated that the future cash flows expected from the sale of this facility were less than the asset carrying value and adjusted the assets to their fair value accordingly. During the third quarter of fiscal 2002, we recorded an impairment charge of $31.9 million on assets in our Northern Ireland facility and intellectual property acquired from Telcordia. The fiscal 2002 impairment charge resulted from a redefinition of our business strategy and solidification of our manufacturing plan and product mix. We determined that the future cash flows expected to be generated from older manufacturing equipment in our Northern Ireland facility and intellectual property acquired in the Telcordia transaction in December 2000 did not exceed their carrying value. This determination resulted in a net impairment charge against property, plant and equipment and intellectual property to adjust these assets to their fair value. INTEREST AND OTHER INCOME. Interest and other income totaled $381,000, $2.0 million, and $1.3 million for fiscal years ended March 31, 2003, 2002, and 2001, respectively. Interest during fiscal 2002 related primarily to interest earned on investments acquired from West Coast Venture Capital in February 2001. These assets were transferred to Berg & Berg as a reduction of our debt outstanding during the fourth quarter of fiscal 2002. INTEREST EXPENSE. Interest expense was $4.2 million, $4.3 million and $2.3 million for the fiscal years ended March 31, 2003, 2002, and 2001, respectively. The $.1 million or 2% reduction in interest expense for fiscal 2003 was due to the payoff of the Henderson facility mortgage and a reduction in the amortization of debt discount on the 1998 loan with Berg & Berg Enterprises, LLC and partially offset by increased borrowings of long-term debt. The 87% increase in interest expense for fiscal 2002 was the result of increased borrowings of long-term debt. EQUITY IN EARNINGS(LOSS) OF JOINT VENTURE. In June 2001, we reached and agreement with our joint venture partner, Hanil Telecom Co., Ltd.(Hanil Telecom) to terminate the Hanil Valence Korean joint venture. As conditions of the termination, Shinhan Bank transferred its payment guarantee obligations under a line of credit from us to Hanil Telecom and we granted a license to an affiliate of Hanil Telecom. In addition, the deferred revenue balance of $2.5 million was offset by approximately $896,000 of accounts receivable and the remaining $1.6 million balance was recorded as license revenue to recognize the license agreement. 17 LIQUIDITY AND CAPITAL RESOURCES At March 31, 2003, our principal sources of liquidity were cash and cash equivalents of $6.6 million and $10.0 million available under an equity line financing commitment (subject to conditions discussed below) and a $4 million working capital commitment with Berg & Berg. On June 2, 2003 we raised net proceeds of approximately $9.6 million through the sale of one thousand shares of newly issued Series C Preferred Stock to an unaffiliated investor. In addition, in June 2003 we received an additional $10.0 million funding commitment from Berg & Berg for which the terms will be negotiated at a later date. Our current forecasts project that these sources of liquidity will be sufficient to allow us to execute on our current business plan without the need for additional financing. Our current business plan contemplates that we will realize increases in cash flow from the sale of our Henderson, Nevada facility, projected increases in product sales and licensing revenue and further cash benefits from continued reductions in our administrative and manufacturing costs., while maintaining capital expenditures and expenditures for research and development at levels consistent with those incurred in 2003. However, our cash requirements may vary materially from those now planned because of changes in our operations, including changes in OEM relationships, market conditions, joint venture and business opportunities, or a request for repayment of a portion or all of our existing grants, which totaled $14.1 million at March 31, 2003, from the Northern Ireland Industrial Development Board (now titled Invest Northern Ireland or INI). If we are unable to realize our business plan or if our cash requirements increase materially from those currently projected, we would require additional debt or equity financing. There can be no assurance that we could obtain the additional financing on reasonable terms, if at all. The Series C Preferred Stock matures December 2, 2004 and carries a 2% annual dividend, paid quarterly in cash or shares of common stock. On the maturity date, we will redeem for cash any unconverted shares of the Series C Preferred Stock at their stated value plus any accrued and unpaid dividends. Our current business plan contemplates conversion of all shares of Series C Preferred Stock prior to their maturity date. If the Series C Preferred Stock shares have not been converted by the maturity date, we may need to raise additional debt or equity financing to facilitate any required redemption. There can be no assurance that we could obtain the additional financing on reasonable terms, if at all. Currently, we do not have material sales to meet our operating needs. Consequently, we are dependent on Berg & Berg's continued willingness to fund our continued operations. However, pursuant to the terms of the equity line financing commitment, as a result of offerings the Company completed in April 2002 and June 2003, and the drawdowns under the commitment of $5.0 million each in September 2002, November 2002, February 2003, and March 2003, Berg & Berg may elect to reduce or eliminate its remaining commitment of $10 million. Berg & Berg has not elected to reduce their commitment to date. Further, the commitment expires on March 31, 2004 and our right to draw down on the line is limited to $5 million per quarter and is further dependent upon our meeting certain operating conditions. However, so long as Stephan Godevais remains as CEO, Berg & Berg has waived these operating conditions for the remainder of the commitment. The additional $10.0 million funding commitment obtained in June 2003 is subject to completion of definitive documentation and any required stockholder approval. At March 31, 2003, we had commitments for capital expenditures for the next 12 months of approximately $241,000 relating to the installation of specified manufacturing equipment, which is included in accounts payable and accrued expenses at March 31, 2003. We may require additional capital expenditures in order to meet greater demand levels for our products than are currently anticipated. We used net cash from operations for fiscal 2003, 2002 and 2001 of $32.5 million, $26.2 million, and $38.2 million, respectively. The cash used in our fiscal 2003 operating activities was primarily due to net loss and the add back of non-cash expenses, including depreciation and amortization, provision for bad debt, impairment charge, accretion of debt discount, and compensation related to issuance of stock options. The increase in operating cash outflows was substantially due to higher cost of sales, marketing expenses, and working capital needs associated with our increased battery sales and battery inventory. We used $706,000, $8.8 million, and $21.8 million in investing activities in fiscal 2003, 2002 and 2001, respectively. Capital expenditures during all periods were primarily related to the establishment and expansion of our manufacturing facilities and equipment in our Northern Ireland facility. The significant decrease in fiscal 2003 investing activities is due to the substantial completion of our Northern Ireland facility. 18 We obtained cash from financing activities of $39.0 million , $32.4 million, and $40.8 million in fiscal 2003, 2002 and 2001, respectively. As a result of the above, we had a net decrease in cash and cash equivalents of $3.1 million and $20.8 million in fiscal 2002 and 2001; and a net increase in cash and cash equivalents of $6.0 million in fiscal 2003. As of March 31, 2003, our short term and long-term debt obligations, including long term interest, were $732,000 and $45.7 million, respectively. During fiscal 2002, we reached an agreement with Berg & Berg to extend the maturity date of our loan agreement with the loan balance of $14.95 million and accrued interest of $4.8 million from August 30, 2002 to September 30, 2005. During fiscal 1994, through our Dutch subsidiary, we signed an agreement or Letter of Offer with the Northern Ireland Industrial Development Board now titled Invest Northern Ireland ("INI"), to open an automated manufacturing plant in Northern Ireland in exchange for capital and revenue grants from the INI. The grants available under the agreement for an aggregate of up to (pound)25.6 million, generally became available over a five-year period through October 31, 2001. As a condition to receiving funding from the INI, the subsidiary needed to maintain a minimum of (pound)12.0 million (approximately $18.9 million) in debt or equity financing from us. As of March 31, 2003, we had received grants aggregating (pound)9.0 million (approximately $14.1 million). The amount of the grants available under the agreement depended primarily on the level of capital expenditures that we made. Any funding received under the grants in a four-year period prior to any alleged default is repayable to the INI if the subsidiary is found to be in default under the agreement. Default includes the permanent cessation of business in Northern Ireland. Funding received under the grants to offset capital expenditures can be included in such repayable amount if related equipment is sold, transferred or otherwise disposed of during a four-year period after the date of grant. Funding received under the grants can be included in such repayable amount if the subsidiary fails to maintain specified employment levels for the two-year period immediately after the end of the five-year grant period. As a result of the reduction of Northern Ireland business activity, specified employment levels have not been maintained, but the INI is not seeking repayment and on the advice of counsel, on the basis that successful negotiations will be concluded, we do not believe that the INI will bring any legal action pursuant to the Letter of Offer. We have begun discussions with the INI to end the current agreement and enter into a new agreement more closely aligned to current business conditions. We may not be able to meet the requirements necessary to retain grants under the INI agreement. We believe that it is unlikely that the INI will demand repayment of any grant funds paid in a four-year period prior to any default on the part of the subsidiary. 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 June 2001, SFAS No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", was issued, which requires, among other things, the discontinuance of goodwill amortization. SFAS 142 also requires us to complete a transitional goodwill impairment test six months from the date of adoption. We adopted SFAS No. 142 on April 1, 2002, and no impairment charge was considered necessary under the adoption. In August 2001, SFAS No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived Assets", was issued, which addresses the financial accounting and reporting for the impairment of long-lived assets. This statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for the disposal of a segment of a business. We adopted SFAS 144 on April 1, 2002. Impairment charges were deemed appropriate and recorded during the quarter period ended March 31, 2003. 19 In April 2002, SFAS No. 145 ("SFAS 145"), "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections" was issued, which rescinds FASB Statement No. 4, "Reporting Gains and Losses from Extinguishment of Debt," and an amendment of that Statement, FASB Statement No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." The Statement also rescinds FASB Statement No. 44, "Accounting for Intangible Assets of Motor Carriers." The Statement amends FASB Statement No. 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. We will adopt SFAS 145 in April 2003 and do not expect this adoption to have a significant effect on the financial statements. In June 2002, SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," was issued, which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." This statement requires recognition of a liability for a cost associated with an exit or disposal activity when the liability is incurred as opposed to the date of an entity's commitment to an exit plan or disposal activity. We adopted SFAS No. 146 in January 2003 which did not have a material effect on the financial statements. In December 2002, SFAS No. 148 ("SFAS 148"), "Accounting for Stock-Based Compensation - Transition and Disclosure an amendment of FASB Statement No. 123", was issued, which amends SFAS Statement No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Certain disclosure requirements under SFAS 148 became effective for us beginning December 15, 2002 and we have complied with those requirements. The remaining disclosure requirements under SFAS No. 148 become effective for us in the first quarter of fiscal 2004. We do not expect these additional reporting requirements to have a material impact on our financial statements. In December 2002, FASB Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34", was issued, which addresses the disclosures to be made by a guarantor in its interim and annual financial statements about its obligation under guarantees and clarifies the requirements related to the recognition of a liability by a guarantor at the inception of a guarantee for the obligations the guarantor has undertaken in issuing that guarantee. We adopted FIN 45 in March 2003 which did not have a material effect on the financial statements. In April 2003, SFAS No. 149 ("SFAS 149"), "Amendments of Statement 133 on Derivative Instruments and Hedging Activities", was issued, which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities". We will adopt SFAS 149 beginning our second quarter of fiscal year 2004 and do not expect this adoption to have a significant impact on our financial statements. In May 2003, SFAS No. 150 ("SFAS 150"), "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity", was issued, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. We will adopt SFAS 150 beginning our first quarter of fiscal year 2004. We are currently reviewing the impact this statement will have on our financial statements. In May 2003, FIN 46, "Consolidation of Variable Interest Entities", was issued, which clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements", to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. We will adopt FIN 46 beginning our second quarter of fiscal year 2004 and do not expect this adoption to have a significant impact on our financial statements. 20 TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS The following table sets forth, as of March 31, 2003, our scheduled principal, interest and other contractual annual cash obligations due by us for each of the periods indicated below (in thousands):
PAYMENT DUE BY PERIOD --------------------- Less than More than Contractual Obligations Total 1 year 1-3 years 3-5 years 5 years ----------------------- ----- --------- --------- --------- --------- Long-term debt obligations 41,383 810 36,717 1,985 1,871 Capital lease obligations - - - - - Operating lease obligations 83 83 - - - Purchase obligations 2,950 2,950 - - - Other long-term liabilities 6,744 - 6,744 - - Total 51,160 3,843 43,461 1,985 1,871
RISK FACTORS CAUTIONARY STATEMENTS AND RISK FACTORS SEVERAL OF THE MATTERS DISCUSSED IN THIS REPORT CONTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. FACTORS ASSOCIATED WITH THE FORWARD-LOOKING STATEMENTS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER FROM THOSE PROJECTED OR FORECASTED IN THIS REPORT ARE INCLUDED IN THE STATEMENTS BELOW. IN ADDITION TO OTHER INFORMATION CONTAINED IN THIS REPORT, YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING CAUTIONARY STATEMENTS AND RISK FACTORS. RISKS RELATED TO OUR BUSINESS EXECUTION OF THE BUSINESS PLAN WITH THE CURRENT AVAILABLE CAPITAL. At March 31, 2003, our principal sources of liquidity were cash and cash equivalents of $6.6 million and $10.0 million available under an equity line financing commitment (subject to conditions discussed below) and a $4 million working capital commitment from Berg & Berg. On June 2, 2003 we raised net proceeds of approximately $9.6 million through the sale of one thousand shares of newly issued Series C Preferred Stock to an independent investor. In addition, in June 2003 we received an additional $10.0 million funding commitment from Berg & Berg for which the terms will be negotiated at a later date. Our current forecasts project that these sources of liquidity will be sufficient to allow us to execute on our current business plan without the need for additional financing. Our current business plan contemplates that we will realize increases in cash flow from the sale of our Henderson, Nevada facility, projected increases in product sales and licensing revenue and further cash benefits from continued reductions in our administrative and manufacturing costs, while maintaining capital expenditures and expenditures for research and development at levels consistent with those incurred in 2003. However, our cash requirements may vary materially from those now planned because of changes in our operations, including changes in OEM relationships, market conditions, joint venture and business opportunities, or a request for repayment of a portion or all of our existing grants, which totaled $14.1 million at March 31, 2003, from the Northern Ireland Industrial Development Board (now titled Invest Northern Ireland or INI). If we are unable to realize on our business plan or if our cash requirements increase materially from those currently projected, we would require additional debt or equity financing. There can be no assurance that we could obtain the additional financing on reasonable terms, if at all. The Series C Preferred Stock matures December 2, 2004 and carries a 2% annual dividend, paid quarterly in cash or shares of common stock. On the maturity date, we will redeem for cash any unconverted shares of the Series C Preferred Stock at their stated value plus any accrued and unpaid dividends. Our current business plan contemplates conversion of all shares of Series C Preferred Stock prior to their maturity date. If the Series C Preferred Stock shares have not been converted by the maturity date, we may need to raise additional debt or equity financing to facilitate any required redemption. There can be no assurance that we could obtain the additional financing on reasonable terms, if at all. 21 Currently, we do not have material sales to meet our operating needs. Consequently, we are dependent on Berg & Berg's continued willingness to fund our continued operations. Pursuant to the terms of the equity line financing commitment, as a result of the offerings we completed in April 2002 and June 2003, Berg & Berg may elect to reduce or eliminate its remaining commitment of $10 million. Berg & Berg has not elected to reduce their commitment to date. Further, the commitment expires on March 31, 2004 and our right to draw down on the line is limited to $5 million per quarter and is further dependent upon meeting certain operating conditions. However, so long as Stephan Godevais remains as CEO, Berg & Berg has waived these conditions for the remainder of the commitment. The additional $10.0 million funding commitment obtained in June 2003 is subject to completion of definitive documentation and any required stockholder approval. OUR WORKING CAPITAL REQUIREMENTS MAY INCREASE BEYOND THOSE CURRENTLY ANTICIPATED. We have planned for an increase in sales, 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 demands would be dependent on our ability to arrange for additional equity or debt financing since it is likely that cash flow from sales is likely to lag behind these increased working capital requirements. If our working capital needs increase from that currently anticipated and we do not receive additional financing from Berg & Berg, we may need to arrange for additional equity or debt financing. ALL OF OUR ASSETS ARE PLEDGED AS COLLATERAL UNDER OUR LOAN AGREEMENTS. OUR FAILURE TO MEET THE OBLIGATIONS UNDER OUR LOAN AGREEMENTS COULD RESULT IN FORECLOSURE OF OUR ASSETS. All of our assets are pledged as collateral under various loan agreements. If we fail to meet our obligations