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BALQON CORP. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis should be read in conjunction with our financial statements and the related notes to financial statements included elsewhere in this report. This report and our financial statements and notes to financial statements contain forward-looking statements, which generally include the plans and objectives of management for future operations, including plans and objectives relating to our future economic performance and our current beliefs regarding revenues we might generate and profits we might earn if we are successful in implementing our business strategies. Our actual results could differ materially from those expressed in these forward-looking statements as a result of any number of factors, including those set forth under the "Risk Factors" section and elsewhere in this report. The forward-looking statements and associated risks may include, relate to or be qualified by other important factors, including, without limitation: · the projected growth or contraction in the industry within which we operate; · our business strategy for expanding, maintaining or contracting our presence in these markets; · anticipated trends in our financial condition and results of operations; · our ability to distinguish ourselves from our current and future competitors; and We do not undertake to update, revise or correct any forward-looking statements. Any of the factors described above, elsewhere in this report or in the "Risk Factors" section of this report could cause our financial results, including our net income or loss or growth in net income or loss to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially. 34 Recent Developments Our financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We do not currently have sufficient liquidity to meet our anticipated working capital, debt service and other liquidity needs in the very near-term. We believe that we have sufficient working capital to continue operations only until approximately August 31, 2013 at the latest unless we successfully restructure our debt, experience a significant improvement in sales and obtain other sources of liquidity. We are in default of $3,361,500 in principal amount of our convertible notes and $365,313 of accrued interest on these notes. Although we are actively pursuing a number of alternatives, including seeking to restructure our debt and seeking to raise additional debt or equity financing, or both, there can be no assurance that we will be successful. If we cannot restructure our debt and obtain sufficient liquidity in the very near term, we may need to seek to protection under the U.S. Bankruptcy Code. See "Risk Factors." During the first three months of 2013, significant portion of our engineering effort has been focused on designing an electric drive system for a six meter bus being jointly developed by us and Sichuan Automotive Group for inner city applications in China. In November 2012, we signed a Joint Development Agreement between our companies and received a purchase order to develop a zero emissions battery-powered inner city six meter bus for the China market. Sichuan Automotive is a leading provider and operator of buses in central China and also manufactures all electric SUV's for the local market. In March 2013, we signed a Memorandum of Understanding with a large port operator in Turkey to develop the electric yard tractor market in Turkey. Under this Agreement, we have agreed to jointly develop a repower kit for diesel yard tractors operated in the region to convert diesel yard tractors to electric yard tractors. In March 2013, we received a purchase order for our electric yard tractor, the Nautilus XRE20, which will be used for testing and evaluation at a port terminal in Turkey. In April 2013, we signed a Memorandum of Understanding with the second largest truck and bus manufacturer in China to integrate our resources to develop electric buses for the China and North American markets. Under the terms of the memorandum of understanding, both companies have agreed to cooperate in developing zero emission battery powered electric bus prototypes for the China and North American markets. Under the terms of the Memorandum of Understanding, we have agreed to be sole the distributor of the resulting products worldwide, while our Chinese partner has agreed to be responsible for all manufacturing and marketing activities in China. Business Overview We are a developer and manufacturer of electric vehicles, drive systems and lithium battery energy storage systems. Our product line includes battery powered heavy-duty on-road trucks and off-highway yard tractors, designed to transport cargo loads of up to 30 tons in short haul applications. We also design, assemble and distribute lithium battery powered energy storage solutions to electric vehicle manufacturers, renewable energy storage providers and industrial equipment manufacturers. Our business strategy leverages our ability to integrate our core technologies, flux vector inverter, BMS, and battery charger into a seamless operating system that provides superior ease-of-use to our customer. We believe continued investment in research and development of electric vehicle, charger and battery system technologies is critical to the sale of innovative products and technologies. As part of our strategy, we plan to partner with solution providers in the solar, wind and renewable energy marketplace to jointly develop product solutions for emerging energy storage markets. We also plan to continue our expansion