SatCon Technology 10-K 2005
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR
For the Fiscal Year Ended September 30, 2005
Commission file number 1-11512
SATCON TECHNOLOGY CORPORATION
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Class
Common Stock, $.01 Par Value
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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 o
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 registrants 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. x
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Act Rule 12b-2 of the Act). Yes o No x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The aggregate market value of the Registrants Common Stock, $.01 par value per share, held by non-affiliates of the Registrant was $50,065,563 based on the last reported sale price of the Registrants Common Stock on the Nasdaq National Market as of the close of business on the last business day of the Registrants most recently completed second fiscal quarter ($1.67). There were 38,382,707 shares of Common Stock outstanding as of December 15, 2005.
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Registrants Proxy Statement for its 2006 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.
This Annual Report on Form 10-K contains or incorporates forward-looking statements within the meaning of section 27A of the Securities Act of 1933 and section 21E of the Securities Act of 1934. You can identify these forwad-looking statements by our use of the words believes, anticipates, plans, expects, may, will, intends, estimates, and similar expressions, whether in the negative or in the affirmative. The forward-looking statements contained in this Annual Report are generally located in the material set forth under the headings Item 1. Business and Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations, but may be found in other locations as well. Although we believe that these forward-looking statements reasonably reflect our plans, intentions and expectations disclosed in the forward-looking statements, our actual results could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. We have included important factors in the cautionary statements under the heading Risk Factors under Item 1A that we believe could cause our actual results to differ materially from the forward-looking statements that we make. We do not intend to update information contained in any forward-looking statements we make.
SatCon Technology Corporation designs and manufactures enabling technologies and products for electrical power conversion and control for high-performance, high-efficiency applications in large, growth markets such as alternative energy, hybrid electric vehicles, distributed power generation, power quality, semiconductor fabrication capital equipment, industrial motors and drives, and high reliability defense electronics.
On August 15, 2005, the Company sold 4,676,151 shares of Common Stock to accredited investors for proceeds of approximately $5.3 million, net of transaction costs. As part of this financing the Company also issued warrants to purchase up to 1,169,038 shares of Common Stock. These warrants have an exercise price of $1.99 per share, are immediately exercisable and expire on August 2, 2010.
On November 21, 2005, we entered into a Second Loan Modification and Security Agreement (the Second Loan Modification Agreement) with Silicon Valley Bank (the Bank), The Second Loan Modification Agreement modifies the Loan and Security Agreement, dated as of January 31, 2005, between the parties, as previously amended by the Loan Modification Agreement, dated as of May 31, 2005 (as amended, the Loan Agreement). Under the Second Loan Modification Agreement, the Bank modified the terms related to the collection of receivables for amounts outstanding under the Loan Agreement, as well as the minimum tangible net worth covenant, as defined, which we must maintain in order to continue to borrow from the Bank. The Bank also provided waivers for our failure to comply with the minimum tangible net worth requirements as of August 6, 2005 and September 30, 2005. In addition, the Second Loan Modification Agreement provides the ability to borrow up to $3,000,000 on a revolver basis paying only interest provided that we remain in compliance with all financial covenants, as defined. The Second Loan Modification Agreement will expire on January 30, 2006.
On December 13, 2005, we sold our shaker and amplifier product lines, and the associated inventory and intellectual property to Qualmark, Inc., for proceeds of approximately $2.3 million. We will account for the sale of these assets in the first fiscal quarter of 2006.
From inception in 1985, through the early 1990s, we were primarily funded through research and development contracts with the U.S. government. These contracts were directed at developing new technologies in motion control, control software and electronics. Through this work, we built an engineering base in magnetics, motor and motor drive technology, digital signal processing and high-speed electronics. In the 1990s, we expanded that base through commercially funded research and development to include design and packaging of high-power electronics, high reliability electronic components and advanced materials. These engineering skills form the technical basis of our business. Since the mid 1990s, through a combination of internal product development and targeted acquisitions, we have leveraged our core technical capabilities into product manufacturing. Our products include: commercial high power conversion and control systems for alternative energy applications, a variety of advanced power control systems for hybrid electric vehicles, commercial motors including motors for hybrid electric vehicles, high power level rotary uninterruptible power supplies for applications requiring very high quality sustainable power, specialty magnetically levitated products for semiconductor material fabrication, and microelectronics primarily used in high reliability defense applications.
In January 1997, we acquired our MagMotor division, a manufacturer of custom and standard electric motors. In April 1997, we acquired Film Microelectronics, Inc., a manufacturer of thin film substrates and custom hybrid microelectronics. In January 1999, we acquired Inductive Components, Inc., a value-added supplier of customized electric motors. In April 1999 we acquired HyComp, Inc., a manufacturer of hybrid microelectronics, followed in October 1999 by Ling Electronics, Inc., a manufacturer of shaker vibration test and measurement systems, power converters, amplifiers and controllers. In November 1999, we acquired intellectual property, tooling, engineers and technicians and other assets from Northrop Grumman Corporation applicable to power electronics and hybrid electric vehicles. In July 2001, we acquired most of the assets of Inverpower Controls, Ltd., a manufacturer of power electronics and high-speed digital controls for use in industrial power and power quality systems. The acquisition included Inverpowers UL and CE certification capability. In September 2002, we acquired the machinery, inventory, backlog and intellectual property of Sipex Corporations hybrid assembly operations that supply product to the defense and aerospace industry. These acquisitions have provided us with increased revenues, a manufacturing capability to transition our technology into commercial products, and an expanded customer base.
Since 1996, our revenue has increased from $9.4 million, primarily from funded research and development, to $36.0 million in 2005, of which $29.9 million, or 83%, was derived from product sales with the balance from funded research and development.
In fiscal year 2005 we recognized the growth potential in two important future market areas: alternative energy and hybrid electric vehicles.
We believe that the fastest growth area for SatCon involves alternative energy and distributed power generation. We sell high power inverters for stationary fuel cell power plants and solar (photo-voltaic) power installations. In almost all cases the electricity produced by alternative energy technology requires an inverter to transform the power produced into usable AC electrical power compatible with typical household and commercial appliances. In this fast emerging market in 2005 we improved our products, added new product offerings for wind power generation and technology for connecting to the existing utility grid connection and increased our business development activities. These efforts have resulted in 118% growth in sales to over $6 million from that of fiscal 2004.
SatCon has had extensive experience since the mid 1990s in advanced technology applicable to hybrid electric vehicles, or HEVs, and holds significant intellectual property in this area. In fiscal 2005, we generated motor and DC-DC converter sales in a segment of the HEV market associated with fleets of delivery vans. The HEV market is developing rapidly and SatCon has technology and manufacturing and outsourcing capability to expand sales into very high annual volume levels of motors, controllers and converters. And, SatCon continues to develop new HEV electrical and electronic technology that will be suitable for a variety of future vehicle types. HEV motors and electronics are a principal focus for our future plans.
In fiscal year 2005, we delivered a high-power, 2.2 megawatt, Rotary Uninterruptible Power Supply (RUPS) to the National Institute of Standards and Technology. This RUPS system provides enough power to keep a small factory on-line in the event of a power outage. We also combined several of the RUPS components into a Rotary Ride Through Device concept which upgrades a customers ability to survive an outage without interruption by simply combining with a customers already installed generator set. We used our expertise in packaging high power electronics to design and prototype Power Control Modules for use in the U.S. Navys future DDX program for all-electric ships. We also completed the development and prototyping of an integrated power system involving unique packaging challenges for the U.S. Navys OASIS, helicopter deployed, minesweeping system. In addition, we began the development of new high reliability microelectronic products for space and avionics applications and continued the robust sales of our magnetically levitated systems for the rapid thermal processing of semi-conductor wafers. We participated in several defense related development programs through our Small Business Innovative Research (SBIRs) projects, our Cooperative Agreement with the Army Research Laboratory and as a sub-contractor to prime contractors such as General Atomics, General Dynamics and the Electric Boat Corporation.
Our products are described in more detail under Products by Business Segment.
In fiscal year 2005, we initiated additional efforts to contain operating costs, improve our cash position and continue our efforts initiated in fiscal 2004 to move toward profitability. We made several key management changes. We reduced outside services costs. In December 2004 and August 2005 we raised cash through a financing transaction, discussed above under Recent Developments. See also Note J to the notes to the Consolidated Financial Statements included in the Annual Report on form 10-K regarding our fiscal year 2005 financing transactions. We initiated and progressed actions on schedule to demonstrate full compliance with Section 404 of the Sarbanes-Oxley Act well in advance of the required deadline. In fiscal year 2006 we are placing additional emphasis on business development.
Revenues for our fiscal years ending September 30, 2005, 2004 and 2003 were $36.0 million, $34.2 million and $26.9 million, respectively. Of those revenues, $3.4 million, $3.7 million and $3.3 million, respectively, were realized from international sales.
Our web site is www.satcon.com. We make available on this site our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon
as reasonably practicable after such reports are electronically filed with the SEC. These reports may be accessed through our websites investor relations page at www.satcon.com/investors/facts.html.
Global trends are developing which have the effect of accelerating the demand for power electronics and innovative motor technology, including:
· Growing demand for alternative energy sources such as fuel cells, solar photo-voltaic and wind-turbines as the cost, environmental impact and security implications of dependence on fossil fuel gain recognition. This demand is also significantly impacted by the burgeoning energy needs of rapidly growing Asian economies.
· Growing demand for high-quality, high-reliability power, as more critical and sensitive electronics are interconnected.
· Increased concerns regarding the capacity and reliability of the electric utility grid.
· Increasing per capita demand for electricity, driven by the increase in computers and electronics technology coupled with population growth.
· Increased use of electrical systems versus mechanical systems.
· Growing concerns for the inefficiency and adverse environmental impact of conventional automotive power technology leading to high interest in hybrid electric vehicles (HEVs).
These trends and concerns lead individuals, businesses and governments to seek more reliable, efficient, cleaner and cost-effective solutions for their power needs. This demand creates a growing market for alternative energy and power management systems. All of these systems require power control products to manage electricity. In order to be commercially viable and operate effectively, these power products must be highly reliable, efficient, low-cost and compact. Many of these products must be customized to meet the evolving needs in the marketplace. We apply SatCons technical expertise to meet these needs for power control products in emerging global markets for alternative energy, uninterruptible power and power quality systems, hybrid electric vehicles and high-reliability defense systems.
We strive to meet our customers needs by providing power control products and systems that encompass the following key attributes:
Performance. Our products use proprietary designs to ensure that high-quality power is efficiently produced in all operating conditions.
Reliability. We design and manufacture high-reliability, long-life electronics for applications such as aircraft navigation systems and satellite uplink electronics. We design, manufacture and test our electronics to last at least fifteen years. We design our products to support the long-life, always-on requirements of the power quality markets.
Efficiency. We design and manufacture our products to meet the efficiency needs of our customers as defined by their specifications and the end use of the product. The overall efficiency of an alternative energy system, or its ability to deliver power with minimum energy loss, is vital to its effective commercialization and depends on the efficiency of all of its component parts. For example, in the specific case of the market for solar photo-voltaic inverters in California, the California Energy Commission requires that rebate-eligible products be tested by a nationally recognized test laboratory in accordance with an Underwriters Laboratory protocol to objectively measure the products efficiency. The twelve
different models of power control units we currently sell in California have been tested, as required, with the result that we deliver the highest efficiency units in the market.
Quality. We maintain high quality standards. For example, we are a certified manufacturer for hybrid microcircuits in accordance with MIL-PRF-38534 for military microelectronics (class H) and microelectronics for applications in space (class K), the highest levels of qualities and reliabilities as reserved for these classes. Our Electronics business segment operates with Quality Management Systems that is certified as ISO 9001:2000 compliant. Our Applied Technology business segment has satisfied all the requirements for ISO 9001:2000 registration. The audit was satisfactorily conducted 11/29/2005 through 12/2/2005 and we have completed all action items. Official registration is now pending with our registrar, International Quality Registrars Corporation.
All of the high power level inverters manufactured in our Power Systems business unit are Underwriter Laboratory listed as meeting their requirements for safety.
High Power Density. We design our products to meet market demands for high power density. High power density, or the ability to convert, condition and manage large amounts of energy within a compact design, is required for cost reduction and is critical in applications such as vehicles, aboard ships and especially in aircraft and spacecraft where weight and space requirements are stringent.
Flexibility. We develop and manufacture our products for use in various alternative energy and power quality systems such as fuel cells, photo-voltaics, wind turbines, micro-turbines and UPS systems. Our products are modular and scalable to meet a wide range of power requirements. Our engineers work closely with our customers to address overall systems design issues and to ensure that our products meet their system specifications. A close working relationship between the customers engineers and our engineers is particularly important in the rapidly evolving alternative energy, power quality and hybrid electric vehicle industries.
