Annual Reports

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  • 10-K (Apr 27, 2012)
  • 10-K (Apr 29, 2011)
  • 10-K (Mar 15, 2011)
  • 10-K (Mar 12, 2010)
  • 10-K (Mar 12, 2009)

 
Quarterly Reports

 
8-K

 
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SatCon Technology 10-K 2007

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Year Ended December 31, 2006

Commission file number 1-11512


SATCON TECHNOLOGY CORPORATION

(Exact name of registrant as specified in its charter)

DELAWARE

04-2857552

(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer
Identification Number)

27 Drydock Avenue, Boston, Massachusetts

02210

(Address of principal executive offices)

(Zip Code)

 

(617) 897-2400

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of Class

 

Name of Exchange on Which Registered

Common Stock, $.01 Par Value

 

The NASDAQ Stock Market, LLC

 

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 registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o

Accelerated filer o

Non-accelerated Filer 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 registrant’s Common Stock, $.01 par value per share, held by non-affiliates of the registrant was $68,018,065 based on the last reported sale price of the registrant’s Common Stock on the Nasdaq Capital Market as of the close of business on the last business day of the registrant’s most recently completed second quarter ($1.89). There were 41,536,053 shares of Common Stock outstanding as of March 1, 2007.

DOCUMENTS INCORPORATED BY REFERENCE:  Portions of the registrant’s Proxy Statement for its 2007 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.

 




SatCon Technology Corporation

TABLE OF CONTENTS

 

 

 

 

 

PAGE

Part I

 

 

 

 

 

 

 

 

Item 1.

 

Business

 

3

 

 

 

Item 1A.

 

Risk Factors

 

15

 

 

 

Item 1B.

 

Unresolved Staff Comments

 

25

 

 

 

Item 2.

 

Properties

 

25

 

 

 

Item 3.

 

Legal Proceedings

 

25

 

 

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

25

 

Part II

 

 

 

 

 

 

 

 

 

Item 5.

 

Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

26

 

 

 

Item 6.

 

Selected Consolidated Financial Data

 

28

 

 

 

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operation

 

30

 

 

 

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

50

 

 

 

Item 8.

 

Consolidated Financial Statements and Supplementary Data

 

51

 

 

 

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

107

 

 

 

Item 9A.

 

Controls and Procedures

 

107

 

 

 

Item 9B.

 

Other Information

 

107

 

Part III

 

 

 

 

 

 

 

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

108

 

 

 

Item 11.

 

Executive Compensation

 

108

 

 

 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

108

 

 

 

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

 

108

 

 

 

Item 14.

 

Principal Accounting Fees and Services

 

108

 

Part IV

 

 

 

 

 

 

 

 

 

Item 15.

 

Exhibits, Financial Statement Schedules

 

109

 

 

 

Signatures

 

110

 

 

2




PART I

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 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. 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. Management’s 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.

Item 1.                        BUSINESS

Overview

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.

Recent Developments

On July 19, 2006, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with thirteen institutional investors (the “Purchasers”) in connection with the private placement (the “Private Placement”) of:

·       $12,000,000 aggregate principal amount of senior secured convertible notes (the “Notes”), convertible into shares of our common stock at a conversion price of $1.65 per share;

·       Warrant A’s to purchase up to an aggregate of 3,636,368 shares of our common stock at a price of $1.815 per share for a period beginning six months from the date of such warrants and ending on the seventh anniversary of the date of such warrants; and

·       Warrant B’s to purchase up to an aggregate of 3,636,368 shares of our common stock at a price of $1.68 per share for a period of 90 trading days beginning the later of six months from the date of such warrants and the date the Securities and Exchange Commission (the “SEC”) declares effective a shelf registration statement covering the resale of the common stock underlying the securities issued in the Private Placement (the “Registration Statement”); to the extent the Warrant B’s are exercised, the Purchasers will receive additional seven-year warrants to purchase a number of shares of common stock equal to 50% of the number of shares of common stock purchased upon exercise of the Warrant B’s at a price of $1.815 per share. Because the registration statement was declared effective on September 27, 2006, these warrants were originally exercisable for the 90 trading day period beginning six months from the date of such warrants (i.e. May 30, 2007). As discussed below, in connection with an amendment to the Purchase Agreement enabling us to issue common stock for the early termination of the lease for our Worcester facility, the expiration date of the Warrant B’s was extended to August 31, 2007.

3




The net proceeds of the sale were approximately $11 million, after deducting placement fees and other offering-related expenses. In connection with the Private Placement, we also entered into a Security Agreement, dated July 19, 2006, with the Purchasers (the “Security Agreement”).

In addition, First Albany Capital (“FAC”) acted as placement agent in connection with the Private Placement. In addition to a cash transaction fee of $590,000, FAC or its designees were entitled to receive five-year warrants to purchase 218,182 shares of our common stock at an exercise price of $1.87 per share. At the discretion of FAC, these warrants were issued to First Albany Companies, Inc., the parent of FAC. We also paid Ardour Capital, our financial advisor, approximately $250,000 for its services related to the Private Placement.

In connection with, and as a condition precedent to, the completion of the Private Placement, on July 20, 2006, we paid all amounts due and owing under our credit facility with Silicon Valley Bank (approximately $2 million) and terminated such facility. In doing so we incurred a termination fee of $17,500 and legal fees of $8,500.

See Note G to our consolidated financial statements included in this Annual Report on Form 10-K for a detailed description of the Notes and related warrants.