pursuant to these loan agreements, our lenders may declare all amounts borrowed from them to be due and payable together with accrued and unpaid interest. If we are unable to repay our debt, these lenders could proceed against our assets. WE HAVE A HISTORY OF LOSSES, HAVE AN ACCUMULATED DEFICIT AND MAY NEVER ACHIEVE OR SUSTAIN SIGNIFICANT REVENUES OR PROFITABILITY. We have incurred operating losses each year since inception in 1989 and had an accumulated deficit of $374.6 million as of March 31, 2003. We have working capital of $4.0 million as of March 31, 2003, and have sustained recurring losses related primarily to the research and development and marketing of our products combined with the lack of material sales. We expect to continue to incur operating losses and negative cash flows during fiscal 2004, as we begin to build inventory, increase our marketing efforts and continue our product development. We may never achieve or sustain significant revenues or profitability in the future. OUR BUSINESS WILL BE ADVERSELY AFFECTED IF OUR SAPHION(TM) 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 is dependent on the acceptance of our batteries and the products using our batteries in their markets. We may have technical issues that arise that may affect the acceptance of our products by our customers. Market acceptance may also depend on a variety of other factors, including educating the target market regarding the benefits of our products. Market acceptance and market share are also affected by the timing of market introduction of competitive products. If we or our customers are unable to gain any significant market acceptance for Saphion(TM) technology based batteries, our business will be adversely affected. It is too early to determine if Saphion(TM) technology based batteries will achievE significant market acceptance. IF WE ARE UNABLE TO DEVELOP, MANUFACTURE AND MARKET PRODUCTS THAT GAIN WIDE CUSTOMER ACCEPTANCE, OUR BUSINESS WILL BE ADVERSELY AFFECTED. The process of developing our products is complex and uncertain, and failure to anticipate customers' changing needs and to develop products that receive widespread customer acceptance could significantly harm our results of operations. We must make long-term investments and commit significant resources before knowing whether our predictions will eventually result in products that the market will accept. After a product is developed, we must be able to manufacture 22 sufficient volumes quickly and at low costs. To accomplish this, we must accurately forecast volumes, mix of products and configurations that meet customer requirements, and we may not succeed. OUR PATENT APPLICATIONS MAY NOT RESULT IN ISSUED PATENTS. Patent applications in the United States are maintained in secrecy until the patents issue or are published. Since publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries by several months, we cannot be certain that we were the first creator of inventions covered by pending patent applications or the first to file patent applications on such 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 which differ from those of the United States, and thus we cannot be certain that foreign patent applications related to issued United States patents will issue. Furthermore, if these patent applications issue, some foreign countries provide significantly less effective patent enforcement than the United States. The status of patents involves complex legal and factual questions and the breadth of claims allowed is uncertain. Accordingly, we cannot be certain that patent applications we file will result in patents being issued, or that our patents and any patents that may be issued to us in the future will afford protection against competitors with similar technology. In addition, patents issued to us may be infringed upon or designed around by others and others may obtain patents that we need to license or design around, either of which would increase costs and may adversely affect our operations. IF WE CANNOT PROTECT OR ENFORCE OUR EXISTING INTELLECTUAL PROPERTY RIGHTS OR IF OUR PENDING PATENT APPLICATIONS DO NOT RESULT IN ISSUED PATENTS, WE MAY LOSE THE ADVANTAGES OF OUR RESEARCH AND MANUFACTURING SYSTEMS. Our ability to compete successfully will depend on whether we can protect our existing proprietary technology and manufacturing processes. We rely on a combination of patent and trade secret protection, non-disclosure agreements and cross-licensing agreements. These measures may not be adequate to safeguard the proprietary technology underlying our batteries. Employees, consultants, and others who participate in the development of our products may breach their non-disclosure agreements with us, and we may not have adequate remedies in the event of their breaches. In addition, our competitors may be able to develop products that are equal or superior to our products without infringing on any of our intellectual property rights. Moreover, we may not be able to effectively protect our intellectual property rights outside of the United States. We have established a program for intellectual property documentation and protection in order to safeguard our technology base. We intend to vigorously pursue enforcement and defense of our patents and our other proprietary rights. We could incur significant expenses in preserving our proprietary rights, and these costs could harm our financial condition. We also are attempting to expand our intellectual property rights through our applications for new patents. We cannot be certain that our pending patent applications will result in issued patents or that our issued patents will afford us protection against a competitor. Our inability to protect our existing proprietary technologies or to develop new proprietary technologies may substantially impair our financial condition and results of operations. INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS BROUGHT AGAINST US COULD BE TIME-CONSUMING AND EXPENSIVE TO DEFEND, AND IF ANY OF OUR PRODUCTS OR PROCESSES ARE FOUND TO BE INFRINGING, WE MAY NOT BE ABLE TO PROCURE LICENSES TO USE PATENTS NECESSARY TO OUR BUSINESS AT REASONABLE TERMS, IF AT ALL. In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. While we currently are not engaged in any intellectual property litigation or proceedings, we may become involved in these proceedings in the future. In the future we may be subject to claims or inquiries regarding our alleged unauthorized use of a third party's intellectual property. An adverse outcome in litigation could force us to do one or more of the following: o stop selling, incorporating or using our products that use the challenged intellectual property; o pay significant damages to third parties; o obtain from the owners of the infringed intellectual property right a license to sell or use the relevant technology, which license may not be available on reasonable terms, or at all; or 23 o redesign those products or manufacturing processes that use the infringed technology, which may be economically or technologically infeasible. Whether or not an intellectual property litigation claim is valid, the cost of responding to it, in terms of legal fees and expenses and the diversion of management resources, could be expensive and harm our business. OUR FAILURE TO DEVELOP PARTNERSHIPS WITH OTHER BATTERY MANUFACTURERS WILL LIMIT OUR ABILITY TO WIDELY INTRODUCE OUR PHOSPHATE CHEMISTRY TECHNOLOGY INTO THE MARKETPLACE AND COULD SIGNIFICANTLY IMPACT OUR SALES AND PROFITABILITY IN FUTURE PERIODS. To successfully implement our business strategy of broadly disseminating the Saphion(TM) technology, we intend to develop relationships with manufacturers of lithium-ion batteries using stacked polymer technology as well as cylindrical and/or prismatic battery manufacturers. Our failure to develop these relationships will limit our ability to widely introduce our phosphate chemistry technology into the marketplace and could significantly impact our sales and profitability in future periods. IN ADDITION TO OUR OWN PRODUCT LINES, OUR BATTERIES ARE INTENDED TO BE INCORPORATED INTO OTHER PRODUCTS. WE WILL NEED TO RELY ON OEMS TO COMMERCIALIZE THESE PRODUCTS. Our business strategy contemplates that we will be required to rely on assistance from OEMs to gain market acceptance for our products. We therefore will need to identify acceptable OEMs and enter into agreements with them. Once we identify acceptable OEMs and enter into agreements with them, we will need to meet these companies' requirements by developing and introducing new products and enhanced, or modified, versions of our existing products on a timely basis. OEMs often require unique configurations or custom designs for batteries, which must be developed and integrated into their product well before the product is launched. This development process not only requires substantial lead-time between the commencement of design efforts for a customized battery system and the commencement of volume shipments of the battery system to the customer, but also requires the cooperation and assistance of the OEMs for purposes of determining the battery requirements for each specific application. We may have technical issues that arise that may affect the acceptance of our products by OEMs. If we are unable to design, develop and introduce products that meet OEMs' requirements, we may lose opportunities to enter into additional purchase orders and our reputation may be damaged. As a result, we may not receive adequate assistance from OEMs or battery pack assemblers to successfully commercialize our products, which could impair our profitability. FAILURE TO IMPLEMENT AN EFFECTIVE LICENSING BUSINESS STRATEGY WILL ADVERSELY AFFECT OUR REVENUE, CASH FLOW AND PROFITABILITY. As a result of the intellectual property assets we have acquired and internally developed, such as our Saphion(TM) technology, we significantly increased the role of licensing in our business strategy. We have not entered into any licensing agreements for our Saphion(TM) technology. Our future operating results could be affected by a variety of factors including: o our ability to secure and maintain significant customers of our proprietary technology; o the extent to which our future licensees successfully incorporate our technology into their products; o the acceptance of new or enhanced versions of our technology; o the rate that 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. 24 THERE IS A POTENTIAL SALES-CHANNEL CONFLICT BETWEEN OUR FUTURE TECHNOLOGY LICENSEES AND US. The acquisition of the Telcordia Technologies, Inc.'s intellectual property assets and our Saphion(TM) technology licensing strategy has added significant diversity to our overall business structure and our opportunities. We recognize that there is potential for a conflict among our sales channels and those of our future technology licensees. If these potential conflicts do materialize, we may not be able to mitigate the effect of a conflict that, if not resolved, may impact our results of operations. OUR FAILURE TO COST-EFFECTIVELY MANUFACTURE BATTERIES IN COMMERCIAL QUANTITIES, WHICH SATISFY OUR CUSTOMERS' PRODUCT SPECIFICATIONS, COULD DAMAGE OUR CUSTOMER RELATIONSHIPS AND RESULT IN SIGNIFICANT LOST BUSINESS OPPORTUNITIES FOR US. To be successful, we must cost-effectively manufacture commercial quantities of our batteries that meet customer specifications. To facilitate commercialization of our products, we will need to reduce our manufacturing costs, which includes substantially raising and maintaining battery yields of commercial quality in a cost-effective manner at our internal manufacturing site and reduce costs through the effective utilization of OEM partners. If we fail to substantially increase yields in our manufacturing process and reduce unit-manufacturing costs, we will not be able to offer our batteries at a competitive price, and we will lose our current customers and fail to attract future customers. OUR ABILITY TO MANUFACTURE LARGE VOLUMES OF BATTERIES IS LIMITED AND MAY PREVENT US FROM FULFILLING ORDERS. We have been manufacturing batteries on a commercial scale to fulfill purchase orders and we are able to produce sufficient quantities of batteries to supply our current customer demands. We are actively soliciting additional purchase orders. We may need additional low cost, quick lead-time equipment or contract manufacturing support to fulfill large volume orders. If we cannot rapidly increase our production capabilities to make sufficient quantities of commercially acceptable batteries, we may not be able to fulfill purchase orders in a timely manner, if at all. In addition, we may not be able to procure additional purchase orders, which could cause us to lose existing and future customers, purchase orders, revenue and profits. IF OUR BATTERIES FAIL TO PERFORM AS EXPECTED, WE COULD LOSE EXISTING AND FUTURE BUSINESS, AND OUR LONG-TERM ABILITY TO MARKET AND SELL OUR BATTERIES COULD BE HARMED. If we manufacture our batteries in commercial quantities and they fail to perform as expected, our reputation could be severely damaged, and we could lose existing or potential future business. Even if the performance failure is corrected, this performance failure might have the long-term effect of harming our ability to market and sell our batteries. WE DEPEND ON A SMALL NUMBER OF CUSTOMERS FOR OUR REVENUES, AND OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION COULD BE HARMED IF WE WERE TO LOSE THE BUSINESS OF ANY ONE OF THEM. To date, our existing purchase orders in commercial quantities are from a limited number of customers. During fiscal 2003, revenue from two customers, Alliant Techsystems Inc. and Pabion Corporation, Ltd., each comprised more than 10% of total revenues. During fiscal 2002, revenue from four customers, Hanil Joint Venture, Amperex Technology Limited, Alliant Techsystems Inc., and Samsung Corporation, each comprised more than 10% of total revenues. For fiscal 2001, revenue from four customers Alliant Techsystems Inc., MicroEnergy Technologies Inc., Moltech Corporation, and Qualcomm, each comprised more than 10% of total revenues. We anticipate that sales of our products to a limited number of key customers will continue to account for a significant portion of our total revenues. We do not have long-term agreements with any of our customers and do not expect to enter into any long-term agreements in the near future. As a result, we face the substantial risk that one or more of the following events could occur: o reduction, delay or cancellation of orders from a customer; o development by a customer of other sources of supply; o selection by a customer of devices manufactured by one of our competitors for inclusion in future product generations; 25 o loss of a customer or a disruption in our sales and distribution channels; or o failure of a customer to make timely payment of our invoices. If we were to lose one or more customers, or if we were to lose revenues due to a customer's inability or refusal to continue to purchase our batteries, our business, results of operations and financial condition could be harmed. THE FACT THAT WE DEPEND ON A SOLE SOURCE SUPPLIER OR A LIMITED NUMBER OF SUPPLIERS FOR KEY RAW MATERIALS MIGHT DELAY OUR PRODUCTION OF BATTERIES. We depend on a sole source supplier or a limited number of suppliers for certain key raw materials used in manufacturing and developing our batteries. We generally purchase raw materials pursuant to purchase orders placed from time to time and have no long-term contracts or other guaranteed supply arrangements with our sole or limited source suppliers. As a result, our suppliers may not be able to meet our requirements relative to specifications and volumes for key raw materials, and we may not be able to locate alternative sources of supply at an acceptable cost. We have in the past experienced delays in product development due to the delivery of nonconforming raw materials from our suppliers, and 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 A SINGLE EXECUTIVE OR THE FAILURE TO HIRE AND INTEGRATE CAPABLE NEW EXECUTIVES COULD HARM OUR BUSINESS. We do not have key man life insurance policies with respect to any of our key members of management. 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. OUR OXIDE-BASED BATTERIES, WHICH NOW COMPRISE A SMALL PORTION OF OUR AVAILABLE PRODUCTS, CONTAIN POTENTIALLY DANGEROUS MATERIALS, WHICH COULD EXPOSE US TO PRODUCT LIABILITY CLAIMS. In the event of a short circuit or other physical damage to an oxide based battery, a reaction may result with excess heat or a gas being generated and released. If the heat or gas is not properly released, the battery may be flammable or potentially explosive. We could, therefore, be exposed to possible product liability litigation. In addition, our batteries incorporate potentially dangerous materials, including lithium. It is possible that these materials may require special handling or that safety problems may develop in the future. We are aware that if the amounts of active materials in our batteries are not properly balanced and if the charge/discharge system is not properly managed, a dangerous situation may result. Battery pack assemblers using batteries incorporating technology similar to ours include special safety circuitry within the battery to prevent such a dangerous condition. We expect that our customers will have to use a similar type of circuitry in connection with their use of our oxide-based products. ACCIDENTS AT OUR FACILITIES COULD DELAY PRODUCTION AND ADVERSELY AFFECT OUR OPERATIONS. An accident in our facilities could occur. Any accident, whether due to the production of our batteries or otherwise resulting from our facilities' operations, could result in significant manufacturing delays or claims for damages resulting from personal or property injuries, which would adversely affect our operations and financial condition. WE DEPEND UPON THE CONTINUED OPERATION OF OUR NORTHERN IRELAND FACILITY. OPERATIONAL PROBLEMS AT THIS FACILITY COULD HARM OUR BUSINESS. Our revenues are dependent upon the continued operation of our manufacturing facility in Northern Ireland. The operation of a manufacturing plant involves many risks, including potential damage from fire or natural disasters. In addition, we have obtained permits to conduct our business as currently operated at the facility. If the facility were destroyed and rebuilt, there is a possibility that these permits would not remain effective at the current location, and we may not be able to obtain similar permits to operate at another location. The occurrence of these or any other operational problems at our Northern Ireland facility may harm our business. 26 WE EXPECT TO SELL A SIGNIFICANT PORTION OF OUR PRODUCTS TO AND DERIVE A SIGNIFICANT PORTION OF OUR LICENSING REVENUES FROM CUSTOMERS LOCATED OUTSIDE THE UNITED STATES. FOREIGN GOVERNMENT REGULATIONS, CURRENCY FLUCTUATIONS AND INCREASED COSTS ASSOCIATED WITH INTERNATIONAL SALES COULD MAKE OUR PRODUCTS AND LICENSES UNAFFORDABLE IN FOREIGN MARKETS, WHICH WOULD REDUCE OUR FUTURE PROFITABILITY. We expect that international sales of our products and licenses, as well as licensing royalties, will represent an increasingly significant portion of our sales. International business can be subject to many inherent risks that are difficult or impossible for us to predict or control, including: o changes in foreign government regulations and technical standards, including additional regulation of rechargeable batteries or technology or the transport of lithium and phosphate, which may reduce or eliminate our ability to sell or license in certain markets; o foreign governments may impose tariffs, quotas and taxes on our batteries or our import of technology into their countries; o requirements or preferences of foreign nations for domestic products could reduce demand for our batteries and our technology; o fluctuations in currency exchange rates relative to the United States dollar could make our batteries and our technology unaffordable to foreign purchasers and licensees or more expensive compared to those of foreign manufacturers and licensors; o longer payment cycles typically associated with international sales and potential difficulties in collecting accounts receivable may reduce the future profitability of foreign sales and royalties; o import and export licensing requirements in Northern Ireland or other countries where we intend to conduct business may reduce or eliminate our ability to sell or license in certain markets; and o political and economic instability in Northern Ireland or other countries where we intend to conduct business may reduce the demand for our batteries and our technology or our ability to market our batteries and our technology in those countries. These risks may increase our costs of doing business internationally and reduce our sales and royalties or future profitability. WE MAY NEED TO EXPAND OUR EMPLOYEE BASE AND OPERATIONS IN ORDER TO EFFECTIVELY DISTRIBUTE OUR PRODUCTS COMMERCIALLY, WHICH MAY STRAIN OUR MANAGEMENT AND RESOURCES AND COULD HARM OUR BUSINESS. To implement our growth strategy successfully, we will have to increase our staff, primarily with personnel in sales, marketing, and product support capabilities, as well as third party and direct distribution channels. However, we face the risk that we may not be able to attract new employees to sufficiently increase our staff or product support capabilities, or that we will not be successful in our sales and marketing efforts. Failure in any of these areas could impair our ability to execute our plans for growth and adversely affect our future profitability. COMPETITION FOR PERSONNEL, IN PARTICULAR FOR PRODUCT DEVELOPMENT AND PRODUCT IMPLEMENTATION PERSONNEL, IS INTENSE, AND WE MAY HAVE DIFFICULTY ATTRACTING THE PERSONNEL NECESSARY TO EFFECTIVELY OPERATE OUR BUSINESS. We believe that our future success will depend in large part on our ability to attract and retain highly skilled technical, managerial and marketing personnel who are familiar with and experienced in the battery industry, as well as skilled personnel to operate our facility in Northern Ireland. 