Leverage our diverse expertise and proprietary technologies. Our strategy is to use our diverse expertise and proprietary technologies in the fields of power electronics, motors and microelectronics to develop products with cross-market applications. Our success should be sustainable in the longer term because it depends on fundamental knowledge of key power technology. We are not critically dependent on the technology of a specific application, the business of a single customer or the success of a single product. We strive to create balance between breadth and focus.
Develop proprietary products. We believe that we have a competitive advantage resulting from our proprietary technology in the areas of power electronics, electro-magnetics, mechanical and thermal dynamics, system controls and microelectronics design. Our products are specifically applicable to the rapidly developing alternative energy and hybrid-electric vehicle markets.
Establish our products as industry standards. We are a major supplier of power control units, frequently called inverters, in alternative energy applications. We are gaining ground in providing standard motors, controllers and converters for hybrid electric vehicles. Our MagLev product has already become an industry standard in the semi-conductor fabrication industrys rapid thermal process. In fiscal 2005 we began introducing standardized high reliability microelectronic products into aerospace applications.
Develop or acquire new technology. We believe that new products, manufacturing capabilities and technologies will enhance our competitive position and growth opportunities. In fiscal 2005 we built relationships and were funded through SBIRs to develop application technology for the introduction of silicon-carbide semi-conductor material into systems. Silicon-carbide will enable much more power dense electronics, which are especially important in applications for vehicles, ships, and aerospace.
Develop strategic alliances and relationships. These alliances may take the form of marketing, sales, distribution or manufacturing agreements. Chief among these alliances is our teaming agreement with General Atomics relating to future work in naval ship power distribution which is described in more detail in the sub-paragraph of this section entitled Strategic Relationships. We also continue to develop and deepen the relationships we have for manufacturing or motor products in China.
Our financial results by business segments for the fiscal years ended September 30, 2005, 2004 and 2003 are presented in Note U to the Consolidated Financial Statements included in this Annual Report on form 10-K.
Our products are sold through our three business segments: SatCon Power Systems, SatCon Electronics and SatCon Applied Technology.
SatCon Power Systems
SatCon Power Systems manufactures and sells our high power line of power control systems including our standard lines of high-performance motors for the industrial machinery, factory automation and automotive markets; MagLev integrated suspension and motor systems; and Ling Electronics vibration test systems and StarSine amplifiers and power converters. We also make and sell Rotary UPS Systems for back-up power and power quality. We completed product development and testing and installed our first 250 kilowatt and 2.2 megawatt systems in calendar 2003. During 2005 we delivered our second 2.2 megawatt Rotary UPS System. In 2005 we also continued development, manufacture and sales of inverters for alternative energy including Underwriter Laboratory (UL) compliance testing, and manufacturing and sales of StarSine industrial and commercial power conversion and conditioning products. Revenues for our fiscal years ended September 30, 2005, 2004 and 2003 from our Power Systems business unit were $20.4 million, $17.4 million and $12.5 million, respectively.
During fiscal year 2005, $6.1 million of revenue was generated by the sales of alternative energy inverters to the solar and fuel cell markets, $1.6 million to the frequency converter market and $3.9 million to the Plasma torch and other markets. In addition, approximately $3.5 million was generated by the sales of shaker vibration and Starsine test systems, $2.8 million was generated by the sales of magnetic levitation systems and $2.6 million was generated by the sales of industrial automation and machine tool motors and parts. Revenue associated with the delivery of a Rotary UPS system in fiscal 2005 has been deferred until all contract elements are completed. Motors and converters for hybrid electric vehicles have generated some revenue late in fiscal year 2005.
Magnetic Levitation Systems. We manufacture magnetic levitation, or MagLev, systems that enable machinery to rotate or move without contacting other machine parts. Our MagLev systems use electro-magnetic fields to lift mechanical components without any surface contact. Sensors within the system determine the actual position of the levitated object and send signals to a high-speed digital controller, which commands electricity to activate the electro-magnets thereby making the object move away from any surface it is about to contact. This is done at extremely high speeds in order to maintain the stability of the levitated object and can be accomplished with objects that spin, such as motors, or objects that move in one direction, like pistons or push rods. Our largest selling MagLev system is the integrated suspension and motor, or ISAM, system that is sold to Applied Materials, Inc. for the rapid thermal process in semi-conductor silicon wafer manufacturing.
Industrial Automation Motors. We manufacture brush and brushless DC motors for the industrial automation market. These small, high-efficiency motors are available with a variety of options including
optical encoders, tachometers, brakes, custom cables and connectors. Our industrial automation motors are typically used in semiconductor equipment manufacturing, medical device assembly and other automated assembly processes. This motor business underlies our entry into the hybrid electric vehicle motor market.
Rotary UPS Systems. Our Rotary Uninterruptible Power Supply (UPS) systems are designed to provide both power quality and UPS functions in power ranges from 250 kilowatts to 2.2 megawatts and beyond in single or multiple unit systems. For comparison, 2.2 megawatts would be enough power to supply 440 homes each using an average of 5 kilowatts of power. Our Rotary UPS product combines a diesel generator, supplied by Cummins, Inc., SatCons preferred supplier, a flywheel energy storage system, electronics and a proprietary control system into an uninterruptible power supply. We believe that this system is an attractive alternative to lead-acid battery based UPS systems due to its seamless transition during power outages, increased reliability, longer life and the ability to operate effectively in remote locations. The protection provided by these systems is critical to defense, government and commercial entities that cannot be out of power even for a fraction of a second. We also combined several of the RUPS technical elements into a Rotary Ride Through Device concept in which the customer already has an installed emergency generator set but requires the addition of our technology for power sustainability and high power quality.
Machine Tool Motors. We manufacture a line of precise positioning motors for use with machine tools such as computer numerical controlled machines. These include machining centers, lathes and milling machines.
High Power Inverters. We have developed modular inverters such as our Three Phase Utility Interactive Multi-Mode Inverter for use in connection with large, commercial sized, fuel cell alternative energy power systems such as stationary fuel cell power plants, photo-voltaic power plants, wind turbines or microturbine distributed power generation systems that produce power ranging from 30 kilowatts to 10 megawatts. Our Powergate® inverters are designed to convert the DC power generated by an alternative energy source, such as a fuel cell, into useable AC power. They also provide the interface with the electric utility grid, an energy storage device, like a battery or flywheel, and the end user applications. These units use a technology that allows them to be combined and scaled to handle high-power requirements. We introduced this product during fiscal year 2002 and, further, introduced inverters for photovoltaic applications in fiscal year 2003. Product offerings and orders for these kinds of units have grown quickly in 2004 and 2005.
Other Power Products. We also sell static transfer switches, static voltage regulators, frequency converters and AC arc furnace line controllers from 5 kilowatts to 100 megawatts.
Shaker Vibration Test Systems. Prior to the sale of our Shaker and Amplifier product lines, as discussed below, we sold shaker vibration test systems that enable manufacturers to understand how their mechanical and electronic products will perform after exposure to vibrations. These shaker vibration test systems replicate vibrations ranging from continuous shaking to high impact forces and are used for testing a variety of products, from small electronic components through automotive systems to aerospace and satellite structures. In addition we continue to sell a line of digitally modulated power amplifiers under the StarSine label. We sold these amplifiers as components of our shaker vibration test systems. On December 13, 2005, we sold our Shaker and Amplifier product lines, the associated inventory and intellectual property to Qualmark, Inc., for proceeds of approximately $2.3 million.
SatCon Electronics designs and manufactures advanced electronic assemblies for the aerospace, defense, wireless and telecom industries including thin film products and custom modules. Revenue for our fiscal years ended September 30, 2005, 2004 and 2003 from our Electronics business unit was
approximately $9.5 million, $9.5 million and $9.2 million, respectively. The following are descriptions of some of our products within the Electronics business unit:
Hybrid Microcircuits. We manufacture standard and custom hybrid microcircuits, which are a combination of several electronic components imbedded in a miniature circuit assembly. Due to their size, versatility and high reliability, these hybrid microcircuits are used in a broad spectrum of applications. Using our semi-automated manufacturing capability, we build and test modules, sub-assemblies and fully integrated electronic systems for both military and commercial customers that require compact, high reliability systems.
Thin Film Substrates. Thin film substrates are miniature circuit assemblies onto which small electronic components are mounted, such as those used in hybrid microcircuits. Some of our thin film substrates are sold directly to customers and some are further integrated at SatCon Electronics into devices. Thin film substrate and resistor products manufactured by SatCon Electronics are used for high-speed telecommunications applications, military modules and high-frequency wireless devices in military and commercial markets.
Radio Frequency Products. SatCon Electronics sells products into both military and commercial wireless communications markets. Using our design, analysis and test capability, we build standard and custom amplifiers, switches and passive devices for secure communication systems, cell tower base stations, point-to-point data transmission, and wireless networks.
SatCon Applied Technology
Our Applied Technology business segment develops, designs and builds power conversion products, which include power electronics, high-efficiency machines and control systems for a variety of defense and commercial applications. One of our objectives is to transition prototype development contracts into production programs. Revenue for our fiscal years ended September 30, 2005, 2004 and 2003 from Applied Technology was approximately $6.1 million, $7.2 million and $5.3 million, respectively.
We pursue development programs in areas where we have technical expertise and where we believe there is significant long-term production potential for the developed technology. Technical disciplines represented at our Applied Technology business unit include electromechanics, digital and analog electronics, power electronics and electronic packaging, thermal management, motor dynamics, materials, software development, control technology, and system integration. To date, SatCon Applied Technology has built products for use in distributed power generation, energy storage and power quality, high performance electric machinery, transportation and defense systems, including components for military hybrid-electric vehicles, all-electric ships and aircraft subsystems.
Power Modules. SatCon Electronics designs, manufactures and tests modules for high power applications. These modules are used as building blocks for motor control applications in aerospace, automotive, industrial, medical and defense markets.
Power Control Modules. As part of a defense contractor team that includes General Atomics and Gibbs and Cox, we have been developing an Integrated-Fight-Through-Power System for potential application to the U.S. Navys all-electric ship. We are under contract to deliver modular, electrical power converter and control assemblies, or Power Control Modules, as part of the Navys on-going development of the all-electric ship platform. We have been awarded approximately $14.0 million in product development funding to date on this program. As of September 30, 2005, approximately $0.1 million of the $14.0 million remains in backlog.
Funded Research and Development. We perform funded research and development in connection with government programs and for third parties. We pursue funded research and development in areas where we have technical expertise and where we believe there is significant commercial application for the
developed technology. We have performed funded research and development in connection with the development of each of our product areas.
We also have specialized engineering expertise in the areas of power electronics, electromechanics, mechanical and thermal dynamics, system controls and microelectronic design. We have leveraged research and development funding from industry and government sources to design, develop and manufacture electronics for power conversion, amplification and storage, high-performance electric motors, flywheel energy storage systems and system controls software. We continue to pursue industry and government funding to supplement the on-going development of our products.
In order to formalize potential collaboration with General Atomics on future work relating to shipboard power distribution, we entered into a teaming agreement with General Atomics in February 2003 in which each party agrees to assist the other in preparing proposals. It further provides that if General Atomics is seeking work in the program area, it will use us as its subcontractor and we agree that we will not collaborate with another entity if General Atomics is soliciting work in that area. It is the intent of the parties to coordinate their respective endeavors in order to obtain additional contracts in the program area. The term of the teaming agreement was originally three years, unless terminated earlier by mutual agreement of the parties. In September 2003, that agreement was extended through March 2007, subject to termination provisions. However, there can be no assurance that any material revenues or expenses will be associated with the teaming agreement in the future.
There was one customer that was classified as a significant customer (i.e. sales to any one customer exceeded 10% of our revenue or gross accounts receivable exceeding 10% of our gross accounts receivable) for the years ended September 30, 2005. At September 30, 2005 the amount outstanding to that one customer accounted for approximately 15% of gross receivables. As of December 15, 2005 we received approximately $524,000 related to these outstanding balances and approximately $550,000 remains outstanding. For the years ended September 30, 2004 and 2003 there was no single customer that could be classified as a significant customer. Approximately 40% of our revenue during fiscal year 2005 was derived from government contracts and subcontracts with the U.S. governments prime contractors.
We believe that the continued and timely development of new products and enhancements to our existing products is necessary to maintain our competitive position. We use technologies developed by our business units, together with information supplied by our distributors and customers, to design and develop new products and product enhancements and to reduce the time-to-market for our products.