into the global vehicle market through joint development of electric trucks and buses with OEMs in the emerging markets. Our sales strategy includes expanding our online sales through addition of third party accessories and components related to energy storage markets. We founded Balqon Corporation to develop inverter technology for electric vehicles with focus on heavy duty truck and bus applications. In 2007, we designed and manufactured the world's first battery powered heavy duty electric tractors for use at the Port of Los Angeles to transport 30 ton containers in both off-highway and short haul applications. Our first product, the Nautilus XE20, featured our proprietary drive systems which was comprised of an electric motor, transmission, our proprietary flux vector motor controller (which controls the speed of an electric motor by varying the input frequency and voltage from a vehicle's batteries), power electronic components and proprietary software configured to specific application needs. In 2009, we incorporated lithium batteries to increase range of the tractor to 150 miles on a single charge. Our lithium battery system also featured our proprietary BMS with operating software designed to protect lithium batteries during over-charge and discharge condition. We also developed fast battery charging system for our trucks and tractors to reduce charge time from 8 hours to 2.5 hours. We are the exclusive distributor of lithium batteries manufactured by Winston Battery Limited. Our distribution agreement provides us access to low cost lithium iron phosphate in the sizes varying from 40 amp hour to 1,000 amp hour batteries. Winston Battery Limited is an exclusive developer and manufacturer of high capacity lithium batteries ranging from 400 amp hour to 1,000 amp hour. We develop, manufacture and market lithium battery storage products designed to be direct replacement of lead acid battery systems. 35 Our core technologies of inverters, BMSs, charger, software, operating system and lithium batteries provides us ability to partner with OEMs of fossil fuel based vehicles and lead acid battery based energy storage system manufacturers. Our ability to provide drive systems, battery systems and a battery charger integrated by our proprietary operating system reduces development time and costs for our OEM customers. We have jointly developed heavy duty trucks, tractors and buses with OEMs in Europe, China, India and United States. We believe familiarity with local brands, designs, ergonomics and service network is essential to customers purchase decision. We have made significant investments in integrating our drive systems into third party OEM vehicle platforms, and believe market introduction of these localized vehicle platforms will provide increased sales for our drive systems. Our joint product development efforts have focused on markets with high urbanization and air pollution to provide us the best opportunity for sales. In smaller regional markets we utilize qualified dealer network to promote and service our products. Our products include battery powered electric trucks and tractors: (i) the Nautilus XRE20, a heavy-duty electric yard tractor; (ii) the Nautilus MX30, a heavy-duty, Class 8 electric short-haul tractor; and (iii) the Mule M150, a heavy-duty, Class 8 electric inner city delivery truck. We also market and sell lithium battery cells and storage solutions under the brand name of HIQAP™. We sell our trucks and tractors through direct sales force and dealers, while our battery related products and accessories are marketed through our online store and retailers of energy storage products. In 2012, we developed high energy capacity lithium battery energy storage systems for the solar, wind and telecommunication industry. We also developed lead acid replacement packs for baggage tractors used at airports and industrial warehouses. In 2012, we received purchase order for electric drive systems from a European manufacturer of yard tractors, located in the Netherlands. In 2012, our OEM partners in Europe (Belgium and the Netherlands) introduced two new products to the market, showcasing our electric drive system. In 2012, significant resources were allocated to the development of our on-road heavy-duty electric tractor, the Nautilus MX30. Currently, this vehicle is undergoing on-road testing and complies with DOT regulations for on-road Class 8 tractors. Our development activities also resulted in the receipt of a grant from the AQMD for the development of three additional tractors for testing at Port of Los Angeles. In 2012, we signed a Joint Development Agreement with the fifth largest bus manufacturer in China to develop all electric inner city bus. Critical Accounting Policies Our financial statements have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis of making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe that the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our financial statements: 36 Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Material estimates relate to the recognition of contract revenues and estimated costs to complete contracts in process, and recoverability of reported amounts of long-lived assets. Actual results may differ from those estimates. Revenues Sales of Production Units and Parts. We recognize revenue from the sale of completed production units and parts when there is persuasive evidence that an arrangement exists, delivery of the product has occurred and title has passed, the selling price is both fixed and determinable, and collectability is reasonably assured, all of which generally