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 with significantly greater financial resources than us. 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. 27 POLITICAL INSTABILITY IN NORTHERN IRELAND COULD INTERRUPT MANUFACTURING OF OUR BATTERIES AND END-USER PRODUCTS AT OUR NORTHERN IRELAND FACILITY AND CAUSE US TO LOSE SALES AND MARKETING OPPORTUNITIES. Northern Ireland has experienced significant social and political unrest in the past and we cannot assure you that these instabilities will not continue in the future. Any political instability in Northern Ireland could temporarily or permanently interrupt our manufacturing of batteries and end-user products at our facility in Mallusk, Northern Ireland. Any delays could also cause us to lose sales and marketing opportunities, as potential customers would find other vendors to meet their needs. RISKS ASSOCIATED WITH OUR INDUSTRY IF COMPETING TECHNOLOGIES THAT OUTPERFORM OUR BATTERIES WERE DEVELOPED AND SUCCESSFULLY INTRODUCED, THEN OUR PRODUCTS MIGHT NOT BE ABLE TO COMPETE EFFECTIVELY IN OUR TARGETED MARKET SEGMENTS. Rapid and ongoing changes in technology and product standards could quickly render our products less competitive, or even obsolete. Other companies are seeking to enhance traditional battery technologies, such as lead acid and nickel cadmium or have recently introduced or are developing batteries based on nickel metal-hydride, liquid lithium-ion and other emerging and potential technologies. These competitors are engaged in significant development work on these various battery systems, and we believe that much of this effort is focused on achieving higher energy densities for low power applications such as portable electronics. One or more new, higher energy rechargeable battery technologies could be introduced which could be directly competitive with, or superior to, our technology. The capabilities of many of these competing technologies have improved over the past several years. Competing technologies that outperform our batteries could be developed and successfully introduced, and as a result, there is a risk that our products may not be able to compete effectively in our targeted market segments. We have invested in research and development of next-generation technology in energy solutions. If we are not successful in developing and commercially exploiting new energy solutions based on new materials, or we experience delays in the development and exploitation of new energy solutions, compared to our competitors, our future growth and revenues will be adversely affected. OUR PRINCIPAL COMPETITORS HAVE GREATER FINANCIAL AND MARKETING RESOURCES THAN WE DO AND THEY MAY THEREFORE DEVELOP BATTERIES SIMILAR OR SUPERIOR TO OURS OR OTHERWISE COMPETE MORE SUCCESSFULLY THAN WE DO. Competition in the rechargeable battery industry is intense. The industry consists of major domestic and international companies, most of which have financial, technical, marketing, sales, manufacturing, distribution and other resources substantially greater than ours. There is a risk that other companies may develop batteries similar or superior to ours. In addition, many of these companies have name recognition, established positions in the market, and long-standing relationships with OEMs and other customers. We believe that our primary competitors are existing suppliers of liquid lithium-ion, competing polymer and, in some cases, nickel metal-hydride batteries. These suppliers include Sanyo, Matsushita Industrial Co., Ltd. (Panasonic), Sony, Toshiba, SAFT and Electrovaya. Most of these companies are very large and have substantial resources and market presence. We expect that we will compete against manufacturers of other types of batteries in our targeted application segments, which include laptops, cellular telephones and personal digital assistant products, on the basis of performance, size and shape, cost and ease of recycling. There is also a risk that we may not be able to compete successfully against manufacturers of other types of batteries in any of our targeted applications. LAWS REGULATING THE MANUFACTURE OR TRANSPORTATION OF BATTERIES MAY BE ENACTED WHICH COULD RESULT IN A DELAY IN THE PRODUCTION OF OUR BATTERIES OR THE IMPOSITION OF ADDITIONAL COSTS THAT WOULD HARM OUR ABILITY TO BE PROFITABLE. At the present time, international, federal, state or local law does not directly regulate the storage, use and disposal of the component parts of our batteries. However, laws and regulations may be enacted in the future which could impose environmental, health and safety controls on the storage, use, and disposal of certain chemicals and metals used in the manufacture of lithium polymer batteries. Satisfying any future laws or regulations could require significant time and resources from our technical staff and possible redesign which may result in substantial expenditures and delays in the production of our product, all of which could harm our business and reduce our future profitability. The transportation of lithium and lithium ion batteries is regulated both internationally and domestically. Under recently revised United Nations recommendations and as adopted by the International Air Transport Association (IATA), our N-ChargeTM system currently falls within the level such that it is no longer exempt and now requires a class 9 designation for transportation. The revised United Nations recommendations are not U.S. law until such time as they are incorporated into the DOT Hazardous Material Regulations. However, DOT has proposed new regulations harmonizing with the UN guidelines. At present it is not known if or when the proposed regulations would be adopted by the US. While we fall under the equivalency levels for the US 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. 28 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 17, 2003, our officers, directors and their affiliates as a group beneficially owned approximately 34.1% of our outstanding common stock. Carl Berg, one of our directors, beneficially owns approximately 31.3% 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 interests as incumbent officers or directors, even if these interests diverge from their interests as stockholders per se and thus from the interests of other stockholders. SOME PROVISIONS OF OUR CHARTER DOCUMENTS MAY MAKE TAKEOVER ATTEMPTS DIFFICULT, WHICH COULD DEPRESS THE PRICE OF OUR STOCK AND LIMIT THE PRICE POTENTIAL ACQUIRERS MAY BE WILLING TO PAY FOR OUR COMMON STOCK. Our board of directors has the authority, without any action by the 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 and may decrease the market price, and 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 17, 2003, the closing sale price of our common stock was $3.57. 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. The market price of the shares 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 29 o other factors and events beyond our control. In addition, the stock market in general has experienced extreme volatility that often has been unrelated to the operating performance of particular companies. These broad market and industry fluctuations may adversely affect the trading price of our common stock, regardless of our actual operating performance. As a result of this potential stock price volatility, investors may be unable to sell their shares of our common stock at or above the cost of their purchase prices. In addition, companies that have experienced volatility in the market price of their stock have been the object of securities class action litigation. If we were the subject of securities class action litigation, this could result in substantial costs, a diversion of our management's attention and resources and harm to our business and financial condition. FUTURE SALES OF CURRENTLY OUTSTANDING SHARES COULD ADVERSELY AFFECT OUR STOCK PRICE. The market price of our common stock could drop as a result of sales of a large number of shares in the market or in response to the perception that these sales could occur. In addition these sales might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate. We had outstanding 71,722,794 shares of common stock as of March 31, 2003. In addition, at March 31, 2003, we had 5,161,629 shares of our common stock reserved for issuance under outstanding options and warrants, and 7,379,681 additional shares reserved for issuance under our stock option plans. In connection with the potential conversion of the Series C Convertible Preferred Stock issued on June 2, 2003, we expect that we may need to issue up to 2,352,942 shares of our common stock (based on a conversion price of $4.25) and up to 352,900 shares in upon exercise of a related warrant issued on June 2, 2003. WE DO NOT INTEND TO PAY DIVIDENDS ON COMMON STOCK AND THEREFORE STOCKHOLDERS WILL ONLY BE ABLE TO RECOVER THEIR INVESTMENT IN OUR COMMON STOCK, IF AT ALL, BY SELLING THE SHARES OF OUR STOCK THAT THEY HOLD. Some investors favor companies that pay dividends on common stock. We have never declared or paid any cash dividends on our common stock. We currently intend to retain any future earnings for funding growth and we do not anticipate paying cash dividends on our common stock in the foreseeable future. Because we may not pay dividends, a return on an investment in our stock likely depends on the ability to sell our stock at a profit. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We considered the provisions of Financial Reporting Release No. 48 "Disclosures of Accounting Policies for Derivative Financial Instruments and Derivative Commodity Instruments, and Disclosures of Quantitative and Qualitative Information about Market Risk Inherent in Derivative Commodity Instruments." We had no holdings of derivative financial or commodity instruments at March 31, 2003. However, we are exposed to financial market risks, including changes in foreign currency exchange rates and interest rates. We have long-term debt, in the form of two building mortgages, which bear interest at a adjustable rates based on the Bank of England base rate plus 1.5% and 1.75% (5.25% and 5.5%, respectively at March 31, 2003). We also have long-term debt in the form of two loans, which mature in September 2005, to a stockholder. The first loan has an adjustable rate of interest at 1% above the lenders borrowing rate (9% at March 31, 2003) and the second loan has a fixed interest rate of 8%. The table below presents principal amounts by fiscal year for our long-term debt.
2004 2005 2006 2007 2008 THEREAFTER TOTAL ---------- -------- -------- -------- ------- ---------- --------- (dollars in thousands) Liabilities: Fixed rate debt: -- ---- 20,000 -- -- -- 20,000 Variable rate debt 810 858 15,859 964 1,021 1,871 21,383
Based on borrowing rates currently available to us for loans with similar terms, the carrying value of its debt obligations approximates fair value. 30 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Company's Consolidated Financial Statements and notes thereto appear on pages F-3 to F-23 of this Form 10-K Annual Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT. DIRECTORS AND EXECUTIVE OFFICERS The following persons serve as our directors:
DIRECTORS AGE PRESENT POSITION --------- --- ---------------- Carl E. Berg (1)(2).................. 66 Director Stephan B. Godevais.................. 41 Director and Chairman of the Board Bert C. Roberts (1).................. 60 Director Alan F. Shugart (1)(2)............... 72 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 ------------------ --- ---------------- Stephan B. Godevais................. 41 President and Chief Executive Officer Joseph F. Lamoreux.................. 41 Vice President of Small Format Energy Solutions Kevin W. Mischnick.................. 36 Vice President of Finance and Assistant Secretary Terry Standefer..................... 46 Vice President of Worldwide Operations Roger A. Williams................... 55 General Counsel and Assistant Secretary The following persons are significant employees: SIGNIFICANT EMPLOYEE AGE PRESENT POSITION -------------------- --- ---------------- David St. Angelo.................... 43 Vice President of Large Format Energy Solutions
Our executive officers are appointed by and serve at the discretion of the Board. There are no family relationships between any director and/or any executive officer. CARL E. BERG. Mr. Berg helped found us and has served on the Board since September 1991. Mr. Berg is a major Silicon Valley industrial real estate developer and a private venture capital investor. Mr. Berg also serves as the Chairman of the Board, Chief Executive Officer and director of Mission West Properties, Inc., Monolithic Systems, Inc. and Focus Enhancements, Inc. Mr. Berg holds a Bachelor of Arts degree in Business Administration from the University of New Mexico. STEPHAN B. GODEVAIS. Mr. Godevais joined us in May 2001 as our Chief Executive Officer, President and a director. In May 2002, the Board appointed him Chairman of the Board. From December 1997 to April 2001, Mr. Godevais served as a Vice President at Dell Computer Corporation where he led Dell's desktop and notebook product lines for consumers and small businesses. During his tenure at Dell, Mr. Godevais launched the company's Inspiron division, growing it into a multi-billion dollar business and introduced the first 15-inch notebook in the industry, sustaining its position as a market leader from 1998 to 2000. Prior to Dell, Mr. Godevais managed the worldwide notebook business of Digital Equipment Corporation. From December 1994 to November 1997, Mr. Godevais served in several positions, including General Manager and Vice President, at Digital. Mr. Godevais also spent ten years at Hewlett Packard 31 Company, where he held positions in marketing for various product and field organizations. Mr. Godevais holds a business management degree from the Institut d'Etudes Politiques de Paris. BERT C. ROBERTS, JR. Mr. Roberts originally joined us as a director in 1992 and served until 1993 prior to rejoining us as a director in 1998. Mr. Roberts served as Chairman 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 and Chief Executive Officer of MCI, a telecommunications company from 1992 until 1998, after having served as President and Chief Operating Officer since 1985. Mr. Roberts serves on the boards of Johns Hopkins University and CaPCURE (a cancer research funding organization). Mr. Roberts holds a Bachelor of Science in Engineering from Johns Hopkins University. ALAN F. SHUGART. Mr. Shugart joined us as a director in March 1992. Mr. Shugart was the Chief Executive Officer and a director of Seagate Technology, Inc., a technology development and manufacturing company, since its inception in 1979 until July 1998. Mr. Shugart also served as Seagate's President from 1979 to 1983 and from September 1991 to July 1998. Additionally, Mr. Shugart served as Chairman of the Board of Seagate from 1979 until September 1991, and from October 1992 to July 1998. Mr. Shugart currently serves as a director of Sandisk Corporation (a manufacturer of digital flash memory chips) and Cypress Semiconductor Corporation. Mr. Shugart holds a Bachelor of Science in Engineering - Physics from the University of Redlands. JOSEPH F. LAMOREUX. Mr. Lamoreux joined us in July 2001 as our Vice President of Small Format Energy Solutions. From May 1997 to May 2001, Mr. Lamoreux worked at Dell Computer Corporation, where he held several positions, including Director of Notebook Supply Chain Management, Director of Notebook Engineering and Director of Engineering, Inspiron. From May 1997 to January 1999, Mr. Lamoreux served as Director of the Portable PC Division at Compaq Computer Corporation. Mr. Lamoreux holds a Bachelor of Science degree in Mechanical Engineering from North Carolina State University. KEVIN W. MISCHNICK. Mr. Mischnick joined us in July 2001 as our Vice President of Finance. From November 2000 to March 2001, he served as Vice President of Finance at CarOrder, Inc., an internet automobile dealership. From March 1997 to October 2000, he served as Vice President of Finance for AMFM, Inc., a radio broadcasting company, and one of its predecessor companies where he was responsible for all aspects of treasury and cash management systems. During other tenures at AMFM and one of its predecessor companies, Mr. Mischnick completed multiple public equity and debt offerings and gained experience in Securities and Exchange Commission reporting. From August 1990 to March 1997, he served in various positions at Ernst & Young LLP, including Audit Manager. He is a certified public accountant and holds a Bachelor of Business Administration degree in Accounting from Texas Tech University. TERRY STANDEFER. Mr. Standefer joined us in August 2001 as our Vice President of Worldwide Operations. From March 1996 to April 2001, Mr. Standefer held several executive positions at Dell Computer Corporation in procurement, manufacturing and new product operations. Prior to his service at Dell, he spent 13 years at Apple Computer where he managed operations for high volume systems assembly. Mr. Standefer holds a Bachelor of Science in Physics and Math from West Texas State University. ROGER WILLIAMS. Mr. Williams joined us in April 2001 and serves as our General Counsel and Assistant Secretary. Mr. Williams has been a practicing intellectual property attorney for 27 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. DAVID ST. ANGELO. Mr. St. Angelo joined us in September 2001 as Vice President of Large Format Energy Solutions. Prior to joining us, Mr. St. Angelo served as program controller for the Multimedia Systems Division of the technology company Motorola Inc. from 1998 to 2001, during which he steered the definition, design, development and commercialization of the division's advanced set-top box product line. From 1994 to 1998 Mr. St. Angelo held various positions including applications manager, site manager, and applications engineer at Eaton Corporation's semiconductor division. Prior to joining Eaton, Mr. St. Angelo was with the energy company Mobil Solar Energy Corporation, from 1988 to 1994, where he held positions in technology transfer, research and product development. He holds a Bachelor of Science in Chemical Engineering from the University of Massachusetts and a Master of Science in Electrical Engineering from Northeastern University. 32 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 during the fiscal year ended March 31, 2003, our directors, officers and 10% holders complied with all filing requirements under Section 16(a) of the Exchange Act, provided, however, Terry Standefer filed three Forms 4 late, which reported three transactions. ITEM 11. EXECUTIVE COMPENSATION. SUMMARY COMPENSATION TABLE The following table sets forth, as to the Chief Executive Officer and as to each of the other four most highly compensated executive officers whose compensation exceeded $100,000 during fiscal 2003 (referred to as the named executive officers), information concerning all compensation paid for services to us in all capacities for each of the three years ended March 31 indicated below.