During the fiscal years ended September 30, 2005, 2004 and 2003, we expended $5.4 million, $6.0 million and $5.0 million, respectively, on funded research and development and other revenue activities funded by commercial customers and U.S. government agency sponsors. Under the agreements funded by the U.S. government, the government retains a royalty-free license to use the technology developed for government purposes and we retain exclusive rights to the technology for commercial and industrial applications. The rights to technology developed under contracts funded by commercial customers are negotiated on a case-by-case basis. We expended approximately $0.5 million, $0 and $1.5 million on internally-funded research and development during our fiscal years ended September 30, 2005, 2004 and 2003, respectively.
We sell our products and services both domestically and internationally through our direct sales force and through independent distributors and representatives. Our direct sales staff manages our key customer accounts, provides customer support and identifies significant market opportunities in their respective markets.
Each of our three divisions manages its own marketing organization and is responsible for developing sales and advertising literature, such as product announcements, catalogs, brochures and magazine articles in trade and other publications. Publication of significant events or material information is handled through our corporate office.
We maintain close contact with our customers design and engineering staffs in order to provide the appropriate products for our customers applications. We maintain this close working relationship with our customers throughout the life of a product, and we believe that it has been a key part of our customers satisfaction.
We compete for and market our research and development contracts through several methods, including pursuing new and existing customer relationships in the commercial and government sectors and responding to unsolicited requests for proposals and through our Internet site.
Our backlog consists primarily of product development contracts, orders for power control systems, electronics and motion control products. At September 30, 2005, our backlog was approximately $21.5 million. Of this amount, approximately $18.5 million is scheduled to be shipped during our fiscal year 2006. Many of our contracts and sales orders may be canceled at any time with limited or no penalty. In addition, contract awards may be subject to funding approval from the U.S. government and commercial entities, which involves political, budgetary and other considerations over which we have no control.
We believe that competitive performance in the marketplace for power control products depends upon several factors, including product price, technical innovation, product quality and reliability, range of products, customer service and technical support. We believe our technical innovation emphasizing product performance and reliability, supported by our commitment to strong customer service and technical support, enables us to continue to compete successfully against the following competitors:
· Manufacturers of inverters for alternative energy such as Trace Engineering, a division of Xantrex Technology, Inc., Asea Brown Boveri Ltd., Siemens Corporation and Alstom S.A.;
· Manufacturers of custom microcircuit such as Natal Engineering, Aeroflex Inc., MS Kennedy and Sensitron;
· Manufacturers of thin film substrates and resistors such as Vishnay and Ultrasource, Inc.; manufacturers of power regulators such as International Rectifier, Sensitron and MS Kennedy;
· Manufacturers of DC to DC converters such as International Rectifier, VPT, Interpoint and Modular Devices;
· Manufacturers of motors such as MCG Inc., Reliance Electric CO/DE and other regional and specialty motor manufacturers;
· Manufacturers of Uninterruptible Power Supplies such as Piller, Inc. and Hitech Power Protection bv.;
· Developers of advanced power electronics and machines such as Moog, Semikron, DRS and Silicon Power; and
· Manufacturers of shaker vibration test systems such as Ling Dynamics Systems, Ltd. and Unholtz-Dickie, Corp.
Some of our competitors have substantially greater financial resources than we do and could devote greater resources to the development, promotion, sale and support of their products and may have more manufacturing expertise and capacity. In addition, some of our competitors have more extensive customer bases and broader customer relationships than we do.
We manufacture our products at our facilities located in Marlborough, Massachusetts; Worcester, Massachusetts; and Burlington, Ontario, Canada. We believe our existing manufacturing capacity is sufficient to meet our current needs. We believe that most of the raw materials used in our products are readily available from a variety of vendors. Additionally, we design and develop our products to use commodity parts in order to simplify the manufacturing process. We have a semi-automated production line in our Marlborough, Massachusetts facility. We intend to add additional production lines for our products in the future as demand dictates and our revenues enable. We have made and expect to continue to make technological improvements that reduce the costs to manufacture our products.
Our manufacturing facilities are subject to numerous environmental laws and regulations, particularly with respect to industrial waste and emissions. Compliance with these laws and regulations has not had a material impact on our capital expenditures or competitive position.
Our success and competitiveness depend on our ability to develop and maintain the proprietary aspects of our technology and operate without infringing on the proprietary rights of others. We rely on a combination of patent, trademark, trade secret and copyright law and contract restrictions to protect the proprietary aspects of our technologies. We seek to limit disclosure of our intellectual property by requiring employees, consultants, and any third parties with access to our proprietary information to execute confidentiality agreements and by restricting access to that information.
As of September 30, 2005, we held approximately 71 U.S. patents and had 1 patent applications pending with the U.S. Patent and Trademark Office. We have also obtained corresponding patents in the rest of North America, Europe and Asia. In addition, we have a non-exclusive, royalty-free license for non-automotive applications for 38 other patents that were issued to our employees and subsequently assigned to DaimlerChrysler. The expiration dates of our patents range from 2009 to 2021, with the majority expiring after 2015.
In 1997, we granted Beacon Power Corporation a perpetual, worldwide, royalty-free, exclusive right and license to our flywheel technology for stationary, terrestrial applications. Beacon Power was formed as a spin-off of SatCon Technology Corporation.
Many of the U.S. patents described above are the result of retaining ownership of inventions made under U.S. government-funded research and development programs. As a qualifying small business, we have retained commercial ownership rights to proprietary technology developed under various U.S. government contracts and grants, including small business innovation research contracts. With respect to any invention made with government assistance, the government has a nonexclusive, nontransferable, irrevocable, paid-up license to use the technology or have the technology employed for or on behalf of the U.S. government throughout the world. Under certain conditions, the U.S. government also has march-in rights. These rights enable the U.S. government to require us to grant a nonexclusive, partially exclusive,
or exclusive license in any field of use to responsible applicants, upon terms that are reasonable under the circumstances.
We have foreign operations through our Power Systems subsidiary in Burlington, Ontario, Canada.
We presently are subject to various federal, state and local laws and regulations relating to, among other things, export control energy generation, safe working conditions, handling and disposal of hazardous and potentially hazardous substances and emissions of pollutants into the atmosphere. To date, we believe that we have obtained all the necessary government permits and have been in substantial compliance with all of these applicable laws and regulations.
We act as a prime contractor or major subcontractor for many different U.S. government programs, including those that involve the development of electro- mechanical transportation, navigation and energy-related products. Over its lifetime, a program may be implemented by the award of many individual contracts and subcontracts, or contracts with option years, or partially funded contracts.
U.S. government contracts include provisions permitting termination, in whole or in part, without prior notice, at the U.S. governments discretion. The U.S. government generally pays compensation for work actually done and commitments made at the time of termination, and some allowance for profit on the work performed. The U.S. government may also terminate for default in performance and pay only the value delivered to the U.S. government. It can also hold the contractor responsible for re-procurement costs.
Our government contract business is also subject to specific procurement statutes and regulations and a variety of socio-economic and other factors. Failure to comply with these regulations and requirements could lead to loss of contract or suspension or debarment from U.S. government contracting or subcontracting for a period of time. Examples of these statutes and regulations are those related to procurement integrity, export control, employment practices, the accuracy of records and the recording of costs.
Sales to the U.S. government may be affected by changes in research interests in the areas in which we engage, changing government department budgets, and changing procurement policies.
At September 30, 2005, we had a total of 184 full-time employees, 5 part-time employees and 40 contract employees. Of the total, 65 persons were employed in engineering, 113 in manufacturing, 38 in administration and 13 in sales and marketing. Our future success depends in large part on the continued service of our key technical and senior management personnel, and on our ability to attract, retain and motivate qualified employees, particularly those highly skilled design, process and test engineers involved in the manufacture of existing products and the development of new products and processes. The competition for such personnel is intense, and the loss of key employees could have a material adverse effect on us. None of our employees are represented by a union. We believe that our relations with our employees are good.
Our future results remain difficult to predict and may be affected by a number of factors which could cause actual results to differ materially from forward-looking statements contained in this Annual Report on Form 10-K and presented elsewhere by management from time to time. These factors include business conditions within the distributed power, power quality, aerospace, transportation, industrial, utility, telecommunications, silicon wafer manufacturing, factory automation, aircraft and automotive industries and the world economies as a whole. Our revenue growth is dependent, in part, on technology developments and contract research and development for both the government and commercial sectors and no assurance can be given that we will continue to obtain such funds. In addition, our growth opportunities are dependent on our new products penetrating the distributed power, power quality, aerospace, transportation, industrial, utility, telecommunications, silicon wafer manufacturing, factory automation, aircraft and automotive markets. No assurance can be given that new products can be developed, or if developed, will be commercially viable; that competitors will not force prices to unacceptably low levels or take market share from us; or that we can achieve and maintain profitability in these or any new markets. Because of these and other factors, including, without limitation, the factors set forth below, past financial performance should not be considered an indicator of future performance. Investors should not use historical trends to anticipate future results and should be aware that the market price of our common stock experiences significant volatility.
We have a history of operating losses, may not be able to achieve profitability and may require additional capital in order to sustain our businesses.
For each of the past ten fiscal years, we have experienced losses from operating our businesses. As of September 30, 2005, we had an accumulated deficit of approximately $137.9 million. During the fiscal year ended September 30, 2005 we had a loss from operations of approximately $9.5 million. If we are unable to operate on a cash flow breakeven basis during 2006, we may need to raise additional capital in order to sustain our operations. There can be no assurance that we will be able to achieve such results or to raise such funds if they are required.
We may not be able to continue as a going concern.
Our financial statements for our fiscal year ended September 30, 2005, which are included in this Annual Report on Form 10-K, contain an audit report from Grant Thornton LLP. The audit report contains a going concern qualification, which raises substantial doubt with respect to our ability to continue as a going concern. The receipt of a going concern qualification may create a concern among our current and future customers and vendors as to whether we will be able to fulfill our contractual obligations.
We could issue additional common stock, which might dilute the book value of our common stock.
We have authorized 50,000,000 shares of our common stock, of which 38,283,208 shares were issued and outstanding as of September 30, 2005. Our board of directors has the authority, without action or vote of our stockholders in most cases, to issue all or a part of any authorized but unissued shares. Such stock issuances may be made at a price that reflects a discount from the then-current trading price of our common stock. In addition, in order to raise the capital that we may need at todays stock prices, we will need to issue securities that are convertible into or exercisable for a significant amount of our common stock. These issuances would dilute your percentage ownership interest, which will have the effect of reducing your influence on matters on which our stockholders vote, and might dilute the book value of our common stock. You may incur additional dilution of net tangible book value if holders of stock options, whether currently outstanding or subsequently granted, exercise their options or if warrant holders exercise their warrants to purchase shares of our common stock.
The sale or issuance of a large number of shares of our common stock could depress our stock price.
As of December 15, 2005, we have reserved 10,818,962 shares of common stock for issuance upon exercise of stock options and warrants, 2,198,311 shares for future issuances under our stock plans and
878,660 shares for future issuances as matching contributions under our 401(k) plan. We have also reserved 961,538 shares of common stock for issuance upon conversion of the outstanding Series B Preferred Stock, which can be converted at any time. As of December 15, 2005, holders of warrants and options to purchase an aggregate of 8,616,151 shares of our common stock may exercise those securities and transfer the underlying common stock at any time subject, in some cases, to Rule 144.
We have not consistently complied with Nasdaqs Marketplace rules for continued listing, which exposes us to the risk of delisting from the Nasdaq National Market.
Our stock is listed on the Nasdaq National Market, which affords us an opportunity for relatively broad exposure to a wide spectrum of prospective investors. As a requirement of continued inclusion in the Nasdaq National Market, SatCon must comply with Nasdaqs Marketplace Rules. In 2003, SatCon received notice from Nasdaq that it was not in compliance with Marketplace Rules. Subsequently, in late 2003, Nasdaq advised SatCon that it had achieved compliance, and SatCon has continued to maintain compliance with the Nasdaq National Market Marketplace Rules for Continued Inclusion since that time. However, if we fail to maintain compliance with these rules and our common stock is delisted from the Nasdaq National Market, there could be a number of negative implications, including reduced liquidity in our common stock as a result of the loss of market efficiencies associated with the Nasdaq National Market, the loss of federal preemption of state securities laws, the potential loss of confidence by suppliers, customers and employees, as well as the loss of analyst coverage and institutional investor interest, fewer business development opportunities and greater difficulty in obtaining financing.
We expect to generate a significant portion of our future revenues from sales of our power control products and cannot assure market acceptance or commercial viability of our power control products.
We intend to continue to expand development of our power control products. We cannot assure you that potential customers will select SatCons products to incorporate into their systems or that our customers products will realize market acceptance, that they will meet the technical demands of their end users or that they will offer cost-effective advantages over existing products. Our marketing efforts have included development contracts with several customers and the targeting of specific market segments for power and energy management systems. We cannot know if our commercial marketing efforts will be successful in the future. Additionally, we may not be able to develop competitive products, our products may not receive market acceptance, and we may not be able to compete profitably in this market, even if market acceptance is achieved. If our products do not gain market acceptance or achieve commercial viability, we will not attain our anticipated levels of profitability and growth.