As a result of our failure to comply with the continued listing requirements of the Nasdaq Global Market (in particular, the requirement that the market value of our common stock be at least $50,000,000), on October 17, 2006 we applied to transfer our securities to The Nasdaq Capital Market. On October 23, 2006 we received notification that our application for listing with the Nasdaq Capital Market was approved. Our stock began trading on the Nasdaq Capital Market at the opening of business on October 25, 2006.

On September 19, 2006, our Board of Directors approved a change in our fiscal year end from September 30 to December 31. As a result, the financial periods presented and discussed in this Annual Report on Form 10-K will be defined as follows:

1.

Year ended December 31, 2006 represents the twelve months ended December 31, 2006,

2.

Three-month transition period ended December 31, 2005 represents the three months ended December 31, 2005,

3.

Fiscal year ended September 30, 2005 represents the twelve month period ended September 30, 2005, and

4.

Fiscal year ended September 30, 2004 represents the twelve month period ended September 30, 2004.

 

On September 19, 2006, our Board of Directors approved a plan to close our Worcester, Massachusetts manufacturing facility by approximately December 31, 2006. The decision to close this facility was in furtherance of our continuing efforts to streamline operations and reduce operating costs. We intend to focus spending on our renewable energy business. As a result of this decision, we recorded approximately $1.6 million related to lease termination costs, warrant revaluation, employee severance and retention bonuses and asset impairments, in our results of operations for the year ended December 31, 2006. Additionally, we anticipate incurring approximately $0.1 million related to employee severance and retention bonus’ which will be paid out during 2007. We currently expect this action will result in a reduction of total overhead expenses of rent, facility and personnel costs of approximately $3.0 million per year.

On December 20, 2006, we entered into a Modification, Termination and Release of Lease (the “Termination Agreement”) with Paul E. Hanlon, Trustee of C&M Realty Trust (the “Landlord”), the landlord with respect to the lease for our manufacturing facility located in Worcester, Massachusetts (the “Worcester Facility”). Our execution of, and performance under the Termination Agreement was in

4




furtherance of our efforts to streamline operations and reduce operating costs. Under the existing lease for the Worcester Facility, the aggregate base rent payable for the remaining term of the lease was approximately $1.3 million. Pursuant to the Termination Agreement, as consideration for the early expiration of the lease, we issued to the Landlord 850,000 shares of our common stock (the “Shares”) on January 2, 2007. Under the Termination Agreement, the lease expired on February 15, 2007.

On December 20, 2006, we entered into a First Amendment to Securities Purchase Agreement (the “Amendment”) with certain of the Purchasers who participated in the Private Placement

Pursuant to the Amendment:

·       the definition of “Excluded Stock” set forth in the Purchase Agreement was amended to enable us to issue up to 1.1 million shares of our common stock in connection with the early termination of the lease for the Worcester facility, without such shares being subject to the Purchasers’ right of participation set forth in the Purchase Agreement and certain prohibitions set forth in the Notes and related warrants (as noted above, we ultimately settled the lease for 850,000 shares); and

·       we agreed to extend the expiration date of the Warrant B’s issued in the Private Placement from May 30, 2007 to August 31, 2007.

As a result of the extension of the expiration date of the Warrant B’s, we recorded a non-cash charge of approximately $193,117 in the period ended December 31, 2006.

Our History, Beginning in R & D and Transitioning to a Product Based Corporation

From inception in 1985, through the early 1990’s, 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 1990’s, 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 1990’s, 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, uninterruptible power supplies and ride-through devices for applications requiring high quality sustainable power, specialty magnetically levitated products and microelectronics primarily used in high reliability applications.

Building Our Capability Through Acquisitions

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 (although we sold our shaker and amplifier product lines in 2005). 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 Inverpower’s UL and CE certification

5




capability. In September 2002, we acquired the machinery, inventory, backlog and intellectual property of Sipex Corporation’s 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.

In fiscal year 2006 we increased our focus on power distribution and alternative energy as high growth potential markets for SatCon’s products.

Alternative Energy

We believe that the fastest growth area for SatCon involves alternative energy and distributed power generation. We sell solar (photo-voltaic) power installations and high power inverters for stationary fuel cell power plants. 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 2006 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.

Hybrid Electric Vehicles

SatCon has had extensive experience since the mid 1990’s in advanced technology applicable to hybrid electric vehicles, or HEV’s, and holds significant intellectual property in this area. In fiscal 2006, 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. In addition, 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.

Other Products and Markets

In addition, we have seen increased revenue from our new high reliability microelectronic products for space and avionics applications. We participated in several defense related development programs through our Small Business Innovative Research (“SBIR’s”) projects, our Cooperative Agreement with the Army Research Laboratory and as a sub-contractor to prime contractors such as General Dynamics and the Electric Boat Corporation.

Our products are described in more detail under the “Products by Business Segment.

Revenue Comparison with Prior Years

 

 

Year Ended

 

Three Months Ended

 

 

 

 

 

December 31,

 

December 31,

 

Year Ended September 30,

 

 

 

2006

 

2005

 

2005

 

2004

 

United States

 

$

30,475,297

 

 

$

6,662,983

 

 

$

32,570,592

 

$

30,424,627

 

International

 

3,281,372

 

 

454,098

 

 

3,384,520

 

3,733,196

 

Total

 

$

33,756,669

 

 

$

7,117,081

 

 

$

35,955,112

 

$

34,157,823

 

 

Reports

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

6




as reasonably practicable after such reports are electronically filed with the SEC. These reports may be accessed through our website’s investor relations page at www.satcon.com/investors/facts.html.