Long-Term Annual Annual Compensation Compensation Compensation Awards ------------ ------------ ------------ Securities Name and Principal Underlying Position Fiscal Year Salary($) Bonus($) Options(#) ---------------------------- ----------- --------- -------- ------------ Stephan B. Godevais......... 2003 500,000 -- 350,000 Chairman of the Board, 2002 442,528 -- 1,500,300 Chief Executive Officer and 2001 -- -- -- President Joseph F. Lamoreux......... 2003 200,000 -- 195,000 Vice President of Small 2002 165,495 -- 225,300 Format Energy Solutions 2001 -- -- -- Terry Standefer......... 2003 180,000 -- 250,000 Vice President of Worldwide 2002 98,563 -- 200,300 Operations 2001 -- -- -- Kevin W. Mischnick......... 2003 135,000 33,750 74,652 Vice President of Finance 2002 93,002 -- 120,300 and Assistant Secretary 2001 -- -- -- Roger A. Williams.......... 2003 180,000 -- 83,334 General Counsel and 2002 164,709 -- 120,300 Assistant Secretary 2001 -- -- --
OPTION GRANTS IN LAST FISCAL YEAR The following table shows for the fiscal year ended March 31, 2003, certain information regarding options granted to, exercised by, and held at year-end by the named executive officers: 33
INDIVIDUAL GRANTS ------------------------------------------------------- NUMBER OF POTENTIAL REALIZABLE VALUE SECURITIES PERCENT OF TOTAL AT ASSUMED ANNUAL RATES UNDERLYING OPTIONS GRANTED EXERCISE OF STOCK PRICE APPRECIATION OPTIONS TO EMPLOYEES IN FOR BASE EXPIRATION FOR OPTION TERM (2) NAME GRANTED (#) FISCAL YEAR (1) PRICE ($/SH) DATE 5% 10% ---------------------- ------------- ---------------- ------------- ------------ --------------------------- STEPHAN B. GODEVAIS 300,000 (3) 9.49% 2.10 5/12/2012 $ 396,204 $ 1,004,058 50,000 (4) 1.58% 1.69 12/20/2012 53,142 134,671 JOSEPH F. LAMOREUX 75,000 (5) 2.37% 2.25 5/6/2012 106,126 268,944 20,000 (6) * 0.72 8/26/2012 9,056 22,950 100,000 (4) 3.16% 1.69 12/20/2012 106,283 269,342 TERRY STANDEFER 100,000 (5) 3.16% 2.25 5/6/2012 141,501 358,592 50,000 (7) 1.58% 0.63 10/9/2012 19,810 50,203 100,000 (4) 3.16% 1.69 12/20/2012 106,283 269,342 KEVIN W. MISCHNICK 5,833 (8) * 1.30 7/1/2012 4,769 12,085 18,819 (9) * 0.70 10/1/2012 8,285 20,995 50,000 (4) 1.58% 1.69 12/20/2012 53,142 134,671 ROGER A. WILLIAMS 4,168 (10) * 3.00 4/1/2012 7,851 19,895 18,333 (8) * 1.30 7/1/2012 14,988 37,984 10,833 (9) * 0.70 10/1/2012 4,769 12,086 50,000 (4) 1.58% 1.69 12/20/2012 53,142 134,671 *...Indicates less than one percent. --------------- (1) Options to purchase an aggregate of 3,159,952 shares were granted to employees in fiscal year 2003. (2) The potential realizable value is calculated based on the term of the option at its time of grant, 10 years, compounded annually. It is calculated by assuming that the stock price on the date of grant appreciates at the indicated annual rate, compounded annually for the entire term of the option and that the option is exercised and sold on the last day of its term for the appreciated stock price. No gain to the optionee is possible unless the stock price increases over the option term, which will benefit all stockholders. These amounts are calculated pursuant to applicable requirements of the Commission and do not represent a forecast of the future appreciation of our common stock. (3) These options vest in 16 equal quarterly installments from the grant date, May 12, 2002. (4) These options vest in 16 equal quarterly installments from the grant date, December 20, 2002. (5) These options vest in 16 equal quarterly installments from the grant date, May 6, 2002. (6) These options vest in 16 equal quarterly installments from the grant date, August 26, 2002. (7) These options vest in 16 equal quarterly installments from the grant date, October 9, 2002. (8) These options vest in 12 equal quarterly installments from the grant date July 1, 2002. (9) These options vest in 12 equal quarterly installments from the grant date October 1, 2002. (10) These options vest in 12 equal quarterly installments from the grant date April 1, 2002.
34 AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR, AND FISCAL YEAR END OPTION VALUES The following table shows (i) the number of shares acquired and value realized from option exercises by each of the named executive officers during the fiscal year ended March 31, 2003 and (ii) the number and value of the unexercised options held by each of the named executive officers on March 31, 2003:
SHARES NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED ACQUIRED OF UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS ON VALUE FISCAL YEAR-END (#) AT FISCAL YEAR-END ($)(1) EXERCISE REALIZED ------------------------------ ------------------------------ Name (#) ($) Exercisable Unexercisable Exercisable Unexercisable ------------------- -------- -------- ------------ ------------- ------------ --------------- Stephan B. Godevais -- -- 715,925 1,134,375 $ 4,250 $ 33,750 Joseph F. Lamoreux -- -- 121,553 298,747 $ 6,450 $ 68,150 Terry Standefer -- -- 103,425 346,875 $ 7,625 $ 114,375 Kevin W. Mischnick -- -- 48,051 146,901 $ 4,540 $ 50,706 Roger A. Williams -- -- 57,805 145,829 $ 5,344 $ 48,946 ------------- (1) Based on the last reported sales price of our common stock on the Nasdaq SmallCap Market on March 31, 2003 ($2.15), less the exercise price of the options multiplied by the number of shares underlying the option.
EMPLOYMENT AGREEMENT Effective May 2, 2001, we entered into an employment agreement with Stephan B. Godevais pursuant to which we retained Mr. Godevais as Chief Executive Officer and President at a salary of $500,000 per year. The Board reviews his salary on January 1 of each year and may (in its sole discretion) increase, but not decrease, his salary. Under his employment agreement, we granted Mr. Godevais stock options to purchase an aggregate of 1,500,000 shares of common stock at an exercise price of $6.52 per share, vesting over a period of four years. We agreed to nominate Mr. Godevais to the Board for the entire period of his employment as Chief Executive Officer and President and to use our best efforts to cause our stockholders to cast their votes in favor of his continued election to the Board. Mr. Godevais agreed to resign from the Board when he no longer serves as Chief Executive Officer and President. Mr. Godevais is entitled to a lump sum payment of $500,000 and continued group health insurance coverage for one year following termination if within the first two years of his employment any of the following occurs: o A liquidation or change in control occurs (excluding an acquisition by Carl Berg or his affiliated companies of more than 50% of our voting stock, which will not constitute a change of control); o We terminate Mr. Godevais' employment for any reason other than for cause; or o Mr. Godevais resigns for good reason. We have employment offer letters with each of our named executive officers that stipulate the initial salaries of each officer and the number of options to which the officer was initially entitled. Each letter specifies that the employment may be terminated at any time by either the employee or us, with or without cause. Further, Joseph Lamoreux's letter, dated May 21, 2001, specifies that if we terminate his employment with us for any or no reason, we will pay him four months salary, payable as of the termination date. DIRECTORS' COMPENSATION. Our non-employee directors receive no cash compensation, but are eligible for reimbursement for their expenses incurred in connection with attendance at Board meetings in accordance with Company policy. Directors who are employees do not receive separate compensation for their services as directors, but are eligible to receive stock options under our 2000 Stock Option Plan. Each of our non-employee directors receives stock option grants pursuant to the 1996 Non-Employee Directors' Stock Option Plan, which we refer to as the Directors' Plan. Only non-employee directors or an affiliate of those directors (as defined in the Internal Revenue Code (referred to as the Code)) are eligible to receive options under the Directors' Plan. The plan provides that new directors will receive initial stock options to purchase 100,000 shares of common stock upon 35 election to the Board. The per share exercise price for these options will be the fair market value of a share of our common stock on the day the options are granted. These options will vest one-fifth on the first and second anniversaries of the date of grant of the options, and equal quarterly installments over the next three years. A director who had not received options upon becoming a director, received stock options to purchase 100,000 shares on the date of the adoption of the Directors' Plan. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. During the fiscal year ended March 31, 2003, the Compensation Committee consisted of Messrs. Shugart and Berg. In July 1990, we entered into a loan agreement with Baccarat Electronics, Inc. Baccarat subsequently assigned all of its rights, duties and obligations under that agreement, as the same has been amended from time to time, to Berg & Berg, a company controlled by Carl Berg, a principal stockholder and one of our directors. The loan agreement, as amended, allowed us to borrow, prepay and re-borrow up to $15.0 million under a promissory note on a revolving basis. The loan bears interest at one percent over the interest rate on the lender's principal line of credit each year (approximately 9% at March 31, 2003). Effective December 31, 2001, we further amended the loan agreement to provide that Berg & Berg has no further obligations to loan or advance funds to us under this loan agreement, as amended. As of March 31, 2003, the principal balance and accrued and unpaid interest owing under the July 1990 loan agreement, as amended, totaled $19,701,397. By amendment dated February 11, 2002, Berg & Berg agreed to extend the maturity date of the loan from August 30, 2002 to September 30, 2005. In fiscal 1998 and 1999, we issued warrants to purchase 594,031 shares of our common stock to Berg & Berg in conjunction with the amended loan agreement. The fair value of these warrants, totaling approximately $2,158,679, has been reflected as additional consideration for the loan from Baccarat. In October 2001, we entered into a loan agreement with Berg & Berg. Under the terms of the loan agreement, Berg & Berg agreed to advance us up to $20.0 million between the date of the loan agreement and September 30, 2003. Interest on the loans accrues at 8.0% per annum, and all outstanding amounts with respect to the loans are due and payable on September 30, 2005. As of March 31, 2003, the principal balance and accrued and unpaid interest owing under this loan agreement totaled $21,837,165. In conjunction with the loan agreement, Berg & Berg received a warrant to purchase 1,402,743 shares of our common stock at an exercise price of $3.208 per share. The warrants are immediately exercisable and expire on October 5, 2005. In March 2002, Berg & Berg agreed to provide up to $30.0 million in equity capital. In exchange for any amounts funded pursuant to this commitment, we will issue to Berg & Berg restricted common stock at a purchase price of 85% of the average closing price of our common stock over the five trading days prior to the purchase date. We have agreed to register the resale of the shares of common stock issued to Berg & Berg. We have drawn $20 million from this commitment as of March 31, 2003. Pursuant to the terms of the equity line financing commitment, as a result of the offerings we completed in April 2002 and June 2003 and previous draws under the commitment, Berg & Berg may elect to reduce or eliminate its remaining commitment of $10 million. Berg & Berg has not elected to reduce their commitment to date. Further, the commitment expires on March 31, 2004 and our right to draw down on the line is limited to $5 million per quarter and is further dependent upon meeting certain operating conditions. We do not currently satisfy these conditions and do not expect to satisfy the conditions for the immediate future. However, so long as Stephan Godevais remains as CEO, Berg & Berg has waived these conditions for the remainder of the commitment. We have also received a $4 million working capital commitment from Berg & Berg. In addition, in June 2003 we received an additional $10.0 million funding commitment from Berg & Berg for which the terms will be negotiated at a later date. 36 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. EQUITY COMPENSATION PLANS The following table summarizes information about the equity securities authorized for issuance under our compensation plans as of March 31, 2003. For a description of these plans, please see Note 14, Stockholders' Equity (Deficit), in our consolidated financial statements.
NUMBER OF SECURITIES NUMBER OF SECURITIES TO BE ISSUED UPON WEIGHTED-AVERAGE REMAINING AVAILABLE EXERCISE OF OUTSTANDING EXERCISE PRICE OF FOR FUTURE ISSUANCE OPTIONS, WARRANTS OUTSTANDING OPTIONS, UNDER EQUITY PLAN CATEGORY AND RIGHTS WARRANTS AND RIGHTS COMPENSATION PLANS -------------------- ------------------- --------------------- ---------------------- Equity compensation plans approved by security holders 6,994,770 $5.47 122,589 Equity compensation plans not approved by security holders (1) 1,925,000 $6.45 -- Total 8,919,770 $5.68 122,589 ---------- (1) Options to purchase 1,500,000 shares were granted to Stephan Godevais in May 2001 pursuant to his employment agreement. The exercise price of his options is $6.52 and they vest over four years. 25% of the options vested in May 2002 and the remainder vest in 12 equal quarterly installments during the term of his employment (750,000 shares vested as of June 17, 2003). The vesting accelerates and become immediately exercisable on the date of a change of control of the Company (or if he has been terminated without good cause or resigned for good reason). Options to purchase 225,000 shares were granted to Joseph Lamoreux in June 2001 pursuant to his employment agreement. The exercise price of his options is $7.18 and they vest over four years. 25% of the options vested in June 2002 and the remainder vest in 12 equal quarterly installments during the term of his employment (112,500 shares vested as of June 17, 2003). Options to purchase 200,000 shares were granted to Terry Standefer in August 2001 pursuant to his employment agreement. The exercise price of his options is $5.15 and they vest over four years. 25% of the options will vest in August 2002 and the remainder vest in 12 equal quarterly installments during the term of his employment (87,500 shares vested as of June 17, 2003).