If we are unable to maintain our technological expertise in design and manufacturing processes, we will not be able to successfully compete.
We believe that our future success will depend upon our ability to develop and provide products that meet the changing needs of our customers. This requires that we successfully anticipate and respond to technological changes in design and manufacturing processes in a cost-effective and timely manner. As a result, we continually evaluate the advantages and feasibility of new product design and manufacturing processes. We cannot, however, assure you that our process improvement efforts will be successful. The introduction of new products embodying new technologies and the emergence of shifting customer demands or changing industry standards could render our existing products obsolete and unmarketable, which would have a significant impact on our ability to generate revenue. Our future success will depend upon our ability to continue to develop and introduce a variety of new products and product enhancements to address the increasingly sophisticated needs of our customers. We may experience delays in releasing new products and product enhancements in the future. Material delays in introducing new products or product enhancements may cause customers to forego purchases of our products and purchase those of our competitors.
We are heavily dependent on contracts with the U.S. government and its agencies or from subcontracts with the U.S. governments prime contractors for revenue to develop our products, and the loss of one or more of our government contracts could preclude us from achieving our anticipated levels of growth and revenues.
Our ability to develop and market our products is dependent upon maintaining our U.S. government contract revenue and research grants. Many of our U.S. government contracts are funded incrementally on a year-to-year basis. Approximately 40% of our revenue during fiscal year 2005 was derived from government contracts and subcontracts. Changes in government policies, priorities or programs that result in budget reductions could cause the government to cancel existing contracts or eliminate follow-on phases in the future which would severely inhibit our ability to successfully complete the development and commercialization of our products. In addition, there can be no assurance that, once a government contract is completed, it will lead to follow-on contracts for additional research and development, prototype build and test or production. Furthermore, there can be no assurance that our U.S. government contracts or subcontracts will not be terminated or suspended in the future. In the event that any of our government contracts are terminated for cause, it could significantly affect our ability to obtain future government contracts, which could seriously harm our ability to develop our technologies and products.
Our contracts with the U.S. government are subject to audit by the Defense Contract Audit Agency and other agencies of the government, which may challenge our treatment of direct and indirect costs and reimbursements, resulting in a material adjustment and adverse impact on our financial condition.
The accuracy and appropriateness of our direct and indirect costs and expenses under our contracts with the U.S. government are subject to extensive regulation and audit by the Defense Contract Audit Agency or by other appropriate agencies of the U.S. government. These agencies have the right to challenge our cost estimates or allocations with respect to any such contract. Additionally, substantial portions of the payments to us under U.S. government contracts are provisional payments that are subject to potential adjustment upon audit by such agencies. Adjustments that result from inquiries or audits of our contracts could have a material adverse impact on our financial condition or results of operations.
Since our inception, we have not experienced any material adjustments as a result of any inquiries or audits, but there can be no assurance that our contracts will not be subject to material adjustments in the future.
The U.S. government has certain rights relating to our intellectual property.
Many of our patents are the result of inventions made under U.S. government-funded research and development programs. With respect to any invention made with government assistance, the government has a nonexclusive, nontransferable, irrevocable, paid-up license to use the technology or have the technology employed for or on behalf of the U.S. government throughout the world. Under certain conditions, the U.S. government also has march-in rights, which enable the U.S. government to require us to grant a nonexclusive, partially exclusive, or exclusive license in any field of use to responsible applicants, upon terms that are reasonable under the circumstances.
Our business could be adversely affected if we are unable to protect our patents and proprietary technology.
As of December 15, 2005, we held approximately 71 U.S. patents and had 1 patent applications pending with the U.S. Patent and Trademark Office. We have also obtained corresponding patents in the rest of North America, Europe, and Asia for many of these patents. The expiration dates of our patents range from 2009 to 2021, with the majority expiring after 2015. As a qualifying small business from our inception to date, we have retained commercial ownership rights to proprietary technology developed under various U.S. government contracts and grants.
Our patent and trade secret rights are of significant importance to us and to our future prospects. Our ability to compete effectively against other companies in our industry will depend, in part, on our ability to protect our proprietary technology and systems designs relating to our products. Although we have attempted to safeguard and maintain our proprietary rights, we do not know whether we have been or will be successful in doing so. Further, our competitors may independently develop or patent technologies that are substantially equivalent or superior to ours. No assurance can be given as to the issuance of additional patents or, if so issued, as to their scope. Patents granted may not provide meaningful protection from competitors. Even if a competitors products were to infringe patents owned by us, it would be costly for us to pursue our rights in an enforcement action and there can be no assurance that we would be successful in enforcing our intellectual property rights. Because we intend to enforce our patents, trademarks and copyrights and protect our trade secrets, we may be involved from time to time in litigation to determine the enforceability, scope and validity of these rights. This litigation could result in substantial costs to us and divert resources from operational goals. In addition, effective patent, trademark, service mark, copyright and trade secret protection may not be available in every country where we operate or sell our products.
We may not be able to maintain confidentiality of our proprietary knowledge.
In addition to our patent rights, we also rely on treatment of our technology as trade secrets through confidentiality agreements, which all of our employees are required to sign, assigning to us all patent rights and other intellectual property developed by our employees during their employment with us. Our employees have also agreed not to disclose any trade secrets or confidential information without our prior written consent. We also rely on non-disclosure agreement to protect our trade secrets and proprietary knowledge. These agreements may be breached, and we may not have adequate remedies for any breach. Our trade secrets may also be known without breach of these agreements or may be independently developed by competitors. Failure to maintain the proprietary nature of our technology and information could harm our results of operations and financial condition by reducing or eliminating our technological advantages in the marketplace.
Others may assert that our technology infringes their intellectual property rights.
We believe that we do not infringe the proprietary rights of others and, to date, no third parties have asserted an infringement claim against us, but we may be subject to infringement claims in the future. The defense of any claims of infringement made against us by third parties could involve significant legal costs and require our management to divert time from our business operations. If we are unsuccessful in defending any claims of infringement, we may be forced to obtain licenses or to pay royalties to continue to use our technology. We may not be able to obtain any necessary licenses on commercially reasonable terms or at all. If we fail to obtain necessary licenses or other rights, or if these licenses are costly, our operating results may suffer either from reductions in revenues through our inability to serve customers or from increases in costs to license third-party technologies.
Our success is dependent upon attracting and retaining highly qualified personnel and the loss of key personnel could significantly hurt our business.
To achieve success, we must attract and retain highly qualified technical, operational and executive employees. The loss of the services of key employees or an inability to attract, train and retain qualified and skilled employees, specifically engineering, operations and business development personnel, could result in the loss of business or could otherwise negatively impact our ability to operate and grow our business successfully.
We expect significant competition for our products and services.
In the past, we have faced limited competition in providing research services, prototype development and custom and limited quantity manufacturing. We expect competition to intensify greatly as commercial applications increase for our products under development. Many of our competitors and potential competitors are well established and have substantially greater financial, research and development, technical, manufacturing and marketing resources than we do. Some of our competitors and potential competitors are much larger than we are. If these larger competitors decide to focus on the development of distributed power and power quality products, they have the manufacturing, marketing and sales capabilities to complete research, development and commercialization of these products more quickly and effectively than we can. There can also be no assurance that current and future competitors will not develop new or enhanced technologies perceived to be superior to those sold or developed by us. There can be no assurance that we will be successful in this competitive environment.
We are dependent on third-party suppliers for the supply of key components for our products.
We use third-party suppliers for components in many of our systems. From time to time, shipments can be delayed because of industry-wide or other shortages of necessary materials and components from third-party suppliers. A suppliers failure to supply components in a timely manner, or to supply components that meet our quality, quantity or cost requirements, or our inability to obtain substitute sources of these components on a timely basis or on terms acceptable to us, could impair our ability to deliver our products in accordance with contractual obligations.
On occasion, we agree to fixed price engineering contracts in our Applied Technology Division, which exposes us to losses.
Most of our engineering design contracts are structured on a cost-plus basis. However, on occasion we have entered into fixed price contracts, which may expose us to loss. A fixed priced contract, by its very nature, requires cost estimates during the bidding process and throughout the contract, as the program proceeds to completion. Depending upon the complexity of the program, the estimated completion costs could change frequently and significantly during the course of the contract. We regularly involve the appropriate people on the program and finance staffs to arrive at a reasonable estimate of the cost to complete. However, due to unanticipated technical challenges and other factors, there is the potential for substantial cost overruns in order to complete the contract in accordance with the contract specifications. Currently we do not have any contracts of this type. During the fiscal year ended September 30, 2005, we had recorded losses on these contracts of approximately $0.1 million related to a fixed price contract which was completed during the period. No other losses were recorded on these contracts during fiscal 2005.
If we experience a period of significant growth or expansion, it could place a substantial strain on our resources.
If our power control products are successful in achieving rapid market penetration, we may be required to deliver large volumes of technically complex products or components to our customers on a timely basis at reasonable costs to us. We have limited experience in ramping up our manufacturing capabilities to meet large-scale production requirements and delivering large volumes of our power control products. If we were to commit to deliver large volumes of our power control products, we cannot assure you that we will be able to satisfy large-scale commercial production on a timely and cost-effective basis or that such growth will not strain our operational, financial and technical resources.
Our business could be subject to product liability claims.
Our business exposes us to potential product liability claims, which are inherent in the manufacturing, marketing and sale of our products, and we may face substantial liability for damages resulting from the faulty design or manufacture of products or improper use of products by end users. We currently maintain
a moderate level of product liability insurance, and there can be no assurance that this insurance will provide sufficient coverage in the event of a claim. Also, we cannot predict whether we will be able to maintain such coverage on acceptable terms, if at all, or that a product liability claim would not harm our business or financial condition. In addition, negative publicity in connection with the faulty design or manufacture of our products would adversely affect our ability to market and sell our products.
We are subject to a variety of environmental laws that expose us to potential financial liability.
Our operations are regulated under a number of federal, state and foreign environmental and safety laws and regulations that govern, among other things, the discharge or release of hazardous materials into the air and water as well as the handling, storage and disposal of these materials. These laws and regulations include the Clean Air Act, the Clean Water Act, the Resource, Conservation and Recovery Act, and the Comprehensive Environmental Response, Compensation and Liability Act, as well as analogous state and foreign laws. Because we use hazardous materials in certain of our manufacturing processes, we are required to comply with these environmental laws. In addition, because we generate hazardous wastes, we, along with any other person who arranges for the disposal of our wastes, may be subject to potential financial exposure for costs associated with an investigation and remediation of sites at which we have arranged for the disposal of hazardous wastes if those sites become contaminated and even if we fully comply with applicable environmental laws. If we were found to be a responsible party, we could be held jointly and severably liable for the costs of remedial actions. To date, we have not been cited for any improper discharge or release of hazardous materials.
Businesses and consumers might not adopt alternative energy solutions as a means for obtaining their electricity and power needs.
On-site distributed power generation solutions, such as fuel cell, photovoltaic and wind turbine systems, which utilize our products, provide an alternative means for obtaining electricity and are relatively new methods of obtaining electrical power that businesses may not adopt at levels sufficient to grow this part of our business. Traditional electricity distribution is based on the regulated industry model whereby businesses and consumers obtain their electricity from a government regulated utility. For alternative methods of distributed power to succeed, businesses and consumers must adopt new purchasing practices and must be willing to rely upon less upon traditional means of purchasing electricity. We cannot assure you that businesses and consumers will choose to utilize on-site distributed power at levels sufficient to sustain our business in this area. The development of a mass market for our products may be impacted by many factors which are out of our control, including:
· market acceptance of fuel cell, photovoltaic and wind turbine systems that incorporate our products;
· the cost competitiveness of these systems;
· regulatory requirements; and
· the emergence of newer, more competitive technologies and products.
If a mass market fails to develop or develops more slowly than we anticipate, we may be unable to recover the losses we will have incurred to develop these products.
Our quarterly operating results are subject to fluctuations, and if we fail to meet the expectations of securities analysts or investors, our share price may decrease significantly.
Our annual and quarterly results may vary significantly depending on various factors, many of which are beyond our control. Because our operating expenses are based on anticipated revenue levels, our sales cycle for development work is relatively long and a high percentage of our expenses are fixed for the short term, a small variation in the timing of recognition of revenue can cause significant variations in operating
results from quarter to quarter. If our earnings do not meet the expectations of securities analysts or investors, the price of our stock could decline.
Provisions in our charter documents and Delaware law may delay, deter or prevent the acquisition of SatCon, which could decrease the value of your shares.