Industry Background

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 have 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 SatCon’s technical expertise to meet these needs for power control products in emerging global markets for alternative energy, energy storage and power quality systems, distributed power systems, hybrid electric vehicles and high-reliability defense systems.

SatCon Product Attributes

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 Underwriter’s Laboratory protocol to objectively measure the product’s efficiency. The twelve

7




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 quality and reliability reserved for these classes. Our Electronics business segment operates with Quality Management Systems and is certified as ISO 9001:2000 compliant. Our Applied Technology business segment is also ISO 9001:2000 certified.

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.

Strategy

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. We also produce 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 2006 we built relationships and were funded through SBIR’s 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. We also continue to develop and deepen the relationships we have for manufacturing or motor products in China.

8




Financial Results by Business Segment

Our financial results by business segments for the calendar year ended December 31, 2006, the three-month transition period ended December 31, 2005 and fiscal years ended September 30, 2005 and 2004 are presented in Note S to the Consolidated Financial Statements included in this Annual Report on Form 10-K.

Products by Business Segment

Our products are sold through our four business segments: SatCon Power Systems US, Satcon Power Systems, Canada, SatCon Electronics and SatCon Applied Technology.

SatCon Power Systems

SatCon Power Systems manufactures and sells our high power line of power control systems StarSine™ amplifiers and power converters. We also make and sell Rotary UPS Systems for back-up power and power quality. In 2006 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 the year ended December 31, 2006 and our fiscal years ended September 30, 2005 and 2004 from our Power Systems business unit were as follows:

 

 

Year Ended

 

Year Ended

 

 

 

December 31,

 

September 30,

 

Product Revenue

 

 

 

2006

 

2005

 

2004

 

 

 

(Amounts in Millions)

 

Alternative Energy Products

 

 

$

10.6

 

 

$

6.1

 

$

2.8

 

Industrial Power

 

 

1.3

 

 

0.3

 

 

Plasma

 

 

 

 

2.6

 

0.7

 

Frequency Converters

 

 

1.2

 

 

1.6

 

1.7

 

Other

 

 

1.0

 

 

1.0

 

0.8

 

Total Power Systems Canada

 

 

$

14.1

 

 

$

11.6

 

6.0

 

Total Power Systems US

 

 

$

4.4

 

 

$

8.8

 

$

11.4

 

Total Power Systems Product Revenue

 

 

$

18.5

 

 

$

20.4

 

$

17.4

 

 

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 2005 and 2006.

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., SatCon’s preferred supplier, a flywheel energy storage system,

9




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. We shipped our third Rotary UPS System in 2005 and our fourth unit in 2006.

SatCon MagMotor

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.

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.

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.

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. In addition we also sell Motors and converters for hybrid electric vehicles, which have seen modest revenue growth.

SatCon Electronics

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 the year ended December 31, 2006, and our fiscal years ended September 30, 2005 and 2004 from our Electronics business unit is as follows:

 

 

Year Ended

 

Year Ended

 

 

 

December 31,

 

September 30,

 

 

 

2006

 

    2005    

 

    2004    

 

 

 

(Amounts in Millions)

 

Product Revenue

 

 

$

10.2

 

 

 

$

9.5

 

 

 

$

9.5

 

 

 

10




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 the year ended December 31, 2006 and our fiscal years ended September 30, 2005 and 2004 from Applied Technology was as follows:

 

 

Year Ended

 

Year Ended

 

 

 

December 31,

 

September 30,

 

 

 

2006

 

2005

 

2004

 

 

 

(Amounts in Millions)

 

Funded Research and Development and other revenue

 

 

$

5.0

 

 

$

6.1

 

$

7.2

 

 

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.

Significant Customers

There were no customers that were 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 year ended December 31, 2006, the three month transition period ended December 31, 2005 and the year ended September 30, 2005. Approximately 40% of our revenue during the year ended December 31, 2006 was derived from government contracts and subcontracts with the U.S. government’s prime contractors.

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Research and Development

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 year ended December 31, 2006 and fiscal years ended September 30, 2005 and 2004, we expended approximately $4.0 million, $5.4 million and $6.0 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 $2.0 million, $0.5 million and $0 on internally-funded research and development during the year ended December 31, 2006 and our fiscal years ended September 30, 2005 and 2004, respectively.

Sales and Marketing

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.

Backlog

Our backlog consists primarily of product development contracts, orders for power control systems, electronics and motion control products. At December 31, 2006, our backlog was approximately $35.5 million. Of this amount, approximately $32.1 million is scheduled to be shipped during 2007. 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.

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Competition

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 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.; and

·       Developers of advanced power electronics and machines such as Moog, Semikron, DRS and Silicon Power.

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.

Manufacturing Facilities

We manufacture our products at our facilities located in Marlborough, Massachusetts; West Boylston, 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.

Intellectual Property

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

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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 December 31, 2006, we held approximately 68 U.S. patents and had 7 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.

Foreign Operations:

We have foreign operations through our Power Systems, Canada subsidiary in Burlington, Ontario, Canada.

Government Regulation

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.

Government Contracts

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. government’s 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

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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.

Employees

At December 31, 2006, we had a total of 195 full-time employees, 8 part-time employees and 48 contract employees. Of the total, 74 persons were employed in engineering, 122 in manufacturing, 37 in administration and 18 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.

Item 1A.                Risk Factors

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.

Risks Related to Our Company

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 December 31, 2006, we had an accumulated deficit of approximately $159.0 million. During the twelve months ended December 31, 2006 we had a loss from operations of approximately $14.8 million. In July 2006, we sold senior secured convertible notes and related warrants for $12 million. The net proceeds of the sale were approximately $11 million, after deducting placement fees and other offering-related expenses. If, however, we are unable to operate on a cash flow breakeven basis in the future, 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.