37 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information regarding beneficial ownership of our common stock as of June 17, 2003, by: o Each of our directors; o Each of the named executive officers; o All directors and executive officers as a group; and o All other stockholders known by us to beneficially own more than 5% of the outstanding common stock. Beneficial ownership is determined in accordance with the rules of the Commission. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of common stock subject to options held by that person that are currently exercisable or exercisable within 60 days of the date as of which this information is provided, and not subject to repurchase as of that date, are deemed outstanding. These shares, however, are not deemed outstanding for the purposes of computing the percentage ownership of any other person. Except as indicated in the notes to this table, and except pursuant to applicable community property laws, each stockholder named in the table has sole voting and investment power with respect to the shares shown as beneficially owned by them. Percentage ownership is based on 71,734,022 shares of common stock outstanding on June 17, 2003. Unless otherwise indicated, the address for each of the stockholders listed below is c/o Valence Technology, Inc., 6504 Bridge Point Parkway, Suite 415, Austin, Texas 78730.
Beneficial Ownership(1) ------------------------------ Beneficial Owner Number of Percent of Shares (#) Total (%) ----------------------------------------------------------- ------------ ------------ Carl E. Berg (2) 23,164,330 31.3% 10050 Bandley Drive, Cupertino, CA 95014 1981 Kara Ann Berg Trust, Clyde J. Berg, Trustee; and Clyde J. Berg 10050 Bandley Drive, Cupertino, CA 95014 (3) 8,604,270 12.0% Alan F. Shugart (4) 518,567 * Bert C. Roberts, Jr. (5) 455,419 * Stephan B. Godevais (6) 1,309,050 1.8% Joseph F. Lamoreux (7) 152,492 * Terry Standefer (7) 140,925 * Kevin W. Mischnick (7) 73,203 * Roger A. Williams (8) 96,403 * All directors and executive officers as a group (8 persons) (9) 25,910,389 34.1% * Indicates less than one percent. ----------------------- (1) This table is based upon information supplied by officers, directors and principal stockholders and Schedules 13D and 13G filed with the Commission. Unless otherwise indicated in the footnotes to this table and subject to community property laws where applicable, each of the stockholders named in this table has sole voting and investment power with respect to the shares indicated as beneficially owned. Applicable percentage ownership is based on 71,734,022 shares of common stock outstanding on June 17, 2003, adjusted as required by rules promulgated by the Commission. (2) Includes 350,000 shares held directly by Mr. Berg; 283,006 shares issuable upon exercise of options held by Mr. Berg that are exercisable within 60 days of June 17, 2003; 1,996,774 shares issuable upon exercise of warrants (subject to adjustment) and 20,440,550 shares held by Berg & Berg Enterprises, LLC, of which Mr. Berg is the sole manager; and 94,000 shares held by Berg &Berg Profit Sharing Plan U/A 1/1/80 FBO Carl E. Berg Basic Transfer, of which Mr. Berg is the Trustee. Mr. Berg has sole voting and dispositive power with respect to 727,006 shares and shared voting and dispositive power with respect to 22,437,324 shares. Berg & Berg has 38 no sole voting and dispositive power with respect to any shares and has shared voting and dispositive power with respect to 22,437,324 shares. (3) Based on information contained in a Schedule 13G filed jointly by 1981 Kara Ann Berg Trust, Clyde J. Berg, Trustee and Clyde J. Berg with the SEC on February 14, 2003. The Trust has no sole voting and dispositive power with respect to any shares and has shared voting and dispositive power with respect to 8,129,270 shares. Clyde J. Berg has sole voting and dispositive power with respect to 475,000 shares and shared voting and dispositive power with respect to 8,129,270 shares. (4) Includes 202,000 shares held by Mr. Shugart and 316,567 shares issuable upon exercise of options that are exercisable within 60 days of June 17, 2003. (5) Includes 100,000 shares held by Mr. Roberts, 100,000 shares held indirectly through various entities, 10,000 shares held by his spouse and 245,419 shares issuable upon exercise of options that are exercisable within 60 days of June 17, 2003. (6) Includes 365,000 shares held by Mr. Godevais and 944,050 shares issuable upon exercise of options that are exercisable within 60 days of June 17, 2003. (7) All shares are issuable upon exercise of options that are exercisable within 60 days of June 17, 2003. (8) Includes 12,000 shares held by Mr. Williams and 84,403 shares are issuable upon exercise of options that are exercisable within 60 days of June 17, 2003. (9) Includes 4,236,839 shares issuable upon exercise of options and warrants that are exercisable within 60 days of June 17, 2003.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. None, except for certain transactions with Carl E. Berg described in Item 11 Executive Compensation; Compensation Committee Interlocks and Insider Participation. ITEM 14. CONTROLS AND PROCEDURES. Within 90 days prior to the filing date of our Annual Report on Form 10-K, we conducted an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic reports with the Commission. In accordance with the Commission's requirements, our Chief Executive Officer and Chief Financial Officer note that, since the date of the most recent evaluation of our disclosure controls and procedures to the date of our Annual Report on Form 10-K, there have been no significant changes in our internal controls or in other factors that could significantly affect internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses. Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. 39 PART IV ITEM 15. PRINCIPAL ACCOUNTANT FEES AND SERVICES. Not applicable. ITEM 16. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) (1) FINANCIAL STATEMENTS - See Index to Consolidated Financial Statements of this Annual Report on Form 10-K. (2) FINANCIAL STATEMENT SCHEDULES - All financial statement schedules have been omitted because they are not applicable or are not required, or because the information required to be set forth therein is included in the Consolidated Financial Statements or Notes thereto. (3) EXHIBITS - See Exhibit Index on pages 42-44 of this Annual Report on Form 10-K. (b) The Company filed the following reports on Form 8-K during the last quarter of the period for which this Annual Report on Form 10-K covers: (i) Form 8-K filed February 7, 2003 reporting under Items 5 and 7. (c) See Exhibit Index on pages 42-44 of this Form 10-K Annual Report. (d) None. 40 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION 3.1 (1) Second Restated Certificate of Incorporation of the Company. 3.2 (6) Amendment to the Second Restated Certificate of Incorporation of the Company. 3.3 (16) Certificate of Designations, Preferences and Rights of Series C Convertible Preferred Stock, filed June 2, 2003. 3.4 (13) Second Amended and Restated Bylaws of the Company. 4.1 (3) Form of Warrant to Baccarat Electronics, Inc. 4.2 (4) Form of Warrant to Placement Agent (Gemini Capital, LLC). 4.3 (4) Form of Warrant to Investor (CC Investments, LDC). 4.4 (7) Form of Warrant dated June 28, 2000 to Acqua Wellington Value Fund Ltd. 4.5 (10) Warrant dated January 4, 2002 to Berg & Berg Enterprises, LLC. 4.6 (16) Warrant to Purchase Common Stock, issued June 2, 2003 (to Riverview Group, LLC). 4.7 (1) Loan Agreement between the Company and Baccarat Electronics, Inc., dated July 17, 1990. 4.8 (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). 4.9 (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). 4.10 (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). 4.11 Amendment No. 4 to Loan Agreement between the Company and Baccarat Electronics, Inc., dated September 1, 1997 (subsequently transferred to Berg & Berg Enterprises, LLC). 4.12 (3) Amendment No. 5 to Loan Agreement between the Company and Baccarat Electronics, Inc., dated July 17, 1998 (subsequently transferred to Berg & Berg Enterprises, LLC). 4.13 Amendment No. 6 to Loan Agreement between the Company and Baccarat Electronics, Inc., dated November 27, 2000 (subsequently transferred to Berg & Berg Enterprises, LLC). 4.14 (13) Second Amended Promissory Note dated November 27, 2000 issued by the Company to Baccarat Electronics, Inc. (subsequently transferred to Berg & Berg Enterprises, LLC). 4.15 (10) Amendment No. 7 to Original Loan Agreement between the Company and Berg & Berg Enterprises, LLC (previously with Baccarat Electronics, Inc.), dated October 10, 2001. 4.16 (13) 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. 4.17 (10) Loan Agreement dated October 5, 2001 between the Company and Berg & Berg Enterprises, LLC. 4.18 (10) Security Agreement dated October 5, 2001 between the Company and Berg & Berg Enterprises, LLC. 4.19 (10) Promissory Note dated October 5, 2001 issued by the Company to Berg & Berg Enterprises, LLC. 4.20 (14) 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). 10.1 (2)* 1990 Stock Option Plan as amended on October 3, 1997. 10.2 (5) 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 (9) Employment Agreement with Stephan B. Godevais dated May 2, 2001. 10.5 Employment Offer Letter with Joseph Lamoreux dated May 21, 2001. 10.6 (13) Option Agreement for Stephan Godevais dated May 2, 2001. 10.7 (13) Option Agreement for Joseph Lamoreux dated June 4, 2001. 10.8 (13) Option Agreement for Terry Standefer dated August 20, 2001. 10.9 (8) Form of Indemnification Agreement entered into between the Company and its Directors and Officers. 10.10 (9) Registration Rights Agreement with West Coast Venture Capital, Inc. (the 1981 Kara Ann Berg Trust) dated January 13, 2001. 41 10.11 (11) Financing commitment letter agreement between the Company and Berg & Berg Enterprises, LLC dated March 12, 2002. 10.12 (17) Waiver of Conditions of Equity Line of Credit (identified herein as Exhibit 10.11) from Berg & Berg Enterprises, LLC to the Company dated May 30, 2003. 10.13 (12) Letter Agreement and Release between the Company and Berg & Berg Enterprises, LLC dated March 31, 2002. 10.14 (17) Commitment Letter from Berg & Berg Enterprises, LLC to the Company dated June 9, 2003. 10.15 (16) Securities Purchase Agreement dated June 2, 2003 (between the Company and the Riverview Group LLC). 10.16 (16) Registration Rights Agreement dated June 2, 2003 (with Riverview Group, LLC). 21.1 List of subsidiaries of the Company. 23.1 Consent of Independent Auditors. 99.1 Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (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 Registration Statement on Form S-8 (File No. 333-43203) filed with the Securities and Exchange Commission on December 24, 1997. (3) 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. (4) 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. (5) 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. (6) 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. (7) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K dated June 22, 2000, and filed with the Securities and Exchange Commission on June 29, 2000. (8) 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. (9) 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. (10) 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. 42 (11) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K dated March 20, 2002, and filed with the Securities and Exchange Commission on March 22, 2002. (12) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K dated March 31, 2002, and filed with the Securities and Exchange Commission on April 15, 2002. (13) 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. (14) 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. (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. (16) 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. (17) Incorporated by reference to the exhibit so described in the Company's Current Report on Form 8-K dated May 30, 2003, and filed with the Securities and Exchange Commission on June 11, 2003. * Portions of the text have been omitted. A separate filing of such omitted text has been made with the Securities and Exchange Commission as part of the Company's Application for confidential treatment. 43 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 27, 2003 By: /S/ Stephan B. Godevais ---------------------------------------- Stephan B. Godevais Chief Executive Officer, President and Chairman of the Board POWER OF ATTORNEY Each person whose signature appears below constitutes and appoints Stephan B. Godevais and Kevin W. Mischnick, and each of them, as his true and lawful attorneys-in-fact and agents with full power of substitution and resubstitution, for him and his name, place and stead, in any and all capacities, to sign any or all amendments to this Annual Report on Form 10-K and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the foregoing, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or either of them, or their substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of Registrant and in the capacities and on the dates indicated.