occurs upon shipment of our product or delivery of the product to the destination specified by the customer. We determine whether delivery has occurred based on when title transfers and the risks and rewards of ownership have transferred to the buyer, which usually occurs when we place the products with the buyer's carrier. We regularly review our customers' financial positions to ensure that collectability is reasonably assured. Except for warranties, we have no post-sales obligations. Contract Revenue and Cost Recognition on Prototype Vehicles. In accounting for contracts, we recognize revenues using the percentage-of-completion method of accounting by relating contract costs incurred to date to the total estimated costs at completion. This method is used because management considers costs to be the best available measure of progress on its contracts. Contract losses are provided for in their entirety in the period that they become known, without regard to the percentage-of-completion. We also recognize as revenues costs associated with claims and unapproved change orders to the extent it is probable that such claims and change orders will result in additional contract revenue, and the amount of such additional revenue can be reliably estimated. Contract costs include all direct material and labor costs. The liability "Billings in excess of costs and estimated earnings on uncompleted contracts" represents billings in excess of revenues earned. Stock-Based Compensation We periodically issue stock instruments, including shares of our common stock, stock options, and warrants to purchase shares of our common stock to employees and non-employees in non-capital raising transactions for services and for financing costs. We account for stock option awards issued and vesting to employees in accordance with authorization guidance of the Financial Accounting Standards Board, or FASB, where the value of stock-based compensation is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period. Options to purchase shares of our common stock vest and expire according to the terms established at the grant date. We account for stock options and warrant grants issued and vesting to non-employees in accordance with the authoritative guidance of the FASB whereas the value of the stock compensation is based upon the measurement date as determined at either (a) the date at which a performance commitment is reached, or (b) at the date at which the necessary performance to earn the equity instruments is complete. 37 We estimate the fair value of stock options and warrants using the Black-Scholes Merton option-pricing model, which was developed for use in estimating the fair value of options that have no vesting restrictions and are fully transferable. This model requires the input of subjective assumptions, including the expected price volatility of the underlying stock and the expected life of stock options. Projected data related to the expected volatility of stock options is based on the average volatility of the trading prices of comparable companies and the expected life of stock options is based upon the average term and vesting schedules of the options. Changes in these subjective assumptions can materially affect the fair value of the estimate, and therefore the existing valuation models do not provide a precise measure of the fair value of our employee stock options. We estimate the fair value of shares of common stock issued for services based on the closing price of our common stock on the date shares are granted. Derivative Financial Instruments We evaluate all of our financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the statements of operations. For stock-based derivative financial instruments, through June 30, 2012 we used the Monte Carlo simulation model to value the derivative instruments at inception and on subsequent valuation dates as of December 31, 2012, the derivative liabilities were valued using a probability weighted average Black Scholes pricing model. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date. Goodwill and Intangible Assets Management performs impairment tests of goodwill and indefinite-lived intangible assets whenever an event occurs or circumstances change that indicate impairment has more likely than not occurred. Management performs impairment testing of goodwill and indefinite-lived intangible assets at least annually. Management tests goodwill for impairment at the reporting unit level. We only have one reporting unit. At the time of goodwill impairment testing, management determines fair value through the use of a discounted cash flow valuation model incorporating discount rates commensurate with the risks involved with its reporting unit. If the calculated fair value is less than the current carrying value, impairment may exist. The use of a discounted cash flow valuation model to determine estimated fair value is common practice in impairment testing in the absence of available domestic and international transactional market evidence to determine the fair value. The key assumptions used in the discounted cash flow valuation model for impairment testing include discount rates, growth rates, cash flow projections and terminal value rates. Discount rates are set by using the Weighted Average Cost of Capital, or WACC, methodology. The WACC methodology considers market and industry data as well as Balqon-specific risk factors for each reporting unit in determining the appropriate discount rates to be used. The discount rate utilized is indicative of the return an investor would expect to receive for investing in such a business. Operational management, considering industry and Balqon-specific historical and projected data, develops growth rates and cash flow projections for Balqon. Terminal value rate determination follows common methodology of capturing the present value of perpetual cash flow estimates beyond the last projected period assuming a constant WACC and low long-term growth rates. As an indicator that each reporting unit has been valued appropriately through the use of the discounted cash flow valuation model, the aggregate fair value of all reporting units is reconciled to our total market capitalization. 