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We may not be able to continue as a going concern.

Our financial statements for the twelve months ended December 31, 2006, which are included in this Annual Report on Form 10-K, contain an audit report from Vitale, Caturano and Company. 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 100,000,000 shares of our common stock, of which 40,105,073 shares were issued and outstanding as of December 31, 2006. 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 today’s stock prices, we will need to issue securities that are convertible into or exercisable for a significant amount of our common stock. For example, in July 2006, we sold senior secured convertible notes and related warrants for $12 million. 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 March 1, 2007, we have reserved 9,392,479 shares of common stock for issuance upon exercise of stock options and warrants, 1,207,536 shares for future issuances under our stock plans and 353,632 shares for future issuances as matching contributions under our 401(k) plan. We have also reserved 845,588 shares of common stock for issuance upon conversion of the outstanding Series B Preferred Stock, which can be converted at any time. In addition, we have reserved 6,969,697 shares of common stock for issuance upon conversion of the outstanding Notes, which can be converted at any time. Furthermore, because principal and interest may be paid in shares of common stock at a price per share equal to a 10% discount to a volume weighted average price preceding the payment date, a significantly larger number of shares of common stock may be issued under the Notes. As of December 31, 2006, holders of warrants and options to purchase an aggregate of 7,596,068 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 Nasdaq’s Marketplace Rules for continued listing, which exposes us to the risk of delisting from the Nasdaq Stock Market.

As a result of our failure to comply with the continued listing requirements of The Nasdaq Global Market, on October 25, 2006 we transferred our securities to The Nasdaq Capital Market. However, if we fail to maintain compliance with the rules for continued listing on The Nasdaq Capital Market, including, without limitation, the minimum $1.00 bid price requirement, and our common stock is delisted from The Nasdaq Capital 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 Capital Market, 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. In addition, if our common stock does not remain listed on a U.S. national securities exchange, we may be required to repurchase our outstanding senior secured convertible notes at

16




a premium and/or incur liquidated damages. In that event, we would likely have significant limitations on our ability to raise capital, including capital necessary in order to fund the repurchase of the senior secured convertible notes or pay the liquidated damages.

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 SatCon’s 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. government’s 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 the twelve months ended December 31, 2006 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

17




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 March 1, 2007, we held approximately 68 U.S. patents and had 7 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 competitor’s 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,

18




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.

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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 supplier’s 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 or 2006.

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

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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.

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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 the year ended December 31, 2006, the three month transition period ended December 31, 2005 and our fiscal year ended September 30, 2005, were approximately $3.3 million, $0.5 million and $3.4 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.

22




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 March 1, 2007, 345 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.

Risks Related to Our Private Placement of Senior Secured Convertible Notes and Warrants

Substantial leverage and debt service obligations may adversely affect our cash flows.

In connection with the sale of our senior secured convertible notes in July 2006, we incurred new indebtedness of $12 million (of which $11.5 million is out standing as of March 1, 2007). As a result of this indebtedness, our principal and interest payment obligations increased substantially. The degree to which we are leveraged could, among other things:

·       require us to dedicate a substantial portion of our future cash flows from operations and other capital resources to debt service, to the extent we are unable to make payments of principal and interest in common stock, due to, among other things failure to satisfy the equity conditions that must be met to enable us to do so;

·       make it difficult for us to obtain necessary financing in the future for working capital, acquisitions or other purposes on favorable terms, if at all;

·       make it more difficult for us to be acquired;

·       make us more vulnerable to industry downturns and competitive pressures; and

·       limit our flexibility in planning for, or reacting to changes in, our business.

Our ability to meet our debt service obligations will depend upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control.

We could be required to make substantial cash payments upon an event of default or change of control under our senior secured convertible notes and related warrants, and, because the notes are secured, holders of the notes could take action against our assets upon an event of default.

Our senior secured convertible notes provide for events of default including, among others, payment defaults, cross-defaults, breaches of any representation, warranty or covenant that is not cured within the proper time periods, failure to perform certain required activities in a timely manner, our common stock no longer being listed on an eligible market, the effectiveness of the registration statement of which this prospectus is a part lapses beyond a specified period and certain bankruptcy-type events involving us or any significant subsidiary. Upon an event of default, the holders of the notes may elect to require us to repurchase all or any portion of the outstanding principal amount of the notes for a purchase price equal to the greater of (i) 115% of such outstanding principal amount, plus all accrued but unpaid interest or (ii) 115% of the then value of the underlying common stock.

In addition, under the terms of the notes and warrants, upon a change of control of our company, (i) the holders of the notes may elect to require us to purchase the notes for 115% of the outstanding

23




principal amount plus any accrued and unpaid interest and (ii) the holders of the warrants may elect to require us to purchase the warrants for a purchase price equal to the Black-Scholes value of the remaining unexercised portion of each warrant.

If either an event of default or change of control occurs, our available cash could be seriously depleted and our ability to fund operations could be materially harmed. Furthermore, because the notes are secured, if an event of default occurs, the holders of the notes may take action against our assets (including the stock of our subsidiaries) under the terms of a Security Agreement.

We are responsible for having the resale of shares of common stock underlying the convertible notes and warrants issued in our July 2006 private placement registered with the SEC within defined time periods and will incur liquidated damages if the shares are not registered with the SEC within those defined time periods.