Name Position Date ------------------------------------- ---------------------------------- ------------------- Chief Executive Officer, June 27, 2003 President and Chairman of the Board (Principal Executive Officer) /s/ Stephan B. Godevais ------------------------------------- Stephan B. Godevais Vice President of Finance June 27, 2003 (Principal Financial and Accounting Officer) /s/ Kevin W. Mischnick ------------------------------------- Kevin W. Mischnick Director June 27, 2003 /s/ Carl E. Berg ------------------------------------- Carl E. Berg Director June 27, 2003 /s/ Bert C. Roberts, Jr. ------------------------------------- Bert C. Roberts, Jr. Director June 27, 2003 /s/ Alan F. Shugart ------------------------------------- Alan F. Shugart
44 Certification of Principal Executive Officer of Valence Technology, Inc. I, Stephan B. Godevais, 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-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures 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) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, 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 in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: June 27, 2003 /s/ Stephan B. Godevais ------------------------------------ By: Stephan B. Godevais Title: Principal Executive Officer Certification of Principal Financial Officer of Valence Technology, Inc. I, Kevin W. Mischnick , 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-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures 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) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, 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 in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: June 27, 2003 /s/ Kevin W. Mischnick ------------------------------------ By: Kevin W. Mischnick Title: Principal Financial Officer VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES Index to Consolidated Financial Statements VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
PAGES CONSOLIDATED FINANCIAL STATEMENTS: Independent Auditors' Report.................................................................F-2 Consolidated Balance Sheets as of March 31, 2003 and March 31, 2002..........................F-3 Consolidated Financial Statements for the years ending March 31, 2003, March 31, 2002 and March 31, 2001: Consolidated Statements of Operations and Comprehensive Loss..........................F-4 Consolidated Statements of Stockholders' Equity (Deficit).............................F-5 Consolidated Statements of Cash Flows.................................................F-6 Notes to Consolidated Financial Statements....................................F-7 to F-23
F-1 INDEPENDENT AUDITORS' REPORT 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, 2003 and 2002, and the related consolidated statements of operations and comprehensive loss, stockholders' equity (deficit), and cash flows for the three years then ended. 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 auditing standards generally accepted in the United States of America. 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, 2003 and 2002, and the results of its operations and its cash flows for each of the three years ended March 31, 2003, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 3 to the financial statements, the Company changed its method of accounting for goodwill and other intangible assets as of April 1, 2002 upon the adoption of Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets." /s/ Deloitte & Touche LLP Austin, Texas June 11, 2003 F-2 VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
March 31, 2003 March 31, 2002 ------------------ ---------------- ASSETS Current assets: Cash and cash equivalents $ 6,616 $ 623 Trade receivables, net of allowance of $130 and $312 as of March 31, 2003 and March 31, 2002, respectively 1,218 362 Inventory 2,757 2,589 Prepaid and other current assets 1,495 1,552 ------------------- ------------------ Total current assets 12,086 5,126 Property, plant and equipment, net 14,279 14,166 Intellectual property, net 9,789 11,239 ------------------- ------------------ Total assets $ 36,154 $ 30,531 =================== ================== =================== ================== LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Current portion of long-term debt $ 810 $ 683 Accounts payable 3,511 2,548 Accrued expenses 2,027 3,038 Grant payable 1,715 1,553 ------------------ ---------------- Total current liabilities 8,063 7,822 Long-term interest 6,744 3,933 Long-term debt, less current portion 5,623 5,884 Long-term debt to stockholder 33,242 28,755 ------------------- ------------------ Total liabilities 53,672 46,394 ------------------- ------------------ Commitments and contingencies Stockholders' equity (deficit): Common stock, $0.001 par value, authorized: 100,000,000 shares, issued and outstanding: 71,722,794 and 45,570,144 shares at March 31, 2003 and March 31, 2002, respectively 72 46 Additional paid-in capital 366,518 331,038 Deferred compensation (181) - Notes receivable from stockholder (5,161) (5,990) Accumulated deficit (374,604) (336,703) Accumulated other comprehensive loss (4,162) (4,254) ------------------- ------------------ Total stockholders' equity (deficit) (17,518) (15,863) ------------------- ------------------ Total liabilities and stockholders' equity (deficit) $ 36,154 $ 30,531 =================== ================== =================== ==================
The accompanying notes are an integral part of these consolidated financial statements. F-3
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Years Ended ------------------------------------------------------- March 31, 2003 March 31, 2002 March 31, 2001 ---------------- ---------------- ---------------- Revenue: Licensing and royalty revenue $ 125 $ 3,203 $ 1,500 Battery and system sales 2,432 1,671 7,191 ---------------- ---------------- ---------------- Total revenues 2,557 4,874 8,691 Cost of sales: Cost of sales 10,996 8,649 19,366 INI revenue grant - - (1,191) ---------------- ---------------- ---------------- Net cost of sales 10,996 8,649 18,175 ---------------- ---------------- ---------------- Gross loss (8,439) (3,775) (9,484) Operating expenses: Research and product development 9,293 9,681 8,516 Marketing 3,210 1,957 1,080 General and administrative 10,140 11,971 11,676 Depreciation and amortization 2,790 7,927 11,309 Asset impairment charge 258 31,884 - ---------------- ---------------- ---------------- Total operating expenses 25,691 63,420 32,581 ---------------- ---------------- ---------------- Operating loss (34,130) (67,195) (42,065) Interest and other income 381 2,049 1,256 Interest expense (4,172) (4,327) (2,332) Gain (loss) on disposal of assets 20 (147) (15) Equity in loss of Joint Venture - - (345) ---------------- ---------------- ---------------- Net loss (37,901) (69,620) (43,501) Beneficial conversion feature and accretion to redemption value on preferred stock - - (591) ---------------- ---------------- ---------------- Net loss available to common stockholders $ (37,901) $ (69,620) $ (44,092) ================ ================ ================ ================ ================ ================ Other comprehensive loss: Net loss $ (37,901) $ (69,620) $ (43,501) Change in foreign currency translation adjustments 92 (117) (4,303) ---------------- ---------------- ---------------- Comprehensive loss $ (37,809) $ (69,737) $ (47,804) ================ ================ ================ ================ ================ ================ Net loss per share available to common stockholders $ (0.65) $ (1.53) $ (1.14) ================ ================ ================ ================ ================ ================ Shares used in computing net loss per share available to common stockholders, basic and diluted 58,423 45,504 38,840 ================ ================ ================
The accompanying notes are an integral part of these consolidated financial statements. F-4
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) for the years ended March 31, 2003, 2002, and 2001 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Notes Accumulated Additional Receivable Other Common Stock Paid-in Deferred from Accumulated Comprehensive Shares Amount Capital Compensation Stockholder Deficit Loss Totals ------- ------ --------- ------------ ----------- ----------- -------------- ---------- Balances, March 31, 2000 36,839 $ 37 $ 256,086 $ - $(5,439) $(223,582) $ 166 $ 27,268 Exercise of stock options at $2.63 to $8.38 per share 243 1,243 1,243 Sale of stock to private investors 847 1 12,499 12,500 Stock issued to acquire Telcordia Technology (purchase of intellectual property) 3,000 3 26,233 26,236 Stock issued to acquire WCVC assets (purchase of investments) 3,493 3 29,633 29,636 Interest receivable from stockholder (274) (274) Net Loss (43,501) (43,501) Beneficial conversion feature on preferred stock (591) (591) Change in translation adjustment (4,303) (4,303) -------------------------------- ------- ------ --------- ------------ ----------- ---------- --------- ---------- Balances, March 31, 2001 44,422 $ 44 $325,103 $ - $(5,713) $(267,083) $(4,137) $48,214 Exercise of stock options at $3.13 to $4.94 per share 39 1 172 173 Conversion of preferred stock 1,109 1 2,735 2,736 Issuance of common stock warrants 2,768 2,768 Stock compensation 260 260 Interest receivable from stockholder (277) (277) Net Loss (69,620) (69,620) Change in translation adjustment (117) (117) -------------------------------- ------- ------ --------- ------------ ----------- ----------- ---------- ---------- Balances, March 31, 2002 45,570 $ 46 $ 331,038 $ - $(5,990) $(336,703) $(4,254) $(15,863) Sale of stock to private investors 26,153 26 35,106 35,132 Modification of stock option 374 (374) - Stock compensation 193 193 Interest receivable from stockholder (278) (278) Payment of accrued interest on note receivable from stockholder 1,107 1,107 Net Loss (37,901) (37,901) Change in translation adjustment 92 92 -------------------------------- ------- ------ --------- ------------ ---------- ----------- ---------- ----------- Balances, March 31, 2003 71,723 $ 72 $ 366,518 $ (181) $(5,161) $(374,604) $(4,162) $(17,518)
The accompanying notes are an integral part of these consolidated financial statements. F-5
VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) Years Ended ------------------------------------------------- March 31, 2003 March 31, 2002 March 31, 2001 --------------- --------------- --------------- Cash flows from operating activities: Net loss $ (37,901) $ (69,620) $ (43,501) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 2,790 7,927 11,309 (Recoveries) provision for bad debt (182) 312 - Accretion of debt discount 924 1,003 651 Impairment charge 258 31,884 - (Gain) loss on disposal of property, plant, & equipment (20) 147 15 Compensation related to the issuance of stock options 193 260 - Interest income on shareholder note receivable (277) (277) (274) Reserve for obsolete inventory 326 - - Equity in loss of Joint Venture - - 345 Changes in operating assets and liabilities: Trade receivables (674) 2,288 (2,911) Prepaid and other current assets 115 253 687 Inventory (492) 2,243 (3,185) Accounts payable 857 (2,868) 224 Accrued expenses and long-term interest 1,599 2,788 (1,581) Deferred revenue - (2,500) - -------------- --------------- --------------- Net cash used in operating activities (32,484) (26,160) (38,221) -------------- --------------- --------------- Cash flows from investing activities: Purchases of property, plant & equipment (726) (8,947) (21,758) Proceeds from disposal of property, plant & equipment 20 - - Proceeds from investments - 154 - -------------- --------------- --------------- Net cash used in investing activities (706) (8,793) (21,758) -------------- --------------- --------------- Cash flows from financing activities: Property and equipment grants - - 5,822 Acquisition of West Coast Venture Capital assets - - 11,949 Proceeds from long-term debt 4,671 34,065 10,052 Payments on other long-term debt (804) (1,836) (702) Proceeds from issuance of common stock and warrants, net of issuance costs 35,132 173 13,728 -------------- --------------- --------------- Net cash provided by financing activities 38,999 32,402 40,849 -------------- --------------- --------------- Effect of foreign exchange rates on cash and cash equivalents 184 (581) (1,671) -------------- --------------- --------------- Increase (decrease) in cash and cash equivalents 5,993 (3,132) (20,801) Cash and cash equivalents, beginning of year 623 3,755 24,556 -------------- --------------- --------------- Cash and cash equivalents, end of year $ 6,616 $ 623 $ 3,755 ============== =============== =============== ============== =============== =============== Supplemental Information: Interest paid $ 269 $ 366 $ 461 Noncash investing and financing activities: Payment of accrued interest on note receivable from stockholder 1,107 - - Fair value of warrants issued in connection with long-term debt to stockholder - 2,768 - Conversion of preferred stock to common stock - 2,736 - Exchange of long-term debt and accrued interest expense for West Coast Venture Capital assets and accrued - 18,485 - interest income Exchange of common stock for Telcordia technology - - 26,236 Exchange of common stock for West Coast Venture Capital assets - - 29,636 Beneficial conversion feature on preferred stock - - 591
The accompanying notes are an integral part of these consolidated financial statements. F-6 1. BUSINESS AND BUSINESS STRATEGY: Valence Technology, Inc. (with its subsidiaries, "the Company") was founded in 1989. From 1989 through 2000, the Company's efforts were focused on developing and acquiring battery technologies. With the appointment of Stephan B. Godevais as its Chief Executive Officer and President in May 2001, the Company initiated the transition of its business by broadening its marketing and sales efforts to take advantage of its strengths in research and development. With this strategic shift, the Company's vision is to become a leader in energy solutions by drawing on the numerous benefits of its latest battery technology, the extensive experience of its management team and the significant market opportunity available to it. In February 2002, the Company unveiled its Saphion(TM) technology, a lithium-ion technology which utilizes a phosphate-based cathode material. The Company believes that by incorporating a phosphate-based cathode material, its Saphion(TM) technology is able to offer greater thermal and electrochemical stability than traditional lithium-ion technologies. The Company believes that the safety characteristics of Saphion(TM) technology will enable it to be designed into a wide variety of products in both existing lithium-ion markets as well as markets not served by current lithium-ion solutions. These markets include, among others, notebook accessories, power tools, consumer appliances, vehicles, network and the telecommunications sectors. The Company's business strategy incorporates a balance of system sales and licensing and a manufacturing plan that leverages internal capabilities and partnerships with contract manufacturers. The market for Saphion(TM) technology will be developed through the Company's own product launches, such as the N-Charge(TM) Power System and K-Charge(TM) Power System, and through products designed by others. The company plans to maximize the adoption of Saphion(TM) technology by offering it in small and large format applications and polymer and cylindrical constructions. In addition, the Company will seek to expand the fields of use of its Saphion(TM) technology through the licensing of its intellectual property related to its battery chemistries and manufacturing processes. The Company's strategy will be implemented in three fluid phases, each building on the one previous, with its own specific technology and market focus. 2. LIQUIDITY AND CAPITAL RESOURCES: At March 31, 2003, the Company's principal sources of liquidity were cash and cash equivalents of $6.6 million, $10 million available under an equity line financing commitment with Berg & Berg and $4 million under a working capital commitment from Berg & Berg. As described in Note 22, Subsequent Financing, in the first quarter of fiscal 2004, the Company secured additional financing including approximately $9.6 million net proceeds through the sale of preferred stock and a $10 million additional funding commitment from Berg & Berg. However, pursuant to the terms of the equity line financing commitment, as a result of offerings the Company completed in April 2002 and June 2003, and the drawdowns under the commitment of $5.0 million each in September 2002, November 2002, February 2003, and March 2003 Berg & Berg may elect to reduce or eliminate its remaining commitment. Further, the commitment expires on March 31, 2004 and the Company's right to draw down on the line is limited to $5 million per quarter and is further dependent on our meeting certain operating conditions. However, so long as Stephan Godevais remains as CEO, Berg & Berg has waived these operating conditions for the remainder of the commitment. At March 31, 2003, the Company had commitments for capital expenditures of approximately $241,000. At the Company's current level of operations, it is using cash from operations of approximately $6.0 to $9.5 million per quarter. To sustain its operations for a longer period of time than can be funded from operations and its commitments from Berg & Berg, the Company may need to seek additional financing. The Company's cash requirements may vary materially from those now planned because of changes in its operations, including changes in OEM relationships, market conditions, joint venture and business opportunities, or a request for repayment of a portion or all of its existing grants, which totaled $14.1 million at March 31, 2003, from the Northern Ireland Industrial Development Board, now known as Invest Northern Ireland ("INI"). The Company believes that its existing cash and cash equivalents, anticipated cash flows from its operating activities and available financing will be sufficient to fund its working capital and capital expenditure needs through fiscal 2004. If the Company's working capital requirements and capital expenditures are greater than it expects, it may need to raise additional debt or equity financing in order to provide for its operations. Additionally, if Berg & Berg does not provide the Company additional funding under its commitments, the Company would exhaust its existing sources of liquidity. In such a case, the Company's ability to continue its operations would be dependent on arranging for additional equity or debt financing, which, given the current equity and debt markets, could be difficult to arrange. F-7 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: USE OF ESTIMATES: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the revenues and expenses for the period. Actual results could differ from those estimates. PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Significant intercompany balances and transactions are eliminated upon consolidation. REVENUE RECOGNITION: Revenues are generated from licensing fees and royalties per technology license agreements and sales of products including batteries and battery systems. 