38 We review intangible assets subject to amortization at least annually to determine if any adverse conditions exist or a change in circumstances has occurred that would indicate impairment or a change in the remaining useful life. If the carrying value of an asset exceeds its undiscounted cash flows, we write-down the carrying value of the intangible asset to its fair value in the period identified. If the carrying value of assets is determined not to be recoverable, we record an impairment loss equal to the excess of the carrying value over the fair value of the assets. Our estimate of fair value is based on the best information available to us, in the absence of quoted market prices. We generally calculate fair value as the present value of estimated future cash flows that we expect to generate from the asset using a discounted cash flow income approach as described above. If the estimate of an intangible asset's remaining useful life is changed, we amortize the remaining carrying value of the intangible asset prospectively over the revised remaining useful life. During the year ended December 31, 2011, we determined that the value of our intangible asset related to the Distribution Agreement with SOL, a related party, was impaired (See Note 4) of our financial statements included elsewhere in this report). Accordingly, the Company recorded an impairment loss of $935,583 for the unamortized value of the Distribution Agreement as of December 31, 2011. During the year ended December 31, 2012, we determined that the value of our intangible asset recorded in connection with the acquisition of substantially all of the assets of EMS was impaired. Accordingly, we recorded an impairment loss of $166,500 for the unamortized value of the EMS acquisition as of December 31, 2012. Impairment of Long-Lived Assets The FASB, has established guidelines regarding when impairment losses on long-lived assets, which include property and equipment, should be recognized and how impairment losses should be measured. Guidance of the FASB also provides a single accounting model for long-lived assets to be disposed of and significantly changes the criteria that would have to be met to classify an asset as held-for-sale. We periodically review, at least annually, such assets for possible impairment and expected losses. If any losses are determined to exist they are recorded in the period when such impairment is determined. Based upon management's assessment, there were no indicators of impairment of our long lived assets at December 31, 2011 or December 31, 2012. Income Taxes We recognize income taxes for the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets are recognized for the future tax consequences of transactions that have been recognized in our financial statements or tax returns. A valuation allowance is provided when it is more likely than not that some portion or the entire deferred tax asset will not be realized. Financial Condition and Results of Operations Our total revenues decreased by $33,805, or 2%, to $2,100,526 for the year ended December 31, 2012 as compared to $2,134,331 for the year ended December 31, 2011. The decrease in revenues was a result of lower sales of electric yard tractors when compared to the prior year. Gross profit (loss) during the year ended 2012 was ($1,366,569), which represents a decrease of $1,915,583, or (349%), from 2011. The loss is primarily due to a $350,000 sale of batteries to a wholesale customer at a loss and the markdown of $996,214 of non-recoverable inventories. Our decision to sell a particular configuration of batteries to a wholesale customer was prompted by our desire to reduce inventory and generate cash for operations. 39 We reported a net loss of $6,046,611 for 2012 as compared to a net loss of $7,056,212 for 2011, a decrease of $1,009,601. Losses from operations as a percentage of sales during 2012 were 288%, as compared to losses from operations as a percentage of sales of 331% during 2011. The decreases in losses during 2012 are attributable to decreases in general and administrative expenses of $1,541,440 as well as a decrease in research and development costs of $297,047. Our product mix during the 2012 has changed from our product mix during 2011. We attribute this change to an increased focus on battery and energy storage system sales. Sales of our electric drive systems accounted for 14% of our total sales during 2012 as compared to 66% of total sales 2011. During 2012, our sales of vehicles and parts accounted for 31% of our total sales, while during 2011, our sales of vehicles and parts accounted for 20% of total sales. As of December 31, 2012, we had a working capital deficit of $8,813,025, an accumulated deficit of $28,441,716 and reported a net loss for the year ended December 31, 2012 of $6,046,611. Our plans for correcting these deficiencies include the future sales of our products and technologies and the raising of capital, which we expect will help provide us with the liquidity necessary to meet