Some provisions of our certificate of incorporation and bylaws may delay, deter or prevent a change in control of SatCon or a change in our management that you, as a stockholder, may consider favorable. These provisions include:
· authorizing the issuance of blank check preferred stock that could be issued by our board of directors to increase the number of outstanding shares and deter a takeover attempt;
· a board of directors with staggered, three-year terms, which may lengthen the time required to gain control of our board of directors;
· prohibiting cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates; and
· limitations on who may call special meetings of stockholders.
In addition, Section 203 of the Delaware General Corporation Law and provisions in some of our stock incentive plans may delay, deter or prevent a change in control of SatCon. Those provisions serve to limit the circumstances in which a premium may be paid for our common stock in proposed transactions, or where a proxy contest for control of our board may be initiated. If a change of control or change in management is delayed, deterred or prevented, the market price of our common stock could suffer.
We are subject to stringent export laws and risks inherent in international operations.
We market and sell our products and services both inside and outside the United States. We are currently selling our products and services throughout North America and in certain countries in South America, Asia, Canada and Europe. Certain of our products are subject to the International Traffic in Arms Regulations (ITAR) 22 U.S.C 2778, which restricts the export of information and material that may be used for military or intelligence applications by a foreign person. Additionally, certain products of ours are subject to export regulations administered by the Department of Commerce, Bureau of Industry Security, which require that we obtain an export license before we can export certain products or technology. Failure to comply with these laws could result in enforcement responses by the government, including substantial monetary penalties, denial of export privileges, debarment from government contracts and possible criminal sanctions.
Revenue from sales to our international customers for our fiscal years ended September 30, 2005 and 2004 were approximately $3.1 million and $3.7 million, respectively. Our success depends, in part, on our ability to expand our market for our products and services to foreign customers and our ability to manufacture products that meet foreign regulatory and commercial requirements. We have limited experience developing and manufacturing our products to comply with the commercial and legal requirements of international markets. We face numerous challenges in penetrating international markets, including unforeseen changes in regulatory requirements, export restrictions, fluctuations in currency exchange rates, longer accounts receivable cycles, difficulties in managing international operations, and the challenges of complying with a wide variety of foreign laws.
We are exposed to credit risks with respect to some of our customers.
To the extent our customers do not advance us sufficient funds to finance our costs during the execution phase of our contracts, we are exposed to the risk that they will be unable to accept delivery or that they will be unable to make payment at the time of delivery. Occasionally, we accept the risk of dealing with thinly financed entities. We attempt to mitigate this risk by seeking to negotiate more timely
progress payments and utilizing other risk management procedures. At September 30, 2005, we had one customer that accounted for approximately 15% of gross accounts receivable. Of the amounts due from this customer approximately $852,000 related to sales greater than ninety days past due. Historically we have not experienced any credit losses as a result of doing business with this customer.
Our agreement with Silicon Valley Bank subjects us to various restrictions, which may limit our ability to pursue business opportunities.
Our loan agreement with Silicon Valley Bank subjects us to various restrictions on our ability to engage in certain activities without the prior written consent of the bank, including, among other things, our ability to:
· dispose of or encumber assets, other than in the ordinary course of business
· incur additional indebtedness
· merge or consolidate with other entities, or acquire other businesses, and
· make investments
The agreement also subjects us to various financial and other covenants with which we must comply on an ongoing or periodic basis. The financial covenant requires us to maintain a minimum level of tangible net worth, as defined, which varies from month to month. If we violate this or any other covenant, any outstanding debt under this agreement could become immediately due and payable, the bank could proceed against any collateral securing indebtedness and our ability to borrow funds in the future may be restricted or eliminated. These restrictions may also limit our ability to pursue business opportunities or strategies that we would otherwise consider to be in the best interests of the company.
The holders of our Series B Preferred Stock are entitled to receive liquidation payments in preference to the holders of our common stock.
As of December 15, 2005, 425 shares of our Series B Preferred Stock were outstanding. Pursuant to the terms of the certificate of designation creating the Series B Preferred Stock, upon a liquidation of our company, the holders of shares of the Series B Preferred Stock are entitled to receive a liquidation payment prior to the payment of any amount with respect to the shares of our common stock. The amount of this preferential liquidation payment is $5,000 per share of Series B Preferred Stock, plus the amount of any accrued but unpaid dividends on those shares. Prior to October 1, 2005, dividends accrued on the shares of Series B Preferred Stock at a rate of 6% per annum. On October 1, 2005, dividends began accruing on the Series B Preferred Stock at a rate of 8% per annum.
If we are unable to effectively and efficiently eliminate the significant deficiencies that have been identified in our internal controls and procedures, there could be a material adverse effect on our operations or financial results.
In December 2005, our management and Audit Committee were notified by our independent accountants, Grant Thornton LLP, of four significant deficiencies in our internal control over financial reporting regarding (i) a significant deficiency related to a need to formalize certain policies and procedures (including those relating to accounting and financial reporting), (ii) a significant deficiency related to financial reporting and income tax disclosures, (iii) a significant deficiency related to the need for monitoring controls to ensure that operational controls are operating as designed and (iv) a significant deficiency related to an instance of a control failure around evaluation of proper revenue recognition. Although we are committed to addressing these deficiencies, we cannot assure you that we will be able to successfully implement the revised controls and procedures or that our revised controls and procedures will be effective in remedying all of the identified significant deficiencies. Our inability to remedy these significant deficiencies potentially could have a material adverse effect on our business.
We lease office, manufacturing and research and development space in the following locations:
We believe our facilities are adequate for our current needs and that adequate facilities for expansion, if required, are available.
From time to time, we are a party to routine litigation and proceedings in the ordinary course of business. We are not aware of any current or pending litigation to which we are or may be a party that we believe could materially adversely affect our results of operations or financial condition or net cash flows.
No matter was submitted to a vote of security holders during the fourth quarter of our fiscal year covered by this report through the solicitation of proxies or otherwise.
Our common stock is publicly traded on the Nasdaq National Market under the symbol SATC.
The following table sets forth the range of high and low sales prices of our common stock as reported on the Nasdaq National Market for our fiscal years ended September 30, 2004 and 2005:
On December 14, 2005, the last reported sale price of our common stock as reported on the Nasdaq National Market was $1.38 per share. As of December 14, 2005, there were 38,382,707 shares of our common stock outstanding held by approximately 280 holders of record.
We have never paid cash dividends on our common stock. We currently intend to retain earnings, if any, to fund the development and growth of our business and do not anticipate paying cash dividends for the foreseeable future. Payment of future cash dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs and plans for expansion. In addition, our Loan and Security Agreement with Silicon Valley Bank, dated as of June 29, 2005, as amended, provides for certain limitations on the payment of dividends by us on our common stock. Furthermore, under the terms of our Series B Preferred Stock, we may not pay dividends on our common stock without the consent of the holders of at least 75% of the outstanding shares of Series B Preferred Stock.
You should read the data set forth below in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. The selected consolidated financial data set forth below for our fiscal years ended September 30, 2005, 2004 and 2003 and the consolidated balance sheet data as of September 30, 2005 and 2004 are derived from our audited consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K. The selected consolidated statement of operations data for our fiscal years ended September 30, 2002 and 2001 and the consolidated balance sheet data as of September 30, 2003, 2002 and 2001 are derived from our audited consolidated financial statements that are not included in this Annual Report on Form 10-K.
This Annual Report on Form 10-K, including, without limitations, this Item 7, contains or incorporates forward-looking statements within the meaning of section 27A of the Securities Act of 1933 and section 21E of the Securities Act of 1934. You can identify these forward-looking statements by our use of the words believes, anticipates, plans, expects, may, will, intends, estimates, and similar expressions, whether in the negative or in the affirmative. Although we believe that these forward-looking statements reasonably reflect our plans, intentions and expectations, our actual results could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. We have included important factors in the cautionary statements under the heading Risk Factors under Item 1A above that we believe could cause our actual results to differ materially from the forward-looking statements that we make. We do not intend to update information contained in any forward-looking statements we make.
On August 15, 2005, we sold 4,676,151 shares of Common Stock to accredited investors for proceeds of approximately $5.3 million, net of transaction costs. As part of this financing we also issued warrants to purchase up to 1,169,038 shares of Common Stock. These warrants have an exercise price of $1.99 per share, are immediately exercisable and expire on August 2, 2010. We filed a registration statement on Form S-3 with the SEC to register the resale of these shares, and it was declared effective on October 7, 2005.
On November 21, 2005, we entered into a Second Loan Modification and Security Agreement (the Second Loan Modification Agreement) with Silicon Valley Bank (the Bank). The Second Loan Modification Agreement modifies the Loan and Security Agreement, dated as of January 31, 2005, between the parties, as previously amended by the Loan Modification Agreement, dated as of May 31, 2005 (as amended, the Loan Agreement). Under the Second Loan Modification Agreement, the Bank modified the terms related to the collection of receivables for amounts outstanding under the Loan Agreement, as well as the minimum tangible net worth covenant, as defined, which we must maintain in order to continue to borrow from the Bank. The Bank also provided waivers for our failure to comply with the minimum tangible net worth requirements as of August 6, 2005 and September 30, 2005. In addition, the Second Loan Modification Agreement provides the ability to borrow up to $3,000,000 on a revolver basis paying only interest provided that we remain in compliance with all financial covenants, as defined. The Loan Agreement will expire on January 30, 2006.
On December 13, 2005, we sold to Qualmark, Inc. our shaker and amplifier product lines, the associated inventory and intellectual property for proceeds of approximately $2.3 million. We will account for the sale of these assets in our first fiscal quarter of 2006.
We design and manufacture enabling technologies and products for electrical power conversion and control for high-performance, high-efficiency applications in large, growth markets such as alternative energy, hybrid electric vehicles, distributed power generation, power quality, semiconductor fabrication capital equipment, industrial motors and drives, and high reliability defense electronics.
Our discussion and analysis of our financial condition and results of our operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make significant 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 and the reported revenue and expenses during the reporting periods. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition, receivable reserves, inventory reserves, investment in Beacon Power Corporation, goodwill and intangible assets, contract losses and income taxes. Management bases its estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting estimates were discussed with our Audit Committee.
The significant accounting policies that management believes are most critical to aid in fully understanding and evaluating our reported financial results include the following:
We recognize revenue from product sales in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition. Product revenue is recognized when there is persuasive evidence of an arrangement, the fee is fixed or determinable, delivery of the product to the customer has occurred and we have determined that collection of the fee is probable. Title to the product passes upon shipment of the product, as the products are typically shipped FOB shipping point, except for certain foreign shipments. If the product requires installation to be performed by us, all revenue related to the product is deferred and recognized upon the completion of the installation. If the product requires specific customer acceptance, revenue is deferred until customer acceptance occurs or the acceptance provisions lapse, unless we can objectively and reliably demonstrate that the criteria specified in the acceptance provisions are satisfied. When appropriate, we provide for a warranty reserve at the time the product revenue is recognized.
We perform funded research and development and product development for commercial companies and government agencies under both cost reimbursement and fixed-price contracts. Cost reimbursement contracts provide for the reimbursement of allowable costs and, in some situations, the payment of a fee. These contracts may contain incentive clauses providing for increases or decreases in the fee depending on how costs compare with a budget. On fixed-price contracts, revenue is generally recognized on the percentage of completion method based upon the proportion of costs incurred to the total estimated costs for the contract. Revenue from reimbursement contracts is recognized as services are performed. In each type of contract, we receive periodic progress payments or payment upon reaching interim milestones and retain the rights to the intellectual property developed in government contracts. All payments to us for work performed on contracts with agencies of the U.S. government are subject to audit and adjustment by the Defense Contract Audit Agency. Adjustments are recognized in the period made. The Defense Contract Audit Agency has agreed-upon the final indirect cost rates for the fiscal year ended September 30, 2003. When the current estimates of total contract revenue and contract costs for product development contracts indicate a loss, a provision for the entire loss on the contract is recorded. Any losses incurred in performing funded research and development projects are recognized as funded research and development expenses as incurred. As of September 30, 2005 and 2004, we have accrued approximately $0.1 million and $0.8 million, respectively, for anticipated contract losses.
Cost of product revenue includes material, labor and overhead. Costs incurred in connection with funded research and development and other revenue arrangements are included in funded research and development and other revenue expenses.
Deferred revenue consists of payments received from customers in advance of services performed, product shipped or installation completed.
Unbilled contract costs and fees represent revenue recognized in excess of amounts billed due to contractual provisions or deferred costs that have not yet been recognized as revenue or billed to the customer.
Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. The estimated allowance for uncollectible amounts is based primarily on a specific analysis of accounts in the receivable portfolio and historical write-off experience. While management believes the allowance to be adequate, if the financial condition of our customers were to deteriorate, resulting in impairment of their ability to make payments, additional allowances may be required.