Pursuant to our agreement with the investors in the July 2006 private placement, we were obligated to (i) file a registration statement covering the resale of the common stock underlying the securities issued in the private placement with the SEC within 30 days following the closing of the private placement (which we have satisfied), (ii) use our best efforts to cause the registration statement to be declared effective within 90 days following the closing of the private placement (which we have satisfied, as the registration statement was declared effective on September 27, 2006) and (iii) use our best efforts to keep the registration statement effective until the earlier of (x) the fifth anniversary of the effective date of the registration statement, (y) the date all of the securities covered by the registration statement have been publicly sold and (z) the date all of the securities covered by the registration statement may be sold without restriction under SEC Rule 144(k). If we fail to comply with these or certain other provisions, then we will be required to pay liquidated damages of 1% of the aggregate purchase price paid by the investors in the private placement for the initial occurrence of such failure and 1.5% of such amount for each subsequent 30 day period the failure continues. The total liquidated damages under this provision are capped at 24% of the aggregate purchase price paid by the investors in the private placement. Any such payments could materially affect our ability to fund operations.

The agreements governing the senior secured convertible notes and related warrants contain various covenants and restrictions which may limit our ability to operate our business.

The agreements governing the senior secured convertible notes and related warrants contain various covenants and restrictions, including, among others:

·       for so long as the notes are outstanding, the obligation that we offer to the holders the opportunity to participate in subsequent securities offerings (up to 50% of such offerings), subject to certain exceptions for, among other things, certain underwritten public offerings and strategic alliances;

·       for so long as the notes are outstanding, the obligation that we not incur any indebtedness that is senior to, or on parity with, the notes in right of payment, subject to limited exceptions for purchase money indebtedness and capital lease obligations;

·       for so long as the notes are outstanding, we must maintain aggregate cash and cash equivalents equal to the greater of (i) $1,000,000 or (ii) $3,000,000 minus 80% of eligible receivables; and

·       for so long as the notes and warrants are outstanding, we may not issue any common stock or common stock equivalents at a price per share less than the conversion price.

These restrictions could limit our ability to plan for or react to market conditions or meet extraordinary capital needs or otherwise restrict corporate activities, any of which could have a material adverse impact on our business.

24




Item 1B.               UNRESOLVED STAFF COMMENTS

None.

Item 2.                        PROPERTIES

We lease office, manufacturing and research and development space in the following locations:

Location

 

 

 

Primary Use

 

Approximate
Number of
Square Feet

 

Expiration
of Lease

 

Boston, MA

 

Corporate headquarters and research and development

 

 

28,000

 

 

 

2011

 

 

Marlborough, MA

 

Manufacturing

 

 

24,000

 

 

 

2010

 

 

West Boylston, MA

 

Manufacturing

 

 

13,000

 

 

 

2008

 

 

Baltimore, MD

 

Research and development

 

 

16,000

 

 

 

2007

 

 

Burlington, Ontario, Canada

 

Manufacturing

 

 

57,000

 

 

 

2009

 

 

 

We believe our facilities are adequate for our current needs and that adequate facilities for expansion, if required, are available. On December 22, 2006 we negotiated a settlement with the landlord of our Worcester facility with respect to the early termination of the related lease. As a result of this negotiation, we agreed to issue to the landlord 850,000 shares of common stock on January 3, 2007 as consideration for the early termination of the lease. As a result of this settlement we recorded a restructuring charge during the three and twelve month period ended December 31, 2006 of approximately $1.1 million. The lease terminated on February 15, 2007, and is not represented in the table above.

Item 3.                        LEGAL PROCEEDINGS

From time to time, we are a party to routine litigation and proceedings in the ordinary course of business.

On May 19, 2006, we filed a suit in U.S. district court, District of Massachusetts, against one of our customers. The suit demands full payment of all outstanding amounts due us from our customer. The customer filed a counterclaim that we believed was without merit. The suit was settled on March 9, 2007.

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.

Item 4.                        SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted to a vote of security holders during the fourth quarter of 2006 covered by this report through the solicitation of proxies or otherwise.

25




PART II

Item 5.                      MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is publicly traded on the Nasdaq Capital 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 Capital Market for our years ended December 31, 2005 and 2006:

 

 

High

 

Low

 

Year Ended December 31, 2005

 

 

 

 

 

First Quarter

 

$

1.96

 

$

1.51

 

Second Quarter

 

$

1.64

 

$

1.30

 

Third Quarter

 

$

2.22

 

$

1.34

 

Fourth Quarter

 

$

2.09

 

$

1.32

 

Year ended December 31, 2006

 

 

 

 

 

First Quarter

 

$

2.44

 

$

1.36

 

Second Quarter

 

$

3.24

 

$

1.80

 

Third Quarter

 

$

1.88

 

$

0.89

 

Fourth Quarter

 

$

1.52

 

$

0.86

 

 

On March 1, 2007, the last reported sale price of our common stock as reported on the Nasdaq Capital Market was $1.56 per share. As of March 1, 2007, there were 41,536,053 shares of our common stock outstanding held by approximately 260 holders of record. The number of record holders does not include beneficial owners of common stock whose shares are held in the names of banks, brokers, nominees or other fiduciaries.

Dividend Policy

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, 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. Furthermore the Securities Purchase Agreement entered into in connection with our Private Placement on July 19, 2006 prohibits the payment of dividends without the consent of the holders of the Notes for so long as at least $3.0 million in principal amount of the Notes remain outstanding.