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 as revenue upon receipt of cash payment from the licensee. Product sales are recognized when the sale is complete, generally upon shipment, 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. CONCENTRATION OF CREDIT RISK: Financial instruments that potentially subject the Company to concentrations of credit risk are primarily accounts receivable and cash and cash equivalents. The Company provides an allowance for doubtful accounts based upon the expected collectibility of accounts receivable. Credit losses to date have been within the Company's estimates. Cash and cash equivalents are invested in deposits with a major financial institution. The Company has not experienced any losses on its deposits of cash and cash equivalents. Management believes that the financial institution is financially sound and, accordingly, minimal credit risk exists. CASH AND CASH EQUIVALENTS: The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. INVENTORY: Inventory is stated at the lower of cost (determined using the first-in, first out method) or market. FAIR VALUE OF FINANCIAL INSTRUMENTS: Financial instruments that potentially subject the Company to an interest and credit risk consist of cash and cash equivalents, trade receivables, accounts payable, and accrued expenses, the carrying value of which are a reasonable estimate of their fair values due to their short maturities. Based on borrowing rates currently available to the Company for loans with similar terms, the carrying value of its debt obligations and grant payable approximate fair value. INVESTMENTS: The Company accounts for its investments in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments In Debt and Equity Securities". Under SFAS No. 115, the Company classifies its securities as held-to-maturity. Held to maturity securities are those investments in which the Company has F-8 the ability and intent to hold the security until maturity. Held to maturity securities are recorded at amortized cost, which approximates market value. Dividend and interest income are recognized in the period earned. PROPERTY, PLANT AND EQUIPMENT: Property and equipment are stated at cost and depreciated on the straight-line method over their estimated useful lives, generally three to five years. Leasehold improvements are amortized over the lesser of their estimated useful life, generally five years, or the remaining lease term. Expenditures for renewals and betterments are capitalized; repairs and maintenance are charged to expense as incurred. The cost and accumulated depreciation of assets sold or otherwise disposed of are removed from the accounts and any gain or loss thereon is reflected in operations. Grants relating to the acquisition of property, plant and equipment are recorded upon satisfaction of the capital investment requirements underlying the grant and the receipt of grant funds. Such grants are deferred and amortized over the estimated useful lives of the related assets as a reduction of depreciation expense. IMPAIRMENT OF LONG-LIVED ASSETS: SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," requires an entity to review long-lived tangible and intangible assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of these assets is measured by comparison of its carrying amount to future undiscounted cash flows 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 market value and is recorded in the period the determination was made. See Note 4 Impairment Charge regarding impairment of tangible and intangible assets. 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, which was changed from 13.67 years to 8 years in the prior year, the effect of which was to increase the net loss by approximately $602,000 annually. The estimated remaining life of the patents was reassessed in the prior year in conjunction with an analysis of the estimated future cash flows to be generated by these assets, which resulted in an impairment charge at that time. See Note 4 Impairment Charge. Intellectual property developed in-house is expensed as incurred. RESEARCH AND DEVELOPMENT: Research and development costs are expensed as incurred. FOREIGN CURRENCY GAINS AND LOSSES: The assets and liabilities of the Company's foreign subsidiaries have been translated to U.S. dollars using the exchange rate in effect at the balance sheet date. Results of operations have been translated using the average exchange rate during the year. Resulting translation adjustments have been recorded as a separate component of stockholders' equity (deficit) as accumulated other comprehensive loss. Foreign currency transaction gains and losses are included in the consolidated statement of operations as they occur. STOCK-BASED COMPENSATION: The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation," as amended by SFAS No. 148 ("SFAS 148"), "Accounting for Stock-Based Compensation - Transition and Disclosure an amendment of FASB Statement No. 123," and consensus of the Emerging Issues Task Force number 96-18. The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25 ("APB No. 25"), "Accounting for Stock Issued to Employees" and complies with the disclosure provisions of SFAS 123, as amended by SFAS 148. Accordingly, no compensation expense has been recognized for the Company's stock plans. F-9 Had compensation expense for the stock plans been determined based on the fair value at the grant date for options granted in 2003, 2002, and 2001 consistent with the provisions of SFAS 123, as amended by SFAS 148, the pro forma net loss would have been reported as follows (in thousands):
2003 2002 2001 -------------------------------- Net loss available to stockholders - as reported $(37,901)$ (69,620) $(44,092) Add: stock-based compensation expense, net related taxes (6,806) (7,595) (6,030) ---------- --------- --------- Net loss available to stockholders - pro forma (44,707) (77,215) (50,122) Net loss available to stockholders per share - as reported (0.65) (1.53) (1.14) Net loss available to stockholders per share, basic and diluted - pro forma (0.77) (1.70) (1.29)
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 2003, 2002, and 2001: 2003 2002 2001 ---------------------------------------------- Risk-free Interest Rate 2.85% 4.25% 5.84% Expected Life 4.71 years 4.81 years 4.63 years Volatility 106.52% 90.62% 88.90% Dividend Yield - - - COMPREHENSIVE INCOME/LOSS: SFAS No. 130, "Reporting Comprehensive Income" requires the disclosure of comprehensive income/loss and its components in the financial statements. Comprehensive income/loss is the change in stockholder's equity (deficit) from foreign currency translation gains and losses. NEW ACCOUNTING STANDARDS: In June 2001, SFAS No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", was issued, which requires, among other things, the discontinuance of goodwill amortization. SFAS 142 also requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company adopted SFAS No. 142 on April 1, 2002, and no impairment charge was considered necessary under the adoption. In August 2001, SFAS No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived Assets", was issued, which addresses the financial accounting and reporting for the impairment of long-lived assets. This statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for the disposal of a segment of a business. The Company adopted SFAS 144 on April 1, 2002. Impairment charges were deemed appropriate and recorded during the quarter period ended March 31, 2003. In April 2002, SFAS No. 145 ("SFAS 145"), "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections" was issued, which rescinds FASB Statement No. 4, "Reporting Gains and Losses from Extinguishment of Debt," and an amendment of that Statement, FASB Statement No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." The Statement also rescinds FASB Statement No. 44, "Accounting for Intangible Assets of Motor Carriers." The Statement amends FASB Statement No. 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. The Company will adopt SFAS 145 in April 2003 and does not expect this adoption to have a significant effect on the financial statements. F-10 In June 2002, SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," was issued, which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." This statement requires recognition of a liability for a cost associated with an exit or disposal activity when the liability is incurred as opposed to the date of an entity's commitment to an exit plan or disposal activity. The Company adopted SFAS No. 146 in January 2003 which did not have a material effect on the financial statements. In December 2002, SFAS 148 was issued, which amends SFAS 123, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Certain disclosure requirements under SFAS 148 became effective for the Company beginning December 15, 2002 and the Company has complied with those requirements. The remaining disclosure requirements under SFAS 148 become effective for the Company in the first quarter of fiscal 2004. The Company does not expect these additional reporting requirements to have a material impact on its financial statements. In December 2002, FASB Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34", was issued, which addresses the disclosures to be made by a guarantor in its interim and annual financial statements about its obligation under guarantees and clarifies the requirements related to the recognition of a liability by a guarantor at the inception of a guarantee for the obligations the guarantor has undertaken in issuing that guarantee. The Company adopted FIN 45 in March 2003 which did not have a material effect on the financial statements. In April 2003, SFAS No. 149 ("SFAS 149"), "Amendments of Statement 133 on Derivative Instruments and Hedging Activities", was issued, which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities". The Company will adopt SFAS 149 beginning its second quarter of fiscal year 2004 and does not expect this adoption to have a significant impact on its financial statements. In May 2003, SFAS No. 150 ("SFAS 150"), "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity", was issued, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The Company will adopt SFAS 150 beginning its first quarter of fiscal year 2004. The Company is currently reviewing the impact this statement will have on its financial statements. In May 2003, FIN 46, "Consolidation of Variable Interest Entities", was issued, which clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements", to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The Company will adopt FIN 46 beginning its second quarter of fiscal year 2004 and does not expect this adoption to have a significant impact on its financial statements. 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 statements and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. NET LOSS PER SHARE: Net loss per share is computed by dividing the net loss by the weighted average shares of common stock outstanding during the period. The dilutive effect of the options and warrants to purchase common stock are excluded from the computation of diluted net loss per share, since their effect is antidilutive. The antidilutive instruments excluded from the diluted net loss per share computation at March 31 were as follows: F-11
2003 2002 2001 ---------------- ---------------- --------------- ---------------- ---------------- --------------- Common stock options 8,920,000 6,426,000 4,398,000 Warrants to purchase common stock 3,237,000 3,237,000 2,494,000 ---------------- ---------------- --------------- ---------------- ---------------- --------------- Total 12,157,000 9,663,000 6,892,000 ================ ================ ===============
RECLASSIFICATIONS: Reclassification of certain prior-year amounts have been made to conform to the current year presentation. Such reclassifications had no effect on the results of operations or stockholder's equity (deficit). 4. IMPAIRMENT CHARGE: During the quarter ended March 31 2003, the Company recorded an impairment charge of $258,000 on the property in Henderson, Nevada related to the planned sale of this facility. The Company estimated that the expected future cash flows related to the facility were less than the asset carrying value of $3.0 million and adjusted the assets to their fair value accordingly. Fair value was based upon quoted market price for the facility. During the quarter ended December 31, 2001, the Company refined its business strategy to focus its efforts on the development of its Saphion(TM) technology and solidified its manufacturing plan and product mix, accordingly. As a result, the Company evaluated the ongoing value of the property, plant and equipment in its Northern Ireland manufacturing facility and the intellectual property acquired from Telcordia in December 2000. The Company determined that assets with a carrying amount of approximately $53.2 million were impaired and wrote them down by approximately $31.9 million to their fair value. Fair value was based on estimated future cash flows to be generated by these assets, discounted at the Company's market rate of interest. The useful lives for property, plant and equipment in the Northern Ireland manufacturing facility were unchanged as a result of the impairment. Based upon the forecast period used in determining the impairment, the useful life for the intellectual property acquired from Telcordia was reduced from 13.67 years to 8 years as described in Note 3. 5. INVESTMENTS: During the fourth quarter of fiscal 2001, the Company completed the acquisition of the assets of West Coast Venture Capital, Inc. which included investment equivalent instruments. Pursuant to a Letter Agreement and Release effective March 31, 2002, the Company disposed of these assets in exchange for a discharge and release of all obligations under the Company's loan agreement with Berg & Berg Enterprises, LLC ("Berg & Berg") dated February 24, 2001. No gain or loss was recorded as a result of this transaction. See Note 11 Long-Term Debt. 6. INVENTORY: Inventory consisted of the following (in thousands) at:
March 31, 2003 March 31, 2002 ------------------ ---------------- Raw materials $ 1,163 $ 1,977 Work in process 1,385 591 Finished goods 209 21 ------------------ ---------------- ------------------ ---------------- Total inventory $ 2,757 $ 2,589 ================== ================
7. OTHER CURRENT ASSETS:
Other current assets consisted of the following (in thousands) at: March 31, 2003 March 31, 2002 ------------------ ---------------- ------------------ ---------------- Other receivables $ 217 $ 287 Deposits 115 253 Prepaid insurance 646 741 Other prepaids 517 271 ------------------ ---------------- F-12 Total other current assets $ 1,495 1,552 ================== ================
8. INTELLECTUAL PROPERTY: During the third quarter of fiscal year 2001, the Company acquired, from Telcordia Technologies, Inc., its rights in lithium-ion polymer battery technology including 42 U.S. patents, 14 U.S. patents pending, and more than 200 foreign patents, issued and pending. The purchase price was 3,000,000 shares of newly issued common stock valued at $26,250,000 at the time of purchase. A payment of $2,000,000 of accrued royalties was made at the time of purchase. During the third quarter of fiscal year 2002, the Company determined the value of these assets to be impaired and reassessed the useful life from 13.67 years to 8 years, the effect of which was to increase the net loss by approximately $602,000 annually. See Note 4 Impairment Charge. Intellectual property consisted of the following (in thousands) at:
March 31, 2003 March 31, 2002 --------------- --------------- Intellectual properties, net of impairment $13,602 $13,602 Less: accumulated amortization (3,813) (2,363) --------------- --------------- Intellectual properties, net of accumulated amortization $ 9,789 $11,239 =============== ===============
Amortization expense on intellectual property for years following March 31, 2003 will be as follows (in thousands): Fiscal Year ----------------- 2004 $1,450 2005 1,450 2006 1,450 2007 1,450 2008 1,450 Thereafter 2,539 -------- $9,789 ======== Amortization expense for the years ended March 31, 2003 and 2002, was approximately $1,450,000 and $1,803,000, respectively. 9. PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment, net of impairment, consisted of the following (in thousands) at:
March 31, March 31, 2003 2002 --------------- ------------- Building and land $ 14,573 $ 13,776 Leasehold improvements 47 38 Machinery and equipment 10,287 7,174 Office and computer equipment 845 817 Construction in progress 2,725 4,741 --------------- ------------- Total cost 28,477 26,546 Less: accumulated depreciation (14,198) (12,380) --------------- ------------- --------------- ------------- Total cost, net of impairment and depreciation $ 14,279 $ 14,166 =============== =============
During the fourth quarter of fiscal year 2003 and the third quarter of fiscal year 2002, the Company determined the value of certain property, plant and equipment assets to be impaired. See Note 4 Impairment Charge. F-13 10. ACCRUED EXPENSES: Accrued expenses consisted of the following (in thousands) at:
March 31, 2003 March 31, 2002 ------------------ ---------------- Accrued compensation $ 1,220 $ 1,008 Professional services 320 467 Warranty reserve 123 - Other accrued expenses 364 1,563 ------------------ ---------------- Total accrued expenses $ 2,027 3,038 ================== ================
11. LONG-TERM DEBT: Long-term debt consisted of the following (in thousands) at:
March 31, March 31, 2003 2002 ----------- ---------- ----------- ---------- Facility loans $6,433 $6,567 Less amounts due within one year (810) (683) ----------- ---------- Long-term debt, less current portion $5,623 $5,884 =========== ========== =========== ==========
In May 2001, the Company purchased an additional building, adjacent to its existing Northern Ireland facility, for a purchase price of $2,090,000. This 10-year facility term loan bears interest at an adjustable interest rate based on the Bank of England base rate plus 1.75% (5.5% at March 31, 2003) on the outstanding principal. The Company makes monthly payments of $16,000 and quarterly payments of accrued interest. The outstanding principal balance as of March 31, 2003 and March 31, 2002 was $ 2,022,000 and $ 1,977,000, respectively. The related building is collateral for the loan. In April 2000, the Company obtained a 15-year facility loan for its Northern Ireland main factory building. The Company makes monthly principal payments of $25,000 and monthly payments of accrued interest. This facility term loan bears interest at an adjustable rate based on the Bank of England base rate plus 1.5% (5.25% at March 31, 2003) on the outstanding principal. In August 2000, the Company borrowed an additional $2,874,000 for the construction of a factory extension. The Company makes semi-annual payments of $153,000 and semi-annual payments of accrued interest. The loan bears interest at an adjustable rate based on the Bank of England plus 1.5% (5.25% at March 31, 2003). The outstanding principal balance as of March 31, 2003 and March 31, 2002 was $4,411,000 and $4,590,000, respectively. Principal payments on long-term debt at March 31, 2003 are due as follows (in thousands): Fiscal Year -------------------- 2004 $810 2005 858 2006 909 2007 964 2008 1,021 Thereafter 1,871 ------- $6,433 ======= F-14 DEBT TO STOCKHOLDER: March 31, March 31, 2003 2002 -------------- ------------ (in thousands) 2001 Loan balance $20,000 $16,436 1998 Loan balance 14,950 14,950 Unaccreted debt discount (1,708) (2,631) -------------- ------------ Balance at year end $33,242 $28,755 ============== ============ 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, and all outstanding amounts with respect to the loans are due and payable on September 30, 2005. On November 8, 2002 the Company and Berg & Berg amended an affirmative covenant in the agreement to acknowledge the Nasdaq SmallCap Market as an acceptable market for the listing of the Company's Common Stock. As of March 31, 2003, accrued interest on the loan totaled $1,837,000, which is included in long-term interest. In conjunction with the 2001 Loan, Berg & Berg received a warrant to purchase 1,402,743 shares of the Company's common stock at the price of $3.208 per share. The warrants were exercisable beginning on the date they were issued and expire on August 30, 2005. The fair value assigned to these warrants, totaling approximately $2,768,000, has been reflected as additional consideration for the debt financing, recorded as a discount on the debt and accreted as interest expense, amortized over the life of the loan. The warrants were valued using the Black-Scholes valuation method using the assumptions of a life of 47 months, 100% volatility, and a risk free rate of 5.5%. Through March 31 2003, a total of $1,060,000 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, 2003 and March 31, 2002 were $1,465,000 and $373,000, respectively. In July 1998, the Company entered into an amended loan agreement ("1998 Loan") with Berg & Berg which allows the Company to borrow, prepay and re-borrow up to $10,000,000 principal under a promissory note on a revolving basis. In November 2000, the 1998 Loan agreement was amended to increase the maximum amount to $15,000,000. As of March 31, 2003, the Company had an outstanding balance of $14,950,000 under the 1998 Loan agreement. The loan bears interest at one percent over lender's borrowing rate (approximately 9.0% at March 31 2003). Effective December 31, 2001, the Company and the lender agreed to extend the loan's maturity date from August 30, 2002 to September 30, 2005. On November 8, 2002 the Company and Berg & Berg amended an affirmative covenant in the agreement to acknowledge the Nasdaq SmallCap Market as an acceptable market for the listing of the Company's Common Stock. As of March 31, 2003, accrued interest on the loan totaled $4,752,000, which is included in long-term interest. In fiscal 1999, the Company issued warrants to purchase 594,031 shares of common stock to Berg & Berg in conjunction with the 1998 Loan agreement, as amended. The warrants were valued using the Black Scholes valuation method and had an average weighted fair value of approximately $3.63 per warrant at the time of issuance. The fair value of these warrants, totaling approximately $2,159,000, has been reflected as additional consideration for the debt financing, recorded as a discount on the debt and accreted as interest expense to be amortized over the life of the line of credit. As of March 31, 2003, a total of $2,159,000 has been accreted. The amounts charged to interest expense for fiscal 2003 and fiscal 2002 were $1,346,000 and $1,346,000, respectively. 