operating expenses. Over the longer-term, we plan to achieve profitability through the sale of our drive systems, electric vehicles, lithium batteriesand energy storage systems. As of May 30, 2013, we had a backlog of $1,724,594. The amount of backlog orders represents revenue that we anticipate recognizing in the future, as evidenced by purchase orders and other purchase commitments received from customers, but on which work has not yet been initiated or with respect to which work is currently in progress. As of the date of this report, 39% of our backlog consists of vehicles, 8% consists of a drive system, 41% consists of a battery and energy storage system, 6% consists of batteries and the remainder consists of inverters and accessories. As of the date of this report, 74 % of our backlog consists of U.S. customers, while 26% of our backlog consists of international customers. Our backlog does not reflect a $975,000 Department of Energy grant awarded to us, which we are awaiting contract documents. Due to the delay in testing and approval of our drive system, we also have not included $15.9 million in drive systems in our backlog until such time we have assurances on production timelines from our customer, WGE, an affiliate of our Chairman of the Board. We believe that the majority of our current backlog will be shipped within the next 12 months. However, there can be no assurance that we will be successful in fulfilling such orders and commitments in a timely manner or that we will ultimately recognize as revenue the amounts reflected as backlog. We anticipate that our future sales will be more diversified than in previous years. We believe future sales will reflect our focus on energy storage systems and battery sales to OEMs. We believe our strategic relationships with OEMs in Europe and Asia will result in additional sales for our electric drive systems. The tables presented below, which compare our results of operations for 2012 and 2011, presents the results for each period, the change in those results from one period to another in both dollars and percentage change, and the results for each period as a percentage of net revenues. The columns present the following: · The first two data columns in each table show the absolute results for each period presented. · The columns entitled "Dollar Variance" and "Percentage Variance" shows the change in results, both in dollars and percentages. These two columns show favorable changes as a positive and unfavorable changes as negative. For example, when our net revenues increase from one period to the next, that change is shown as a positive number in both columns. Conversely, when expenses increase from one period to the next, that change is shown as a negative in both columns. · The last two columns in each table show the results for each period as a percentage of net revenues. 40 Results as a Percentage of Net Revenues for the Year Ended Dollar Percentage Years Ended December 31, Variance Variance December 31, Favorable Favorable 2012 2011 (Unfavorable) (Unfavorable) 2012 2011 Net revenues $ 2,100,526 $ 2,134,331 $ (33,805 ) (2% ) 100% 100% Cost of revenues 2,470,881 1,585,317 (885,564 ) (56% ) 118% 74% Write down of inventory 996,214 - (996,214 ) (100% ) 47% 0% Gross profit (1,366,569 ) 549,014 (1,915,583 ) (349% ) (65% ) 26% General & administrative expenses 2,497,347 4,038,787 1,541,440 38% 119% 189% Research & development 258,792 555,839 297,047 53% 12% 26% Depreciation & amortization 29,706 568,491 538,785 95% 1% 27% Financing costs (671,809 ) - (671,809 ) (100% ) (32% ) -% Change in derivative liability 795,091 (279,690 ) 1,074,781 (384% ) 38% (13% ) Impairment Loss 166,500 (935,583 ) 769,083 82% 8% (44% ) Interest expense 1,850,979 1,786,216 (64,763 ) (4% ) 88% 84% Net Loss $ (6,046,611 ) $ (7,056,212 ) $ 1,009,602 14% (288% ) (331% ) Net Revenues. Our net revenues in 2012 decreased by $33,805 or 2%, to $2,100,526 f as compared to $2,134,331 for 2011. The decrease in net revenues was mainly attributable to slowdown in vehicle sales caused due to lack of federal government incentives and lack of working capital to promote new products related to energy storage systems. Write-down of non-recoverable inventories. The write-down of non-recoverable inventories of $996,214 in 2012 is attributable to the write-down charges of $257,214 attributable to inventory and $739,000 attributable to the equipment inventory held for lease by customer under an agreement with T&K Logistics. During the fourth quarter of 2012, we determined these assets were non-recoverable and recorded the corresponding write-down of non-recoverable inventories. Gross Profit. Gross profit (loss) during 2012 was ($1,366,569), down $1,915,583 or 349%, from 2011. Our loss was mainly attributable to the sale of $350,000 of batteries to a wholesale customer at a loss and the write-down of $996,214 of non-recoverable inventories. Our lack of liquidity attributed to sales of excess inventory of electric drive systems and batteries at below costs to fund working capital needs. General & Administrative Expenses. General and administrative expenses decreased by $1,541,440 or 38% in 2012 as compared to 2011. In 2012, the slowdown in domestic sales required us to restructure our organization to reduce these expenses. This decrease is attributable to a $420,742 decrease in marketing and sales expenses, a $155,698 decrease in legal expenses, a $472,063 decrease in unapplied overhead, a decrease of $194,894 in consulting fees and a $298,043 net decrease in other general and administrative expenses. Our general and administrative expenses are expected to be lower as a percentage of net revenues as we increase our net revenues. We expect that our continued restructuring of our general and administrative expenses combined with diversified growth of electric vehicles and energy storage systems, is expected to reduce our general and administrative costs as a percentage of revenue. However, lack of liquidity and working capital is expected to reduce our gross margins as we continue to reduce our inventory of vehicles and batteries. 