Recent Sales of Unregistered Securities

None

Comparative Stock Performance Graph

The comparative stock performance graph below compares the cumulative total stockholder return (assuming reinvestment of cash dividends, if any) from investing $100 on December 31, 2001, and plotted at the end of the last trading day of each year, in each of (i) our common stock; (ii) the Nasdaq National Market Index of U.S. Companies (the “Nasdaq Market Index”); and (iii) a peer group index of four companies that provide similar services to those of our company (Ballard Power Systems, Inc., IMPCO Technologies, Inc., Mechanical Technology Incorporated and UQM Technologies, Inc. (formerly known as Unique Mobility, Inc.) (the “Peer Group Index”)).

26




The comparisons shown in the graph below are based upon historical data. We caution that the stock price performance shown in the graph below is not necessarily indicative of, nor is it intended to forecast, the potential future performance of our common stock.

COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN

AMONG SATCON TECHNOLOGY CORPORATION,

NASDAQ MARKET INDEX AND PEER GROUP INDEX

GRAPHIC

 

 

2001

 

2002

 

2003

 

2004

 

2005

 

2006

 

SATCON TECHNOLOGY CORP.

 

$

100.00

 

$

26.92

 

$

39.42

 

$

38.85

 

$

28.85

 

$

21.92

 

PEER GROUP INDEX

 

$

100.00

 

$

38.34

 

$

46.10

 

$

30.76

 

$

19.26

 

$

24.15

 

NASDAQ MARKET INDEX

 

$

100.00

 

$

69.97

 

$

106.36

 

$

115.98

 

$

120.15

 

$

134.80

 

 

The performance graph above shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or otherwise subject to the liability of that section. This graph will not be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

27




Item 6.                        SELECTED CONSOLIDATED FINANCIAL DATA

You should read the data set forth below in conjunction with “Management’s 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 the year ended December 31, 2006, the three-month transition period ended December 31, 2005, and the fiscal years ended September 30, 2005 and 2004, and the consolidated balance sheet data as of December 31, 2006 and 2005 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, 2003 and 2002 and the consolidated balance sheet data as of September 30, 2005, 2004, 2003 and 2002 are derived from our audited consolidated financial statements that are not included in this Annual Report on Form 10-K.

 

 

Year
Ended

 

Three
Months
Ended

 

 

 

 

 

December 31,

 

December 31,

 

Fiscal Year Ended September 30,

 

 

 

2006

 

2005

 

2005

 

2004

 

2003

 

2002

 

 

 

(Amounts in thousands, except per share data)

 

Statement of Operations Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product revenue

 

 

$

28,767

 

 

 

$

6,038

 

 

$

29,891

 

$

26,971

 

$

21,648

 

$

30,799

 

Funded research and development and other 
revenue

 

 

4,990

 

 

 

1,079

 

 

6,064

 

7,187

 

5,282

 

10,831

 

Total revenue

 

 

33,757

 

 

 

7,117

 

 

35,955

 

34,158

 

26,930

 

41,630

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of product revenue

 

 

27,824

 

 

 

5,802

 

 

27,631

 

22,373

 

26,019

 

29,644

 

Research and development and other revenue expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Funded research and development and other revenue expenses

 

 

4,041

 

 

 

1,111

 

 

5,412

 

5,982

 

5,038

 

7,177

 

Unfunded research and development
expenses

 

 

2,000

 

 

 

260

 

 

514

 

3

 

1,492

 

5,850

 

Total research and development and other revenue expenses

 

 

6,041

 

 

 

1,371

 

 

5,926

 

5,985

 

6,530

 

13,027

 

Selling, general and administrative expenses

 

 

13,008

 

 

 

2,488

 

 

10,802

 

9,363

 

13,564

 

15,851

 

Amortization of intangibles

 

 

431

 

 

 

112

 

 

447

 

447

 

505

 

589

 

Gain on sale of assets

 

 

(399

)

 

 

(1,443

)

 

(318

)

 

 

 

Restructuring costs

 

 

1,612

 

 

 

 

 

(256

)

 

 

1,500

 

Write-off of impaired long-lived assets

 

 

 

 

 

 

 

1,190

 

 

700

 

 

Write-off of impaired goodwill and intangible 
assets

 

 

 

 

 

 

 

 

 

5,751

 

 

Total operating costs and expenses

 

 

48,517

 

 

 

8,330

 

 

45,422

 

38,168

 

53,069

 

60,611

 

Operating loss

 

 

(14,760

)

 

 

(1,213

)

 

(9,467

)

(4,010

)

(26,139

)

(18,981

)

Net realized gain on sale of marketable
securities

 

 

 

 

 

 

 

 

 

 

17

 

Net unrealized gain (loss) on warrants to purchase common stock

 

 

 

 

 

 

 

(7

)

(90

)

82

 

(519

)

Unrealized loss on Series B warrants

 

 

 

 

 

 

 

 

35

 

(1,879

)

 

Write-down of investment in Beacon Power Corporation common stock

 

 

 

 

 

 

 

 

 

(542

)

(1,400

)

Realized gain on sale of Beacon Power Corporation common stock

 

 

 

 

 

 

 

 

 

899

 

 

Other income (loss)

 

 

(4,251

)

 

 

(4

)

 

(117

)

(1

)

71

 

(10

)

Interest income

 

 

384

 

 

 

47

 

 

42

 

12

 

5

 

292

 

Interest expense

 

 

(1,151

)

 

 

(138

)

 

(697

)

(6,905

)

(3,978

)

(160

)

Net loss

 

 

$

(19,778

)

 

 

$

(1,308

)

 

$

(10,246

)

$

(10,959

)

$

(31,481

)

$

(20,761

)

Net loss attributable to common stockholders per weighted average share, basic and diluted

 

 

$

(0.50

)