12. GRANT AGREEMENTS During fiscal 1994, the Company signed an agreement with the INI, to open an automated manufacturing plant in Northern Ireland in exchange for capital and revenue grants from the INI. Under the terms of the existing agreements, the Company qualified for and received revenue grants, through March 31, 2003, totaling (pound)969,000 ($1.5 million.) During fiscal 2001, these funds were made available to reduce the cost of labor in Northern Ireland and have been accounted for as a reduction of the labor costs included in the cost of sales. The Company has also qualified for and received capital grants through March 31, 2003 totaling (pound)7,990,000 ($12.6 million). As of March 31, 2003, the Company is not in compliance with certain grant agreement terms and is currently in negotiations with the INI to amend its agreement to be more in line with the business strategy (Note 13). F-15 13. COMMITMENTS AND CONTINGENCIES: LEASES: Total rent expense for the years ended March 31, 2003, 2002 and 2001 was approximately $256,000, $182,000, and $77,000, and respectively. Future minimum payments on leases for years following March 31, 2003 are $83,000 in fiscal year 2004 and none thereafter. WARRANTIES: The Company has established a warranty reserve in connection with the sale of N-Charge(TM) Power Systems covering a warranty period ranging from 12 to 15 months during which time if a customer were to return the purchased product due to a product performance issue, the Company would provide a replacement unit. The Company has established its initial product warranty reserves as 10% of N-Charge(TM) Power System sales. The Company will adjust the percentage based on actual experience for future warranty provisions. In addition, the Company has established a reserve for its 30 day right of return policy under which a customer may return a purchased N-Charge(TM) Power System. The Company has estimated its right of return liability as 5% of the previous month's N-Charge(TM) Power System sales. The total warranty liability as of March 31, 2003 is $123,000. Product warranty liabilities at March 31, 2003 are as follows (in thousands): Beginning balance $0 Less: claims (37) Plus: accruals 160 ------- Ending balance $123 ======= LITIGATION: The Company is subject to various claims and litigation in the normal course of business. In the opinion of management, all pending legal matters are either covered by insurance or, if not insured, will not have a material adverse impact on the Company's consolidated financial statements. GRANTS: Resulting from the reduction of Northern Ireland manufacturing activity at the end of the fiscal year ended March 31, 2001, the employment levels specified by the Industrial Development Board, now the INI, have not been maintained. Consequently, the Company is in default of its agreement with the INI. The INI is not seeking repayment and on the advice of counsel, on the basis that successful negotiations will be concluded, the Company does not believe that the INI will bring any legal action pursuant to the Letter of Offer. The Company has begun discussions with the INI to end the current agreement and enter into a new agreement more closely aligned to current business conditions. Initial discussions with the INI resulted in the INI releasing its potential clawback on $170,000 of capital grants during fiscal 2002. Management believes that it is unlikely that the INI will demand repayment of a portion of the total amounts received, which include revenue grants of $1.5 million and equipment grants of $12.6 million, net of the $170,000 release. For equipment that was disposed of in fiscal 2001, the Company has accrued $1,715,000. LETTER OF CREDIT: At March 31, 2003, the Company had an outstanding stand-by letter of credit of approximately $51,000 secured by a certificate of deposit in a like amount. F-16 14. STOCKHOLDERS' EQUITY (DEFICIT): STOCK OPTIONS AND WARRANTS: The Company has a stock option plan (the "1990 Plan") under which options granted may be incentive stock options or supplemental stock options. Options are to be granted at a price not less than fair market value (incentive options) or 85% of fair market value (supplemental options) on the date of grant. The options vest as determined by the Board of Directors and are generally exercisable over a five-year period. Unvested options are canceled and returned to the 1990 Plan upon an employee's termination. Generally, vested options, not exercised within three months of termination, are also canceled and returned to the Plan. The 1990 Plan terminated on July 17, 2000, and as such options may not be granted after that date. Options granted prior to July 17, 2000 expire no later than ten years from the date of grant. In February 1996, the Board of Directors adopted a stock plan for outside Directors (the "1996 Non-Employee Director's Stock Option Plan"). The plan provides that new directors will receive an initial stock option of 100,000 shares of common stock upon their election to the Board. The exercise price for this initial option will be the fair market value on the day it is granted. This initial option will vest one-fifth on the first and second anniversaries of the grant of the option, and quarterly over the next three years. A director who had not received an option upon becoming a director will receive an initial stock option of 100,000 shares on the date of the adoption of the plan. During fiscal year 2003, no shares were granted under this plan. As of March 31, 2003, a total of 21,260 shares remained available for grant under this plan. In October 1997, the Board of Directors adopted the 1997 Non-Officer Stock Option Plan (the "1997 Plan"). The Company may grant options to non-officer employees and consultants under the 1997 Plan. Options are to be granted at a price not less than fair market value (incentive options) on the date of grant. The options vest as determined by the Board of Directors, generally quarterly over a three-year period. The options expire no later than ten years from the date of grant. Unvested options are canceled and returned to the 1997 Plan upon an employee's termination. Vested options, not exercised within three months of termination, also are canceled and returned to the 1997 Plan. During fiscal year 2003, a total of 1,172,100 shares were granted under this plan. At March 31, 2003, the Company had no 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 nonstatutory stock options to non-employee members of the Board of Directors and consultants under the 2000 Plan. Options are to be granted at a price not less than fair market value on the date of grant. In the case of an incentive stock option granted to an employee who owns stock possessing more than 10% of the total combined voting power of all classes of stock of the Company or any affiliate, the option is to be granted at a price not less than 110% of the fair market value on the date of grant. The options are exercisable as determined by the Board of Directors, generally over a four-year period. The options expire no later than ten years from the date of grant. Unvested options are canceled and returned to the 2000 Plan upon an employee's termination. Vested options, not exercised within three months of termination, also are canceled and returned to the 2000 Plan. During fiscal year 2003, a total of 1,687,852 shares were granted under this plan. At March 31, 2003, the Company had 101,329 shares available for grant under the 2000 Plan. During fiscal 2003, the Company granted inducement options to purchase a total of 300,000 shares of common stock to certain officers of the Company outside of the Company's current stock option plans. These options vest over four years with 25% vesting after the first year with the remainder vesting in 12 equal installments. The options expire ten years from the date of grant. F-17 Aggregate option activity is as follows (shares in thousands): Outstanding Options --------------------------------- Number of Weighted Avg. Shares Exercise Price Balance, March 31, 2000 3,722 $7.20 Granted 1,457 $14.77 Exercised (243) $5.12 Canceled (538) $8.45 --------- Balance, March 31, 2001 4,398 $8.81 ========= ========= Granted 3,683 $5.47 Exercised (39) $4.47 Canceled (1,018) $8.62 --------- Balance, March 31, 2002 7,024 $7.58 ========= ========= Granted 3,160 $1.67 Exercised - $0.00 Canceled (1,264) $6.24 --------- Balance, March 31, 2003 8,920 $5.68 ========= ========= At March 31, 2003, March 31, 2002, and March 30, 2001, vested options to purchase 4,225,000, 2,455,000, and 2,020,000 shares, respectively, were unexercised. The following table summarizes information about fixed stock options outstanding at March 31, 2003 (shares in thousands):
Options Outstanding Options Exercisable ---------------------------------------------------------------------- ----------------------------------- Weighted Average Weighted Weighted Range of Number Remaining Average Number Average Exercise Prices Outstanding Contractual Life (years) Exercise Price Exercisable Exercise Price ---------------- ------------ ---------------------- -------------- ------------ ---------------- ---------------- ------------ ---------------------- -------------- ------------ ---------------- $0.63 - $0.83 198 10.14 $0.67 17 $0.69 $1.30 - $1.94 1,973 9.83 1.48 78 1.57 $2.06 - $2.99 641 9.09 2.30 125 2.33 $3.10 - $4.62 1,158 7.21 4.00 685 4.10 $4.75 - $7.12 3,355 7.15 6.08 2,111 6.01 $7.16 - $10.06 875 7.04 7.84 654 7.81 $11.31 - $15.75 213 7.39 14.00 169 14.29 $17.12 - $23.56 401 7.17 19.48 280 19.62 $29.28 - $34.62 106 6.91 32.80 106 32.80 ------------ ---------------------- -------------- ------------ ---------------- 8,920 7.95 $5.68 4,225 $7.67
At March 31, 2003, the Company has reserved 12,541,000 shares of common stock for the exercise of stock options and warrants. F-18 15. SIGNIFICANT CUSTOMERS: Revenues from three significant customers represented a total of 26% of total revenues for the year ended March 31 2003 and a total of 69% of the trade accounts receivable at March 31, 2003. For fiscal year 2002, six customers represented 83% of total revenues for the year and 65% of trade accounts receivable at March 31, 2002. In fiscal year 2001, five customers represented 98% of total revenues for the year and 95% of trade accounts receivable at March 31, 2001. 16. INCOME TAXES: There was no income tax benefit related to the losses of fiscal years 2003, 2002 or 2001 due to the uncertain ability of the Company 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: F-19 The components of the net deferred tax asset as of March 31, 2003 and March 31, 2002 were as follows (in thousands):
Year Ended: ------------------------------------- March 31, March 31, March 31, 2003 2002 2001 ---------- ----------- ----------- ---------- ----------- ----------- Federal tax benefit at statutory rate (12,886) $ (23,671) $ (14,790) Rate differential - foreign 403 1,324 1,028 State tax provision (435) - - Expenses not deductible for tax 20 31 (351) Research and experimentation credit (175) (285) (268) Provision for prior-year true-ups - - 2,440 Foreign losses not available as carryforward 4,247 7,721 1,476 Change in valuation allowance 8,826 14,880 10,465 ---------- ----------- ----------- ---------- ----------- ----------- Tax provision $ - $ - $ - ========== =========== =========== ========== =========== ===========
The components of the net deferred tax asset as of March 31, 2003 and March 31, 2002 were as follows (in thousands):
March 31, March 31, 2003 2002 ---------- ---------- Current assets: Accrued liabilities $ 185 $ 118 Valuation allowance (185) (118) ---------- ---------- - - ========== ========== Non-current assets: Depreciation and amortization 828 761 Research and experimentation credit carryforwards 1,447 1,272 Net operating loss carryforwards - Federal 51,677 46,406 Net operating loss carryforwards - Foreign 42,132 39,105 Impairment reserve 654 481 Imputed interest 1,207 1,160 Valuation allowance (97,945) (89,185) ---------- ---------- $ - - ========== ==========
At March 31, 2003 the Company had federal net operating loss carryforwards available to reduce future taxable income of approximately $150.7 million. The carryforwards expire between 2007 to 2023, 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 $136.6 million. 17. 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. F-20 18. JOINT VENTURE AGREEMENTS: On November 12, 2002, the Company announced that it had signed an agreement to establish a Chinese joint venture with Baoding Fengfan Group Limited Liability Company ("Fengfan"). The commencement of this venture is subject to standard Chinese government approval. The purpose of the joint venture is to provide low cost manufacturing of the Company's Saphion(TM) Lithium-ion batteries in China. Under the agreement, the Company will contribute capital equipment and engineering expertise. Fengfan will provide the cash required to fund the joint venture for the first two years as well as the land and facility needed for manufacturing operations. There was no activity or financial position for the years ended March 31, 2003, 2002, and 2001. In July 1996, the Company, through its Dutch subsidiary, and Hanil Telecom Co., Ltd. ("Hanil Telecom") signed an agreement to establish a joint venture in Korea. All funds were to be provided to the joint venture by Hanil Telecom. Hanil Telecom and the Company, through its Dutch subsidiary, each held a 50% stake of the company. The Company supplied the technology, initial equipment and product designs and technical support out of its Northern Ireland facility. Hanil Telecom was to market the joint venture's initial products for a period of several years, depending on the market. The Company accounted for the joint venture using the equity method. At March 31, 2001, the joint venture had a net deficit and net loss of approximately $(1,072,000) and $(6,105,000), respectively. The proportionate share of the joint venture's income (losses) was recorded in the statements of operations as non-operating income (loss). The Company discontinued applying the equity method as the investment has been reduced to zero in fiscal 2001. In June 2001, the Company and Hanil Telecom reached an agreement to terminate the joint venture. As conditions of the termination, Shinhan Bank transferred its payment guarantee obligations under a line of credit from the Company to the Company's former joint venture partner and the Company granted a license to an affiliate of Hanil Telecom. In addition, the deferred revenue balance of $2.5 million was offset by approximately $896,000 of accounts receivable and the remaining $1.6 million balance was recorded as license revenue to recognize the license agreement. Following is a summary of the operating results and financial position of the joint venture (in thousands). There was no activity or financial position for the years ended March 31, 2003 and 2002: ------------- Year ended ------------- March 31, 2001 Operations: Net sales $ 257 Net loss $ (6,105) Financial position: Current assets $ 2,315 Noncurrent assets 28,970 ------------- ------------- 31,285 ============= Current liabilities 19,234 Noncurrent liabilities 13,123 Shareholders' deficit (1,072) ------------- $ 31,285 ============= 19. RELATED PARTY TRANSACTIONS: In March 2002, the Company obtained $30 million of additional equity financing commitment with Berg & Berg, an affiliate of Carl Berg, a director and principal shareholder in the Company. The Company's financing commitment with Berg & Berg enables it to access up to $5.0 million per quarter (but no more than $30.0 million in the aggregate) in equity capital over the next two years. This commitment was approved by stockholders at the Company's 2002 annual meeting held on August 27, 2002. In exchange for any amounts funded pursuant to this new agreement, the Company will issue to Berg & Berg restricted common stock at 85% of the average closing price of the Company's common stock over the five trading days prior to the purchase date. The Company will agree to register any shares it issues to Berg & F-21 Berg under this agreement. Berg & Berg's obligation to fund the equity commitment is subject to conditions including, but not limited to, the Company's achievement of operating milestones. As of May 30, 2003, so long as Stephan Godevais remains as CEO, Berg & Berg agreed to waive these conditions to funding. In addition, Berg & Berg has the option to reduce the commitment to the extent the Company enters into a debt or equity financing arrangement with a third party at any time during the term of the commitment. Pursuant to the terms of the commitment, as a result of an offering the Company completed in April 2002, and the draw downs under the commitment of $5.0 million each in September 2002, November 2002, February 2003 and March 2003, Berg & Berg may elect to reduce or eliminate its remaining commitment of $10 million. 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, 2003, amounts of $3,549,134 and $1,612,036 were outstanding under Dawson Note One and Dawson Note Two, respectively, and under each of the Dawson Notes, interest from the Issuance Date accrues on unpaid principal at the rate of 5.69% per annum, or at the maximum rate permissible by law, whichever is less. In accordance with the Dawson Notes, interest is payable annually in arrears and had been unpaid until June 21, 2002. Accrued interest through March 4, 2002 totaled $1,106,705. On June 21, 2002, the accrued interest, through March 4, 2002, was paid in full. Accrued interest through March 4, 2003 totaling $276,676 was paid subsequent to year-end. 20. GEOGRAPHIC INFORMATION: The Company conducts its business in two geographic segments. Long-lived asset information by geographic area at March 31, 2003 and 2002 is as follows (in thousands): 2003 2002 --------- -------- United States $4,930 $5,733 International 19,138 19,672 --------- -------- TOTAL $24,068 $25,405 ========= ======== Revenues by geographic area for the years ended March 31, 2003, 2002 and 2001 are as follows (in thousands): 2003 2002 2001 --------- --------- --------- United States $1,726 $1,876 $5,120 International 831 2,998 3,571 --------- --------- --------- TOTAL $2,557 $4,874 $8,691 ========= ========= ========= F-22 21. QUARTERLY FINANCIAL DATA (UNAUDITED)
1st 2nd 3rd 4th Total Qtr Qtr Qtr Qtr ------------------------------------------------------------------ (Dollars in thousands, except per share amounts) YEAR ENDED MARCH 31, 2003 Revenue $ 509 $ 260 $ 638 $ 1,150 $ 2,557 Operating loss (8,652) (8,689) (7,683) (9,106) (34,130) Net loss available to common stockholders (9,659) (9,613) (8,563) (10,066) (37,901) Basic and diluted EPS(1) (0.19) (0.19) (0.14) (0.13) (.65) YEAR ENDED MARCH 31, 2002 Revenue $2,858 $ 527 $ 1,103 $ 386 $ 4,874 Operating loss (8,587) (9,566) (41,004) (8,038) (67,195) Net loss available to common stockholders (9,141) (10,107) (42,165) (8,207) (69,620) Basic and diluted EPS(1) (0.20) (0.22) (0.93) (0.18) (1.53) ---------- (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.
22. SUBSEQUENT FINANCING: On June 2, 2003, the Company raised $10 million (net proceeds of $9.6 million) through the sale of Series C Convertible preferred stock and warrants to purchase common stock. The preferred stock is convertible into common stock at $4.25 per share, which represents an 11.3% premium over the closing price of the Company's common stock on May 22, 2003. The preferred stock is redeemable by the holder upon maturity and upon the occurrence of certain triggering or default events. Net proceeds from the financing will be used for working capital purposes. On June 10, 2003, Berg & Berg committed to provide the Company an additional $10 million in fiscal 2004. The commitment is conditioned upon negotiation and execution of definitive documents and any necessary shareholder approval under the rules of the NASDAQ SmallCap Market. This issuance will be on competitive terms, which will be finalized as part of the definitive documents. F-23