41 Research & Development Expenses. Our research and development expenses for 2012 and 2011 were $258,792 and $555,839, respectively. The decrease in research and development expenses of $297,047 in 2012 is attributable to a decrease of $264,692 in salaries for personnel in the research & development department, a decrease of $32,356 of experimental supplies and materials. Depreciation and Amortization. . During 2012 our depreciation and amortization expenses decreased by $538,785, largely due to impairment and loss of goodwill of $935,583 related to Distribution Agreement during the year ended December 31, 2011. Private Placement Costs. During 2012, we incurred $671,809 of private placement costs relating to the issuance of certain of our convertible notes and warrants. Change in derivative liability. During 2011, the fair value of our derivatives decreased by $279,690. During 2012, we incurred non-cash costs of $966,279 relating to a derivative liability created upon issuance of certain of our convertible notes and warrants. At December 31, 2012, the fair value of our derivatives decreased by $795,091 resulting in a gain on the change in fair value of the derivative liability. This change in derivative liability is a non-cash benefit reported on the statements of operations. Impairment Loss. During the year ended December 31, 2012, we incurred an impairment loss of goodwill of $166,500. We recorded a $935,583 impairment loss related to our battery Distribution Agreement during the year ended December 31, 2011. The amount recorded as impairment loss represents the unamortized value of the intangible asset as of December 31, 2011. Interest Expenses. The increase of $64,763 in interest expense during 2012 was partly due to a $340,000 of secured debt borrowing that incurred in March 2012. Interest expense also increased due to increases in amortization of the beneficial conversion feature interest cost incurred on our convertible notes and warrants. Liquidity and Capital Resources Our financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We do not currently have sufficient liquidity to meet our anticipated working capital, debt service and other liquidity needs in the very near-term. We believe that we have sufficient working capital to continue operations only until approximately August 31, 2013 at the latest unless we successfully restructure our debt, experience a significant improvement in sales and obtain other sources of liquidity. We are in default on $3,361,500 in principal amount of our convertible notes and in default on $365,313 of accrued interest on these notes. We are also delinquent on $307,619 of payroll taxes. Although we are actively pursuing a number of alternatives, including seeking to restructure our debt and seeking to raise additional debt or equity financing, or both, there can be no assurance that we will be successful. If we cannot restructure our debt and obtain sufficient liquidity in the very near term, we may need to seek to protection under the U.S. Bankruptcy Code. See "Risk Factors." For the twelve months ended December 31, 2012, we recorded a net loss of $6,046,611. During 2012, we funded our operations from cash provided from operations, the issuance of Secured Subordinated Convertible Promissory Notes in an aggregate amount of $340,000. In addition we used proceeds from sale of batteries consigned to us by SOL, a related party, and deferred payment of $1,308,862 to fund working capital needs. During 2011, we funded our operations primarily with cash from financing activities, which included the issuance of secured and unsecured debt and the issuance of equity securities. As of December 31, 2012, we had a working capital deficiency of $8,813,025 as compared to a working capital deficiency of $4,241,177 at December 31, 2011. At December 31, 2012 and 2011 we had an accumulated deficit of $28,441,716 and $22,395,105, respectively, and cash and cash equivalents of $33,869 and $32,663, respectively. 42 During 2009, under the terms of the City of Los Angeles Agreement, we requested and were issued an advance payment in the amount of $1,159,601 from the City of Los Angeles. During June 2012, we billed $630,000 to the City of Los Angeles to upgrade six of the electric trucks previously delivered to from lead acid batteries to lithium ion batteries. This billed amount was applied as a reduction of the advance payment leaving an unpaid balance of $529,601 on this advance. Our agreement with City of Los Angeles has been terminated, to the extent that we do not receive additional purchases from City of Los Angeles for the remaining balance due, we may be required to return the unpaid balance to City of Los Angeles. We anticipate selling additional products and services during the next 12 months to reduce the unpaid balance; however we presently do not have the funds to pay this advance if payment is requested by the Cityof Los Angeles. Our available capital resources at December 31, 2012 consisted primarily of approximately $33,869 in cash and cash equivalents. We expect that our future available capital resources will consist primarily of cash on