We value our inventory at the lower of actual cost to purchase and/or manufacture the inventory or the current estimated market value of the inventory. We periodically review inventory quantities on hand and record a provision for excess and/or obsolete inventory based primarily on our estimated forecast of product demand, as well as based on historical usage. Due to the custom and specific nature of certain of our products, demand and usage for products and materials can fluctuate significantly. A significant decrease in demand for our products could result in a short-term increase in the cost of inventory purchases and an increase of excess inventory quantities on hand. In addition, our industry is characterized by rapid technological change, frequent new product development, and rapid product obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. Therefore, although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and our reported operating results.
At the end of June 2003, we were actively engaged in selling our Shaker product line, and we were pursuing a strategy that we hoped would lead to a strategic alliance with a larger company for the development and exploitation of the advantages embodied in our Uninterruptible Power Supply (UPS) system. At that time the gross inventory for our Shaker product line inventory totaled approximately $2.1 million and our valuation reserve against that inventory was $2.0 million, or 95%. In addition, we had originally accrued approximately $0.9 million for purchase commitments related to the UPS and Shaker product lines (See Note F. to our Consolidated Financial Statements included in this Annual Report on Form 10-K). The table below details the resulting approximate reduction of costs related to both the inventory reserves of our Shaker and UPS product lines, as well as reserves established related to the purchase commitments as follows:
Although it is unclear how much of the remaining inventory we will sell and during which periods it will occur, as we sell this inventory our cost of product revenue will be lower than normal as this inventory
has been largely written-down. As a result, to the extent this inventory is sold in the future, our margins will be favorably impacted compared with results that would otherwise be achieved.
On December 13, 2005, we sold to Qualmark, Inc. our shaker and amplifier product lines, the associated inventory and intellectual property for proceeds of approximately $2.3 million. We will account the sale of these assets in our first fiscal quarter of 2006.
Investment in Beacon Power Corporation
In September 2001, we owned 4,705,910 shares, or approximately 11.0%, of Beacon Powers outstanding voting stock. We determined that we did not have the ability to exercise significant influence over the operating and financial policies of Beacon Power and, therefore, accounted for our investment in Beacon Power using the fair value method as set forth in Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Debt and Equity Securities. The investment was carried at fair value and designated as available for sale and any unrealized holding gains or losses were to be included in stockholders equity as a component of accumulated other comprehensive income (loss) so long as any unrealized losses were deemed temporary in nature. If the decline in fair value was judged to be other than temporary, the cost basis was written down to the fair value as a new cost basis and the amount of the write-down was included in the statement of operations. The new cost basis would not be changed for subsequent recoveries in fair value. Subsequent increases in the fair value were to be included in stockholders equity as a component of accumulated other comprehensive income (loss). Subsequent decreases in fair value, if not an other-than-temporary impairment, also were to be included in stockholders equity as a component of accumulated other comprehensive income (loss).
As of September 30, 2002, the quoted fair market value of Beacon Powers common stock held by us was $0.17 per share, or $0.8 million. Our historical cost basis in our investment in Beacon Powers common stock was approximately $0.59 per share, or $2.8 million, resulting in an unrealized loss of $2.0 million as of September 30, 2002. We determined that of this $2.0 million, $1.4 million represented an other than temporary decline based on the extent and length of the time the stock price has been below its cost as well as its assessment of the financial condition and near term prospects of Beacon Power. We recorded a charge of $1.4 million in the statement of operations to realize this portion of the loss. This charge was measured based on the trading value of Beacon Powers common stock during the month of November and early December of 2002 and was less than the gross unrealized loss due to subsequent recovery of Beacon Powers stock price, as well as our ability and intent to hold the stock for a long enough period of time for it to recover to the new cost basis. After this write-down, the new cost basis of the Beacon Power common stock held by us was approximately $0.30 per share and the unrealized loss of the Beacon Power common stock held by us was $0.6 million as of September 30, 2002.
As of March 29, 2003, the quoted fair market value of Beacon Powers common stock held by us was $0.18 per share, or $0.8 million. Our cost basis in our investment in Beacon Powers common stock was approximately $0.30 per share, or $1.4 million, resulting in an unrealized loss of $0.5 million as of March 29, 2003. As of March 29, 2003, we believed the difference in the current fair market value and the cost basis of our investment represented an other than temporary decline based upon our ability and intent to hold the stock for a long enough period of time for it to recover. We recorded a charge of $0.5 million in our statement of operations to realize this loss. After the write-down, the new cost basis of the Beacon Power stock held by us was $0.18 per share.
During June and July 2003, we sold all of our 4,705,910 shares of our Beacon Power Corporation common stock for proceeds of $1.7 million, net of fees and commissions. As a consequence of the sale of these shares, we realized a gain of $0.9 million, which is included in our results for the fiscal year ending September 30, 2003.
The following summarizes our investment in Beacon Power Corporation:
In addition, we had a warrant to purchase 173,704 shares of Beacon Powers common stock that had an exercise price of $1.25 per share and expired un-exercised in April 2005. We accounted for this warrant in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and, therefore, recorded the warrant at its fair value. As of September 30, 2005 and 2004, the warrant to purchase Beacon Power common stock had a fair value $0 and $7,036, respectively.
Goodwill and Intangible Assets
Purchase accounting requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair market value of the assets purchased and liabilities assumed. We have accounted for our acquisitions using the purchase method of accounting. Values were assigned to goodwill and intangible assets based on third-party independent valuations, as well as managements forecasts and projections that include assumptions related to future revenue and cash flows generated from the acquired assets.
We have adopted the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. This statement affects our treatment of goodwill and other intangible assets. The statement requires impairment tests be periodically repeated and on an interim basis, if certain conditions exist, with impaired assets written down to fair value. Additionally, existing goodwill and intangible assets must be assessed and classified within the statements criteria. Intangible assets with finite useful lives will continue to be amortized over those periods. Amortization of goodwill and intangible assets with indeterminable lives ceased.
We determine the fair value of each of the reporting units based on a discounted cash flow income approach. The income approach indicates the fair value of a business enterprise based on the discounted value of the cash flows that the business can be expected to generate in the future. This analysis is largely based upon projections prepared by us and data from sources of publicly available information available at the time of preparation. These projections are based on managements best estimate of future results. In making these projections, we consider the markets we are addressing, the competitive environment and our advantages. There will usually be differences between estimated and actual results as events and circumstances frequently do not occur as expected, and those differences may be material. In addition, we perform a macro assessment of the overall likelihood that we would achieve the projected cash flows and performed sensitivity analysis using historical data as the basis for projected cash flows.
We have adopted SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which 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. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets.
The statement requires that long-lived assets be reviewed for possible impairment, if certain conditions exist, with impaired assets written down to fair value.
We determine the fair value of certain of the long-lived assets based on a discounted cash flow income approach. The income approach indicates the fair value of a long-lived assets based on the discounted value of the cash flows that the long-lived asset can be expected to generate in the future over the life of the long-lived asset. This analysis is based upon projections prepared by us. These projections represent managements best estimate of future results. In making these projections, we consider the markets we are addressing, the competitive environment and our advantages. There will usually be differences between estimated and actual results as events and circumstances frequently do not occur as expected, and those differences may be material. In addition, we perform a macro assessment of the overall likelihood that we would achieve the projected cash flows and performed sensitivity analysis using historical data as the basis for projected cash flows.
The preparation of our consolidated financial statements requires us to estimate our income taxes in each of the jurisdictions in which we operate, including those outside the United States, which may be subject to certain risks that ordinarily would not be expected in the United States. The income tax accounting process involves estimating our actual current exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in the recognition of deferred tax assets and liabilities. We must then record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized.
Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against deferred tax assets. We have recorded a full valuation allowance against our deferred tax assets of approximately $40 million as of September 30, 2005, due to uncertainties related to our ability to utilize these assets. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods we may need to adjust our valuation allowance which could materially impact our financial position and results of operations.
Results of Operations
Fiscal Year Ended September 30, 2005 Compared to Fiscal Year Ended September 30, 2004
Product Revenue. Product revenue increased by $2.9 million, or 10.8%, from $27.0 million in fiscal year 2004 to $29.9 million in fiscal year 2005. Product revenue by segment for the fiscal year ended September 30, 2005 and 2004 is as follows:
This increase of approximately $2.9 million in revenue from our Power Systems division for the fiscal year ended September 30, 2005, as compared to the same period in 2004, was largely due to increases in the following lines of business:
· Fuel Cell Inverters line of approximately $0.5 million,
· Solar Converter line of approximately $2.8 million,
· the Plasma Torch line of approximately $2.1 million and
· other increases amounting to approximately $0.5 million.
These increases were partially offset by decreases in the following lines of business, as compared to the same period in 2004:
· Test and Measurement product line of approximately $1.4 million,
· MagLev product line of approximately $0.6 million and
· Rotary UPS line of approximately $0.9 million.
During the fiscal year ended September 30, 2005 we shipped a Rotary UPS to a customer and have deferred approximately $1.3 million in revenue until all elements of revenue recognition are achieved. In fiscal 2004 we recognized revenue of approximately $0.9 million related to a RUPS unit sale for which revenue recognition was deferred in the prior year.
The Electronics division remained relatively flat as compared to the prior year.
Funded research and development and other revenue. Funded research and development and other revenue decreased by $1.1 million, or 16%, from $7.2 million in fiscal year 2004 to $6.1 million in fiscal year 2005. This decrease was primarily attributable to less overall business in our Applied Technology division, delays in starting-up several existing contracts, a decrease in revenue of $1.5 million from a Naval program which existed in fiscal 2004, and a decrease in revenue of $0.6 million from a contract with General Atomics to deliver power converter and control assemblies for the RV Triton, a British research vessel, combined with efforts focused on completing the contract with EDO Corporation in the first and second quarters of fiscal 2005, which took away from our ability to work on other opportunities. The EDO program was completed and delivered during the second quarter of fiscal 2005, and during our fourth quarter ended September 30, 2005 the customer accepted all elements previously delivered by us and we have included approximately $1.5 million in revenue offset by approximately $1.6 million in costs during the period. (See Note L. to our Consolidated Financial Statements included in this Annual Report on Form 10-K). These factors resulted in lower funded research and development and other revenue during fiscal 2005 as compared to same period in fiscal 2004.
Cost of product revenue. Cost of product revenue increased by $5.3 million, or 23.5%, from $22.4 million in fiscal year 2004 to $27.6 million in fiscal year 2005. Cost of product revenue by segment for the fiscal year ended September 30, 2005 and 2004 is as follows:
The increase was primarily attributable to an increase in material costs due to higher sales volume across all divisions, higher material costs, such as steel and copper which are material components to our products, the mix of products sold, and higher manufacturing labor and overhead costs as compared to the same period in fiscal 2004.
Gross Margin. Gross margins on product revenue decreased from 17% for the fiscal year ended September 30, 2004 to 8% for the fiscal year ended September 30, 2005. Gross margin by division is broken out below.
In our Power Systems division, the decrease in gross margin by 12% is a direct result of the product mix for the year as compared to the same period in fiscal 2004, along with higher materials costs and continued manufacturing inefficiencies.
In our Electronics division, the decrease in gross margins by 3% was attributable to the sales mix consisting of lower margin business in conjunction with manufacturing efficiencies and higher materials costs.
Funded research and development and other revenue expenses. Funded research and development and other revenue expenses decreased by $0.6 million, or 10%, from $6.0 million in fiscal year 2004 to $5.4 million in fiscal year 2005. A primary reason for the decrease was directly related to efforts focused on the completion of the EDO contract and less overall business. The gross margin on funded research and other revenue declined from 16.7% in fiscal year 2004 to 11% in fiscal year 2005. The primary reason for the decline in gross margin is directly related to our efforts in completing the EDO contract which led to lower efficiency levels of our staff due to the slower start-up of new programs and the EDO contract which resulted in approximately $1.5 million in revenues offset by approximately $1.6 million in deferred costs, resulting in no margin.
Unfunded research and development expenses. We expended approximately $0.5 million on unfunded research and development in fiscal year 2005 and a minimal amount in fiscal year 2004. Funds were expended in 2005 in order to facilitate new product development and modifications and enhancements to existing products in our Electronics and Power Systems divisions.
Selling, general and administrative expenses. Selling, general and administrative expenses increased by approximately $1.4 million, or 15%, from $9.4 million in fiscal year 2004 to $10.8 million in fiscal year 2005. The increase was primarily the result of approximately $0.5 million incurred as a result of increased head count and payroll related costs across all operating units, approximately $0.2 million related to the settlement of a law suit, approximately $0.2 million in costs related to our efforts to comply with Section 404 of the Sarbanes-Oxley Act, and approximately $0.5 million primarily consisting of increased legal, accounting and other corporate costs, as compared to fiscal 2004 across all operating divisions.