 

 

$

(0.03

)

 

$

(0.31

)

$

(0.41

)

$

(1.72

)

$

(1.25

)

Weighted average number of common shares, basic and diluted

 

 

39,290

 

 

 

38,356

 

 

32,900

 

26,834

 

18,258

 

16,597

 

 

28




 

 

 

Year
Ended
December 31,

 

Three
Months
Ended
December 31,

 

As of September 30,

 

 

 

2006

 

2005

 

2005

 

2004

 

2003

 

2002

 

 

 

(in thousands)

 

Balance Sheet Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents, including restricted cash and cash equivalents

 

 

$

8,275

 

 

 

$

9,279

 

 

$

6,711

 

$

2,183

 

$

1,235

 

$

2,120

 

Investment in Beacon Power Corporation

 

 

 

 

 

 

 

 

 

 

800

 

Total assets

 

 

30,577

 

 

 

28,328

 

 

27,732

 

25,586

 

24,982

 

42,360

 

Working capital

 

 

6,007

 

 

 

10,690

 

 

11,393

 

5,141

 

(1,413

)

10,971

 

Redeemable convertible Series A preferred stock

 

 

 

 

 

 

 

 

 

1,659

 

 

Redeemable convertible Series B preferred stock

 

 

1,725

 

 

 

2,125

 

 

2,125

 

2,125

 

 

 

Convertible subordinated debentures

 

 

12,740

 

 

 

 

 

 

 

763

 

 

Investor warrant and Placement Agent Warrant Liability

 

 

2,921

 

 

 

 

 

 

 

 

 

Other long-term liabilities, net of current portion

 

 

108

 

 

 

452

 

 

460

 

875

 

770

 

1,217

 

Stockholders’ equity (deficit)

 

 

$

(2,468

)

 

 

$

14,501

 

 

$

15,602

 

11,659

 

6,162

 

29,926

 

 

29




Item 7.                        MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Special Note Regarding Forward-Looking Information

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.

Recent Developments

On July 19, 2006, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with thirteen institutional investors (the “Purchasers”) in connection with the private placement (the “Private Placement”) of:

·       $12,000,000 aggregate principal amount of senior secured convertible notes (the “Notes”), convertible into shares of our common stock at a conversion price of $1.65 per share;

·       Warrant A’s to purchase up to an aggregate of 3,636,368 shares of our common stock at a price of $1.815 per share for a period beginning six months from the date of such warrants and ending on the seventh anniversary of the date of such warrants; and

·       Warrant B’s to purchase up to an aggregate of 3,636,368 shares of our common stock at a price of $1.68 per share for a period of 90 trading days beginning the later of six months from the date of such warrants and the date the Securities and Exchange Commission (the “SEC”) declares effective a shelf registration statement covering the resale of the common stock underlying the securities issued in the Private Placement (the “Registration Statement”); to the extent the Warrant B’s are exercised, the Purchasers will receive additional seven-year warrants to purchase a number of shares of common stock equal to 50% of the number of shares of common stock purchased upon exercise of the Warrant B’s at a price of $1.815 per share. Because the registration statement was declared effective on September 27, 2006, these warrants were originally exercisable for the 90 trading day period beginning six months from the date of such warrants (i.e. May 30, 2007). As discussed below, in connection with an amendment to the Purchase Agreement enabling us to issue common stock for the early termination of the lease for our Worcester facility, the expiration date of the Warrant B’s was extended to August 31, 2007.

The net proceeds of the sale were approximately $11 million, after deducting placement fees and other offering-related expenses. In connection with the Private Placement, we also entered into a Security Agreement, dated July 19, 2006, with the Purchasers (the “Security Agreement”).

In addition, First Albany Capital (“FAC”) acted as placement agent in connection with the Private Placement. In addition to a cash transaction fee of $590,000, FAC or its designees were entitled to receive five-year warrants to purchase 218,182 shares of our common stock at an exercise price of $1.87 per share. At the discretion of FAC, these warrants were issued to First Albany Companies, Inc., the parent of FAC. We also paid Ardour Capital, our financial advisor, approximately $250,000 for its services related to the Private Placement.

30




In connection with, and as a condition precedent to, the completion of the Private Placement, on July 20, 2006, we paid all amounts due and owing under our credit facility with Silicon Valley Bank (approximately $2 million) and terminated such facility. In doing so we incurred a termination fee of $17,500 and legal fees of $8,500.

See Note G to our consolidated financial statements included in this Annual Report on Form 10-K for a detailed description of the Notes and related warrants.

On September 19, 2006, our Board of Directors approved a change in our fiscal year end from September 30 to December 31. As a result, the financial periods presented and discussed in this Annual Report on Form 10-K will be defined as follows:

1.                Year ended December 31, 2006 represents the twelve months ended December 31, 2006,

2.                Three-month transition period ended December 31, 2005 represents the three months ended December 31, 2005,

3.                Fiscal year ended September 30, 2005 represents the twelve month period ended September 30, 2005, and

4.                Fiscal year ended September 30, 2004 represents the twelve month period ended September 30, 2004.

For purposes of our Management Discussion and Analysis of Financial Condition and Results of Operations we will be comparing the following periods:

·       Twelve months ended December 31, 2006 compared to the Twelve months ended September 30, 2005

·       Three months ended December 31, 2005 compared to the three months ended January 1, 2005 (unaudited)

·       Twelve months ended September 30, 2005 compared to the twelve months ended September 30, 2004.