hand, sale of consigned batteries, cash generated from our business, if any, and future debt and/or equity financings, if any. Cash used in operating activities in 2012 was $93,778 compared to $5,226,096 in 2011. For 2012, cash used in operating activities included a net loss of $6,046,611, amortization of note discount of $1,519,605, the fair value of warrants issued upon conversion of common stock of $671,809, reduction in the fair value of derivative liabilities of $795,091, write down of non-recoverable inventory of $996,214, and the loss on goodwill impairment of $166,500. Material changes in asset and liabilities at December 31, 2012 as compared to December 31, 2011 that affected these results include: · a decrease in accounts receivable of $788,089; · a decrease in inventory of $542,372; · a net increase in accounts payable and accrued expenses of $2,225,043, of which $1,308,862 was an increase in related party accounts payable; and · a decrease of $573,528 in customer deposits. Cash provided by financing activities totaled $94,984 for 2012 as compared to $881,896 for 2011. Between February 2010 and April 2010, we entered into agreements with 11 accredited investors for the sale by us of an aggregate of $1,500,000 of 10% Unsecured Subordinated Convertible Promissory Notes which were initially convertible into an aggregate of 1,999,993 shares of our common stock at a conversion price of $0.75 per share of common stock, subject to adjustment. Additionally, we issued to these investors three-year warrants to purchase an aggregate of 1,999,993 shares of common stock. Between July 2010 and December 2010, we raised an aggregate of $850,000 through the issuance of senior secured convertible debentures to 26 accredited investors. The senior secured convertible debentures are secured by a security interest in all of our personal property (subject to customary exceptions) and were initially convertible into shares of our common stock at an initial conversion price of $0.75 per share (subject to adjustment). In connection with this offering, we also issued five-year warrants to purchase an aggregate of 850,000 shares of our common stock at an initial exercise price of $0.75 per share (subject to adjustment). Under the adjustment provisions of the senior secured convertible debentures and warrants, the conversion price of the senior secured convertible debentures and the exercise price of the warrants were reduced to $0.64 in connection with a private placement of our common stock and warrants in December 2010. The terms of the senior secured convertible debentures include a restriction on our ability to pay dividends on our common stock. 43 In December 2010, we raised $5,000,000 through the issuance of 7,812,500 shares of our common stock and a five-year warrant to purchase up to 7,812,500 shares of our common stock at an exercise price of $0.64 per share. In 2011, we raised $148,666 in connection with the issuance of 283,332 shares of our common stock upon the exercise of warrants. On May 18, 2012, we entered into agreements with 3 accredited investors for a sale by us of an aggregate of $340,000 10% Secured Subordinated Convertible Promissory Notes (the "May 2012 Notes") which are convertible into an aggregate of 850,000 shares of our common stock at a conversion price of $0.40 per share of common stock, subject to adjustment. The notes were due on March 31, 2013 and are subordinated to the right to the prior payment of all Senior Indebtedness (as defined in the notes). The security agreement is subordinate to existing bank financing and the Debentures (as defined below) that currently have a principle balance due of $775,000 and the Amended Notes that currently have a balance due of $891,500. Additionally, we issued three-year warrants to purchase an aggregate of 340,000 shares of our common stock at an exercise price of $0.40 per share, subject to adjustment. As of December 31, 2011, Mr. Winston Chung, our Chairman of the Board, had advanced $500,000 to Balqon. The advance received were non-interest bearing, and with no other defined terms. As of December 31, 2011, Mr. Chung also held warrants to acquire 7,812,500 shares of our common stock at an exercise price of $0.64 per share. The warrants were vested and have a 5-year term or an expiration date on December 30, 2015. Effective March 31, 2012, we, Mr. Chung and SOL, a company related to the Chairman by common ownership, entered into an agreement whereby the exercise price of certain warrants held by SOL were reduced to $0.40 per share. Due to the modification of the exercise price, during the year ended December 31, 2012 we recognized a cost to induce conversion of $225,000 relating to the additional 468,750 shares that would be issued under the modified exercise price. SOL then elected to exercise the warrants to acquire 1,250,000 shares of common stock at a price of $0.40 for which we issued 1,250,000 shares of our common stock to SOL. In consideration of the exercise of the warrants, Mr. Chung agreed to cancel the $500,000 owed to him. We recognized a cost of $446,809, which represents the incremental fair value of the warrants after modification and was reflected as financing cost. Effective February 18, 2009, we entered into a Business Financing Agreement with Bridge Bank, National Association, or Bridge Bank Agreement. The Bridge Bank Agreement, as amended to date, provides us with an accounts receivable based credit facility in the aggregate amount of up to $2,000,000.In 2012, we cancelled the Business Financing Agreement with Bridge Bank. As of December 31, 2012, there was no outstanding balance under the credit facility. We believe that we presently have sufficient plant and production equipment to meet our current operational plan and we do not intend to dispose of any plant and equipment. We presently have 10 employees on a full-time basis and 2 employees on a part-time basis, and expect to hire additional personnel pursuant to increase in market demand. Our present staff is sufficient to meet our current operational plan for 2013. 