Amortization of intangibles. Amortization of intangibles remained flat at $0.4 million for the fiscal years ended September 30, 2005 and 2004.
Gain on sale of assets. Gain on sale of assets held for sale of approximately $0.3 million consisted of the receipt of payment related to the sale of our SPLC technology in 2004, for which we deferred recognition until payments were received.
Restructuring costs. We recorded a reduction in accrued restructuring costs of $255,512 during fiscal 2005. This reduction was a direct result of our determining that the remaining balance was no longer warranted. (See Note V. to our Consolidated Financial Statements included in this Annual Report on Form 10-K).
Write-off of long-lived assets. We recorded a $1.2 million charge representing an impairment in the carrying value of the long-lived assets in our Worcester, Massachusetts manufacturing facility. Based in large part on our recent history, we prepared a cash flow forecast of the Worcester facilities product lines over four and a half years, the remaining life of our current lease on the facility. Based on these cash flow projections we do not expect to recoup the value of our long-lived assets in our Power Systems Worcester Division. The assets evaluated, before the write-down, approximate a net book value of $1.2 million and are comprised primarily of leasehold improvements and plant equipment. Given this situation, we performed a fair market analysis of these assets and determined that a $1.2 million charge was required in our fiscal fourth quarter representing an impairment of these long-lived assets.
Net realized and unrealized loss on warrants to purchase common stock. Net realized loss on warrants to purchase common stock in fiscal year 2005 was approximately $7,000 compared to a net unrealized loss of approximately $100,000 in 2004. We accounted for our warrants to purchase Mechanical Technology Incorporateds common stock and to purchase Beacon Power Corporations common stock in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and, therefore, we have recorded these warrants at their fair value at June 26, 2004. Our warrants to purchase Mechanical Technology Incorporateds common stock expired un exercised on October 21, 2003 and January 31, 2004. Our warrants to purchase Beacon Power Corporations common stock expired un exercised on April 7, 2005.
Other (loss) income. Other expense was approximately $0.1 million in fiscal 2005. This consisted primarily of the payment of state taxes from prior years.
Interest expense. Interest expense was approximately $0.7 million for fiscal year 2005 compared with approximately $6.9 million for fiscal year 2004, a decrease of approximately $6.2 million. Interest expense in fiscal 2005 includes non-cash interest of approximately $350,000 associated with our December 2004 financing transaction and our August 2005 financing transaction and the related anti-dilution effects on the Series B preferred stock and warrants issued with the Series B preferred stock. In addition, non-cash interest of approximately $127,500 related to the issuance of common stock in lieu of cash dividends for the Series B Preferred Stock. In addition, during the fiscal year ended September 30, 2005 we had borrowing under our credit facility with Silicon Valley Bank, and interest expense related to our line of credit during this period was approximately $35,000. In addition, we amortized a portion of the value of the warrants issued in connection with the Loan Modification and related fees of approximately $95,000 and interest related to lease obligations during fiscal 2005 was approximately $75,000. There were no outstanding amounts under the line of credit at September 30, 2005. Interest expense for fiscal year 2004 was comprised of virtually all non-cash items, including $6.1 million amortization of discount on the convertible redeemable Series B Preferred Stock, $0.2 million amortization of the discount on the subordinated convertible debentures, $0.2 million associated with the redeemable convertible Series A Preferred Stock and subordinated debentures, $0.2 million associated with the line of credit with Silicon Valley Bank and $0.1 million associated with the Series B Preferred Stock, offset by a benefit from the negotiated reduction in fees associated with the February 2003 financing transaction.
Fiscal Year Ended September 30, 2004 Compared to Fiscal Year Ended September 30, 2003
Product Revenue. Product revenue increased by $5.3 million, or 24.6%, from $21.6 million in fiscal year 2003 to $27.0 million in fiscal year 2004.
Nearly all of the increase in revenue came from our Power Systems division and was due to increased sales across all product lines, most noticeably in our Magnetics and Power Conversion products. In addition, our Power Systems revenue included approximately $0.9 million of revenue that was deferred as of September 30, 2003 related to two UPS systems for which certain conditions were not fulfilled, requiring deferral until those conditions were satisfied in fiscal 2004.
Funded research and development and other revenue. Funded research and development and other revenue increased by $1.9 million, or 36%, from $5.3 million in fiscal year 2003 to $7.2 million in fiscal year 2004. This increase was primarily attributable to an increase in revenue of $1.7 million from a Naval program and $0.9 million from a photovoltaics contract. These increases were offset in part by a $0.7 million reduction in revenue from the wind down of a contract with General Atomics to develop integrated power systems for the future U.S. Navys all-electric ship.
Cost of product revenue. Cost of product revenue decreased by $3.5 million, or 14%, from $26.0 million in fiscal year 2003 to $22.4 million in fiscal year 2004 despite the increase in product revenue of $5.3 million.
The decrease was primarily attributable to two factors: lower manufacturing cost structure and the absence of the $2.7 million charge incurred in the third quarter of fiscal 2003 to reduce the carrying value of inventory. These factors were offset in part, however, by an increase in higher materials cost associated with the increase in sales volume. In addition, we sold products that contained certain materials, which had been substantially written down or reserved which resulted in reduced costs. This improved gross margin by $0.7 million during 2004. As a result of these changes and higher sales volumes, gross margins improved from (20%) in 2003, to 17% in 2004.
Funded research and development and other revenue expenses. Funded research and development and other revenue expenses increased by $1.0 million, or 20%, from $5.0 million in fiscal year 2003 to $6.0 million in fiscal year 2004. The total in 2004 includes $0.9 million accrued on fixed price contracts where we expect to incur additional future losses. During fiscal year 2003, we began work on a $1.1 million program with EDO Corporation for the design and development of a power converter for a new mine sweeping system for the U.S. Navys Organic Airborne and Surface Influence Sweep system (OASIS). This contract was subsequently increased to $1.5 million during fiscal year 2004. We have deferred recognizing revenue on this program until the contract is complete. In fiscal year 2004 and 2003, approximately $0.9 million and $0.6 million of the contract loss was incurred which relates to the contract with EDO Corporation, of which approximately $0.5 million was accrued in the fourth quarter of fiscal 2004. The gross margin on funded research and other revenue improved from 5% in fiscal year 2003 to 17% in fiscal year 2004. This improvement is primarily reflective of an increase in revenues.
Unfunded research and development expenses. We did not expend funds on unfunded research and development in fiscal year 2004 compared with $1.5 million in fiscal year 2003. The primary reason for this reduction in unfunded research and development expenses was due to the completion of the UPS development activity and, to a lesser degree, the elimination of the radio frequency research effort in our Electronics division.
Selling, general and administrative expenses. Selling, general and administrative expenses decreased by $4.2 million, or 31%, from $13.6 million in fiscal year 2003 to $9.4 million in fiscal year 2004. Approximately half of this decrease was due to a reduction in the selling and administrative cost structure in our Power Systems division. The remaining reduction was also due to reduced spending in our corporate costs reflecting general streamlining of outside services and internal staffing.
Amortization of intangibles. Amortization of intangibles decreased by $0.1 million from $0.5 million in fiscal year 2003 to $0.4 million in fiscal year 2004.
Write-off of long-lived assets. There were no write offs of long-lived assets in fiscal year 2004. In fiscal year 2003, we recorded a $0.7 million charge representing an impairment in the carrying value of the long-lived assets in our Worcester, Massachusetts manufacturing facility. This was required as a result of our decision to streamline our operations. We had decided to reduce our UPS sales, our Shaker product line, marketing and development effort and planned to form a strategic alliance with a major company. In this scenario, our Worcester facility will have the Magnetics (Servo Motors and its Maglev products), EPT and StarSine as its remaining product lines. Based in large part on our recent history, we prepared a cash flow forecast of these products over the 7 yearsrepresenting the current lease and our 5-year option to extend. At that time we did not expect to recoup the value of our long-lived assets. These assets, before write-down, approximate $3.2 million and are comprised primarily of leasehold improvements made within the last few years. Given this situation, we performed a fair market analysis of this asset and determined that a $0.7 million charge was required in our fiscal third quarter of 2003 representing an impairment of this long-lived asset. Subsequently, late in calendar 2003, we decided to retain our Shaker product line due in part to a significant improvement in our liquidity situation and increased demand for the product. In fiscal year 2006 we sold the Shaker product line, as discussed in more detail under Recent Developments.
Write-off of impaired goodwill and intangible assets. There were no write offs of impaired goodwill and intangible assets in fiscal year 2004. In fiscal year 2003, we experienced a significant adverse change in the business climate, in particular, significant reductions in revenue and cash flows. This coupled with our current liquidity issues at that time, required us to consider selling assets unrelated to our engineering and manufacturing expertise in electromechanical systems. The assets and product lines we considered selling included our Ling Shaker product line, our patented smart predictive line control technology utilized by the electric arc steel manufacturing industry and patents acquired from Northrop Grumman related to the
hybrid electric vehicles. Based on these conditions, we performed an impairment test on an interim basis. We determined the fair value of each of the reporting units based on a discounted cash flow income approach. This analysis was largely based upon historical data. Based on the results of the first step of the goodwill impairment test, we determined that the fair value of the Applied Technology and Electronics reporting units exceeded their carrying amounts and, therefore, no goodwill impairment existed as of March 29, 2003. As a result, the second step of the goodwill impairment test was not required to be completed. We will continue to perform a goodwill impairment test for these reporting units on an annual basis and on an interim basis, if certain conditions exist. Based on the results of the first step of the goodwill impairment test, we determined that the fair value of the Power Systems reporting unit did not exceed its carrying amount. The fair value was determined to approximate the fair value of the net tangible assets. The second step of the impairment test required us to write off the unamortized balance of the goodwill and intangible assets of the Power Systems reporting unit as of March 29, 2003 of $5.8 million. Late in calendar 2003, we decided to retain our Shaker product line due in part to a significant improvement in our liquidity situation. However, we continued to consider selling our patented smart predictive line control technology utilized by the electric arc steel manufacturing industry, which was sold in fiscal year 2004, and patents acquired from Northrop Grumman related to hybrid electric vehicles.
Net realized and unrealized gain/(loss) on warrants to purchase common stock. We incurred a $0.1 million net unrealized loss on warrants to purchase common stock in fiscal year 2004, compared with an unrealized gain of $0.1 million in 2003. We account for our warrants to purchase Mechanical Technology Incorporateds common stock and to purchase Beacon Power Corporations common stock in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and, therefore, we have recorded these warrants at their fair value at September 30, 2004. Our warrants to purchase Mechanical Technology Incorporateds common stock expired unexercised on October 21, 2003 and January 31, 2004 and we no longer account for these warrants in accordance with SFAS No. 133.
Write-down of investment in Beacon Power Corporation. We accounted for our investment in Beacon Power using the fair value method as set forth in SFAS No. 115, Accounting for Certain Debt and Equity Securities. As of March 29, 2003, the quoted fair market value of Beacon Powers common stock held by us was $0.18 per share, or $0.8 million. Our cost basis in our investment in Beacon Powers common stock was approximately $0.30 per share, or $1.4 million, resulting in an unrealized loss of $0.5 million as of March 29, 2003. As of March 29, 2003, we believed the difference in the current fair market value and the cost basis of our investment represented an other than temporary decline based upon our ability and intent to hold the stock for a long enough period of time for it to recover. We recorded a charge of $0.5 million in the statement of operations to realize this loss. After the write-down, the new cost basis of the Beacon Power stock held by us was $0.18 per share. During 2003, we sold all of our shares of Beacon Power Corporation common stock.
Realized gain from sale of Beacon Power Stock. During June 2003, we commenced the sale of the 4,705,910 shares of Beacon Power Corporation common stock. Through June 28, 2003, we had sold 3,996,626 of those shares for proceeds of $1.5 million, net of fees and commissions. As a consequence of the sale of these shares, we realized a gain of $0.8 million. The remaining shares were sold early in our fiscal fourth quarter of 2003 and we realized a gain of $0.1 million, which was included in our results for the fiscal quarter ended September 30, 2003.
Interest expense. Interest expense was $6.9 million for fiscal year 2004 compared with $4.0 million for fiscal year 2003, an increase of $2.9 million. Interest expense for fiscal year 2004 was virtually all comprised of non-cash items, including $6.1 million amortization of discount on the convertible redeemable Series B Preferred Stock, $0.2 million amortization of the discount on the subordinated convertible debentures, $0.2 million associated with the redeemable convertible Series A Preferred Stock and subordinated debentures, the amortization of the fair value, as determined using the Black-Scholes option pricing model, of the warrants we issued in connection with our existing line of credit of $0.1 million and
$0.1 million associated with the Series B Preferred Stock, offset by a benefit from the negotiated reduction in fees associated with the February 2003 transaction. Interest expense for the fiscal year ended September 30, 2003 includes the following: $0.1 million fees associated with the line of credit; $0.2 million of interest expense associated with outstanding amounts under the line of credit; $0.3 million of expense associated with the issuance of warrants in connection with the line of credit; $0.1 million of fess associated with forbearances of loan covenant violations; $0.1 million on capital lease obligations; $2.5 million amortization of discount on the convertible redeemable Series A preferred stock; $0.2 million dividends on convertible redeemable Series A preferred stock; and $0.4 million of amortization of discount on the convertible subordinated debentures.
The following table presents unaudited quarterly statement of operations data for the eight quarters ended September 30, 2005. This data has been prepared on a basis consistent with our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. This data includes all adjustments, consisting solely of normal recurring adjustments, which we believe necessary for a fair presentation of this information. The historical quarterly data for the quarters ended January 1, 2005, April 2, 2005 and July 2, 2005 have been adjusted to reflect the reclassification of amounts previously accounted for as cost of product sales to un-funded research and development expenses. The impact of the reclassification is as follows:
The operating results for any quarter are not necessarily indicative of results to be expected for any future period.
Liquidity and Capital Resources
As of September 30, 2005, we had $6.7 million of cash, of which $0.1 million was restricted. At that time no funds had been drawn against our $7.0 million line of credit with Silicon Valley Bank. The maximum amount we can borrow under this agreement is $7.0 million based upon 80% of eligible receivables. As of September 30, 2005, approximately $4.1 million could have been borrowed based on the level of eligible receivables.
On December 22, 2004, we sold 4,848,485 shares of common stock under a universal shelf registration statement directly to a group of investors for proceeds of $7,470,000, net of transaction costs. As part of the December 22, 2004 financing we also issued warrants to purchase up to 2,181,818 shares of common stock.
These warrants have an exercise price of $2.00 per share. These warrants are immediately exercisable and expire on December 21, 2009. A portion of the proceeds was used to pay off amounts outstanding under the line of credit.
On June 29, 2005, our Loan and Security Agreement (the Loan) with Silicon Valley Bank (the Bank) was modified pursuant to a Loan Modification Agreement (the Modification Agreement). The Modification Agreement has an effective date of May 31, 2005. Under the Modification Agreement, certain financial covenants relating to tangible net worth and minimum cash, which covenants we must satisfy in order to continue to borrow from the Bank, were modified. The Bank also provided a waiver for our failure to comply with the minimum tangible net worth requirements as of May 31, 2005. In addition, certain conditions precedent to the making of advances were also modified. The Loan Agreement, as amended, will expire on January 30, 2006. As consideration for the modifications, we (i) paid the Bank a modification fee of $20,000 and (ii) issued to the Bank a 10-year warrant to purchase 151,515 shares of our common stock at an exercise price of $1.386 per share. We valued these warrants at $119,427 using the Black-Scholes option pricing model with the following assumptions: an expected life of seven years, expected volatility of 52.3%, no dividends, and risk-free interest rate of 4.0%. The value of these warrants will be amortized ratably over the remaining term of the Loan Agreement.
On August 15, 2005, we sold 4,676,151 shares of Common Stock to accredited investors for proceeds of approximately $5.2 million, net of transaction costs. As part of this financing we also issued warrants to purchase up to 1,169,038 shares of Common Stock. These warrants have an exercise price of $1.99 per share, are immediately exercisable and expire on August 2, 2010.
On November 21, 2005, we entered into a Second Loan Modification and Security Agreement (the Second Loan Modification Agreement) with the Bank. The Second Loan Modification Agreement modifies the Loan Agreement, as previously amended. Under the Second Loan Modification Agreement, the Bank modified the terms related to the collection of receivables for amounts outstanding under the Loan Agreement, as well as the minimum tangible net worth covenant, as defined, which we must maintain in order to continue to borrow from the Bank. The Bank also provided waivers for our failure to comply with the minimum tangible net worth requirements as of August 6, 2005 and September 30, 2005. In addition, the Second Loan Modification Agreement provides the ability to borrow up to $3,000,000 on a revolver basis paying only interest provided that we remain in compliance with all financial covenants, as defined. The Loan Agreement, as amended, will expire on January 30, 2006. We paid the Banks legal costs associated with the Second Loan Modification Agreement, which were approximately $5,000.
On December 14, 2005, we sold to Qualmark, Inc. our Shaker and Amp product lines, the associated inventory and intellectual property for proceeds of approximately $2.3 million. We will account for the sale of these assets in our first fiscal quarter of 2006.
We anticipate that our current cash, cash from the sale of our shaker and amplifier product lines, together with the ability to borrow under the Loan Agreement, as amended, will be sufficient to fund our operations at least through September 30, 2006. This assumes that we will achieve our business plan, be able to amend or extend our current agreement with the Bank at least through September 30, 2006, and remain in compliance with all Loan Agreement covenants, as amended. The business plan envisions a significant increase in revenue and significant reductions in the cost structure and the cash burn rate from the results experienced in the recent past. If, however, we are unable to realize our business plan, and are unable to agree upon and remain in compliance with our amended Loan Agreement with the Bank, we may be forced to raise additional funds by selling stock or taking other actions to conserve our cash position.
If additional funds are raised in the future through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and our stockholders may experience additional dilution. The terms of additional funding may also limit our operating and financial
flexibility. There can be no assurance that additional financing of any kind will be available to us on terms acceptable to us, or at all. Failure to obtain future funding when needed or on acceptable terms would materially, adversely affect our results of operations.
Our financial statements for our fiscal year ended September 30, 2005, which are included in this Annual Report on Form 10-K, contain an audit report from Grant Thornton LLP. The audit report contains a going concern qualification, which raises substantial doubt with respect to our ability to continue as a going concern. However, our business plan, which envisions a significant improvement in results from the recent past, contemplates sufficient liquidity to fund operations at least through September 30, 2006. The receipt of a going concern qualification may create a concern among our current and future customers and vendors as to whether we will be able to fulfill our contractual obligations.
We have incurred significant costs to develop our technologies and products. These costs have exceeded total revenue. As a result, we have incurred losses in each of the past five years. As of September 30, 2005, we had an accumulated deficit of $137.9 million. Since inception, we have financed our operations and met our capital expenditure requirements primarily through the sale of private equity securities, public security offerings, and borrowings on our line of credit and capital equipment leases.
As of September 30, 2005, our cash and cash equivalents were $6.7 million, including restricted cash and cash equivalents of $0.1 million; this represents an increase in our cash and cash equivalents of approximately $4.5 million from the $2.2 million on hand at September 30, 2004. Cash used in operating activities for the twelve months ended September 30, 2005 was $7.9 million as compared to $5.5 million for the twelve months ended September 30, 2004. Cash used in operating activities during the twelve months ended September 30, 2005 was primarily attributable to the net loss of $10.2 million offset by non-cash items such as write-off of impaired long-lived assets, depreciation and amortization, deferred revenue, increases in allowances for uncollectible accounts and excess and obsolete inventory, non-cash compensation and consulting expense, non-cash interest expense and decreases in working capital.
Cash used in investing activities during the twelve months ended September 30, 2005 was $0.3 million as compared to $0.4 million for the twelve months ended September 30, 2004. Cash used in investing activities during the fiscal year ended September 30, 2005 and 2004, was a result of capital expenditures during each of the respective periods.
Cash provided by financing activities for the twelve months ended September 30, 2005 was $12.7 million as compared to $6.9 million for the twelve months ended September 30, 2004. Net cash provided by financing activities during fiscal 2005 includes $7.5 million of net proceeds from the December 2004 financing transaction, $5.2 million of net proceeds from the August 2005 financing transaction and approximately $0.2 million received from the exercise of incentive stock options, offset in part by approximately $0.2 million related to payments on our capital lease obligations. Net cash provided by financing activities during the twelve months ended September 30, 2004 includes $7.0 million of proceeds from the sale of the redeemable convertible Series B Preferred Stock and the convertible subordinated debentures, $1.9 million of proceeds from the exercise of warrants to purchase common stock, offset in part by a repayment of $1.8 million in bank borrowings and $0.3 million repayment of long-term debt.
We lease equipment and office space under non-cancelable capital and operating leases. Future minimum rental payments, as of September 30, 2005, under the capital and operating leases with non-cancelable terms are as follows:
We believe that inflation and changing prices over the past three years have not had a significant impact on our net revenue or on our income from continuing operations.
In December 2004, the FASB issued SFAS No. 123 (Revised 2004) Share-Based Payment (SFAS No. 123R). SFAS No. 123R addresses all forms of share-based payment (SBP) awards, including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. SFAS No. 123R will require Satcon to expense SBP awards with compensation cost for SBP transactions measured at fair value. The FASB originally stated a preference for a lattice model because it believed that a lattice model more fully captures the unique characteristics of employee stock options in the estimate of fair value, as compared to the Black-Scholes model which Satcon currently uses for its footnote disclosure. The FASB decided to remove its explicit preference for a lattice model and not require a single valuation methodology. SFAS No. 123R requires Satcon to adopt the new accounting provisions beginning in our first quarter of 2006. The effects of adopting this standard will depend on our future stock option activity and the term of options granted.
On December 21, 2004, the FASB issued FASB Staff Position 109-1, Application of FASB Statement No.109, Accounting for Income Taxes (SFAS No. 109), to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004 (The Act) (FSP 109-1). FSP 109-1, which was effective upon issuance, states the deduction under this provision of the Act should be accounted for as a special deduction in accordance with SFAS 109. As we have substantial net operating losses, which would need to be utilized first, it is unlikely that we would benefit from this Act.
The Act also allows for an 85% dividends received deduction on the repatriation of certain earnings of foreign subsidiaries. On December 21, 2004, the FASB issued FASB Staff Position 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 (FSP 109-2). FSP 109-2, which was effective upon issuance, allows companies time beyond the financial reporting period of enactment to evaluate the effect of the Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. Additionally FSP 109-2 provides guidance regarding the required disclosures surrounding a companys reinvestment or repatriation of foreign earnings. Currently, we do not expect to repatriate foreign earnings.
In May 2005, the FASB issued Statement 154, Accounting Changes and Error Correctionsa replacement of APB Opinion No. 20 and FASB Statement No. 3, or FAS 154. FAS 154 changes the accounting for and reporting of a change in accounting principle. The provisions of FAS 154 require, unless impracticable, retrospective application to prior periods financial statements of (1) all voluntary
changes in accounting principles and (2) changes required by a new accounting pronouncement, if a specific transition is not provided. FAS 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate, which requires prospective application of the new method. FAS 154 is effective for all accounting changes made in fiscal years beginning after December 15, 2005.
The following discussion about our market risks disclosures involves forward-looking statements. Actual results could differ materially from those discussed in the forward-looking statements. We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We do not use derivative financial instruments for speculative or trading purposes.
Interest Rate Risk
We are exposed to market risk from changes in interest rates primarily through our financing activities. Interest on outstanding balances under the Loan Agreement accrues at a rate equal to the Banks prime rate of interest plus 3.0% per annum. Our ability to carry out our business plan or our ability to finance future working capital requirements may be impacted if the cost of carrying debt fluctuates to the point where it becomes a burden on our resources.
Foreign Currency Risk
Nearly all of our sales outside the United States are priced in US Dollars. If the US Dollar strengthens versus local currencies, it may result in our products becoming more expensive in foreign markets. In addition, approximately 15-20% of our costs are incurred in foreign currencies, especially the Canadian Dollar. If the US Dollar weakens versus these local currencies, it may result in an increase in our cost structure.
To the Board of Directors and Shareholders of
We have audited the accompanying consolidated balance sheets of SatCon Technology Corporation and its subsidiaries (the Company) (a Delaware corporation) as of September 30, 2005 and 2004 and the related consolidated statements of operations, changes in stockholders equity and comprehensive loss and cash flows for each of the three years in the period ended September 30, 2005. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of SatCon Technology Corporation and its subsidiaries as of September 30, 2005 and 2004 and the consolidated results of their operations and their cash flows for each of the three years in the period ended September 30, 2005, in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note B to the consolidated financial statements, during the fiscal year ended September 30, 2005, the Company incurred a net loss of $10.2 million and used $7.9 million in its operating activities. In addition, the Company has historically incurred losses and used cash, rather than provided cash, from operations. The Company currently has a line of credit agreement which expires on January 30, 2006. The line of credit contains certain restrictive covenants. The Company needs to continue to maintain certain monthly tangible net worth milestones in order to remain in compliance with the loan. The Company believes that in order to remain in compliance it will need to reach an estimated breakeven cash run rate. These factors, among others, as discussed in Note B to the consolidated financial statements, raise substantial doubt about the Companys ability to continue as a going concern. Managements plan in regards to these matters is also described in Note B. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.