44 Although, we expect sale of consigned batteries and completion and delivery of the products in our backlog will provide us with additional liquidity and capital resources, we believe that we will need additional liquidity and capital resources through debt and/or equity financing to complete our entire existing and anticipated future product backlog. As discussed in this report and in notes to our financial statements included in this report, we have suffered recurring losses from operations and at December 31, 2012, we had an accumulated deficiency of $28,441,716 and a working capital deficiency of $8,813,025 These factors, among others, raise substantial doubt about our ability to continue as a going concern. As a result, our independent registered public accounting firm, in its report on our 2012 financial statements, has raised substantial doubt about our ability to continue as a going concern. The financial statements do not include any adjustments that might be necessary should we be unable to continue as a going concern. We have been, and currently are, working towards identifying and obtaining new sources of financing. No assurances can be given that we will be successful in obtaining additional financing in the future. Any future financing that we may obtain may cause significant dilution to existing stockholders. Any debt financing or other financing of securities senior to common stock that we are able to obtain will likely include financial and other covenants that will restrict the our flexibility. At a minimum, we expect these covenants to include restrictions on our ability to pay dividends on our common stock. Any failure to comply with these covenants would have a material adverse effect on our business, prospects, financial condition, results of operations and cash flows. In addition, our senior secured convertible debentures issued between July and December 2010 contain covenants that include restrictions on our ability to pay dividends on our common stock. If adequate funds are not available, we may be required to delay, scale back or eliminate portions of our operations and product and service development efforts or to obtain funds through arrangements with strategic partners or others that may require us to relinquish rights to certain of our technologies or potential products or other assets. Accordingly, the inability to obtain such financing could result in a significant loss of ownership and/or control of our proprietary technology and other important assets and could also adversely affect our ability to fund our continued operations and our product and service development efforts. Backlog As of May 30, 2013, we had a backlog of $1,724,594. The amount of backlog orders represents revenue that we anticipate recognizing in the future, as evidenced by purchase orders and other purchase commitments received from customers, but on which work has not yet been initiated or with respect to which work is currently in progress. As of the date of this report, 39% of our backlog consists of vehicles, 8% consists of a drive system, 41% consists of a battery and energy storage system, 6% consists of batteries and the remainder consists of inverters and accessories. As of the date of this report, 74 % of our backlog consists of U.S. customers, while 26% of our backlog consists of international customers. We believe that the majority of our current backlog will be shipped within the next 12 months. However, there can be no assurance that we will be successful in fulfilling such orders and commitments in a timely manner or that we will ultimately recognize as revenue the amounts reflected as backlog. In 2011 and 2012 we made significant investments in developing new products with our OEM partners and diversifying our market strategy to participate in lithium battery and energy storage system markets. We believe our strategy reduces our growth risk and provides us with additional flexibility during economic downturns and positions us for a more sustainable growth in the future. We rely on our OEM partners to market completed products in the regions assigned, with three of our four OEM partners completing prototypes during 2012 provides us with a better opportunity to sell additional electric drive systems during 2013. In domestic markets, we believe that increased restrictions on diesel trucks combined with government incentives for heavy-duty tractors may contribute to higher sales for our heavy-duty trucks and tractors. In the lithium battery market segment, we believe we have a significant cost advantage over our competitors. Although our competitors are substantially larger than us, we believe our low cost and technical support capabilities provide us an advantage in this growth market. 45 Effects of Inflation The impact of inflation and changing prices has not been significant on the financial condition or results of operations of our company. Impacts of New Accounting Pronouncements There are recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants ("AICPA"), and the SEC, however these are not believed by management to have a material impact on our present or future financial statements. |