On September 19, 2006, our Board of Directors approved a plan to close our Worcester, Massachusetts manufacturing facility by approximately December 31, 2006. The decision to close this facility was in furtherance of our continuing efforts to streamline operations and reduce our operating costs. We intend to focus spending on our renewable energy business. As a result of this decision, we incurred approximately $1.6 million related to employee severance and retention bonuses and asset impairments, warrant revaluation and lease termination costs. On December 22, 2006, we negotiated a settlement with the Worcester landlord, issuing 850,000 shares of common stock on January 3, 2007 as consideration for the early termination of the lease. The lease terminated on February 15, 2007. We currently expect this action will result in a reduction of total overhead expenses of rent, facilities and personnel costs of approximately $3.0 million per year.

On December 20, 2006, in connection with the early termination of the lease for the Worcester facility, we entered into a First Amendment to Securities Purchase Agreement (the “Amendment”) with certain of the Purchasers who participated in the Private Placement.

Pursuant to the Amendment:

·       the definition of “Excluded Stock” set forth in the Purchase Agreement was amended to enable us to issue up to 1.1 million shares of our common stock in connection with the early termination of the lease for our facility located in Worcester, Massachusetts, without such shares being subject to the Purchasers’ right of participation set forth in the Purchase Agreement and certain prohibitions

31




set forth in the Notes and related warrants (as noted above, we ultimately settled the lease for 850,000 shares); and

·       we agreed to extend the expiration date of the Warrant B’s issued in the Private Placement from May 30, 2007 to August 31, 2007.

Overview

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.

Critical Accounting Policies and Significant Judgments and Estimates

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:

Revenue Recognition

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

32




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. As of December 31, 2006, and 2005, we have accrued approximately $0 and $0.1 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

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.

Inventory

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.

33




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 D 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:

Year

 

 

 

Value of
Inventory
Reserve
Used

 

Value of
Purchase
Commitments
Reserve
Used

 

Period
Reduction to
Cost of
Sales

 

Cumulative
Reduction
to Cost of
Sales

 

Fiscal Year 2005

 

$

141,000

 

 

$

88,000

 

 

 

$

229,000

 

 

$

1,003,000

 

Three Months Ended December 31, 2005

 

$

 

 

$

 

 

 

$

 

 

$

1,003,000

 

Year Ended December 31, 2006

 

$

 

 

$

 

 

 

$

 

 

$

1,003,000

 

 

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 our shaker and amplifier product lines, and the associated inventory and intellectual property to Qualmark, Inc., for proceeds of approximately $2.3 million. This sale involved shaker and amplifier inventory of approximately $1.8 million. This inventory had approximately $1.0 million in reserves, due to the fiscal 2003 write-down as described above. Remaining reserves related to the fiscal 2003 write-down, as described above, relate only to our UPS inventory and will be accounted for in future sales of these products.

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 management’s 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 statement’s 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 management’s best estimate of future results. In

34




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.

Long-Lived Assets

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 management’s 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.

Convertible Debt Instruments and Warrant Liabilities

We account for our senior secured convertible Notes and associated warrants in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” Our convertible Notes include features that qualify as embedded derivatives, such as (i) the holders’ conversion option, (ii) our option to settle the Notes at the scheduled dates in cash or shares of our common stock, and (iii) premiums and penalties we would be liable to pay in the event of default. As permitted under SFAS 155, we have elected, as of January 1, 2007, to measure the Notes in their entirety at fair value with changes in fair value recognized as either gain or loss. This election was made by us after determining that the aggregate fair value of the Notes to be more meaningful in the context of our financial statements than if separate fair values were assigned to each of the multiple embedded instruments contained such Notes.

We record interest expense under our convertible Notes based on the greater of (i) 7% or (ii) the six-month LIBOR, in effect at the time plus 350 basis points, as well as the amortization of the debt discount, which we compute using the effective interest method. The debt discount represents the difference between our gross proceeds of $12.0 million and the fair value of the convertible debt upon issuance, after separately valuing the investor warrants, the placement agent warrants and the convertible Notes on a relative fair value basis. By amortizing the debt discount to interest expense, rather than recognizing it as a change in fair value of the convertible debt instrument and warrants, which is a separate line item in our statement of operations, we believe our interest expense line item more appropriately reflects the cost of the debt associated with our convertible Notes.

We determined the fair values of our convertible Notes, investor warrants and placement agent warrants in consultation with valuation specialists, using valuation models we consider to be appropriate. Our stock price has the most significant influence on the fair value of our convertible Notes and our warrants. An increase in our common stock price would cause the fair values of both convertible Notes and warrants to increase, because the conversion and exercise prices, respectively, of such instruments are fixed

35




at $1.65 and $1.68 per share, respectively, and result in a charge to our statement of operations. A decrease in our stock price would likewise cause the fair value of the convertible Notes and the warrants to decrease and result in a credit to our statement of operations. If the price of our common stock were to decline significantly, however, the decrease in the fair value of the convertible Notes would be limited by the instrument’s debt characteristics. Under such circumstances, our estimated cost of capital would become another significant variable affecting the fair value of the convertible Notes.

Income Taxes

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 $47.4 million and $ 41.0 million as of December 31, 2006 and 2005, respectively, 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.

Recent Accounting Pronouncements

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS 155”), which amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”). SFAS 155 simplifies the accounting for certain derivatives embedded in other financial instruments by allowing them to be accounted for as a whole if the holder elects to account for the whole instrument on a fair value basis. SFAS 155 also clarifies and amends certain other provisions of SFAS 133 and SFAS 140. SFAS 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring in fiscal years beginning after September 15, 2006. We adopted SFAS 155 on January 1, 2007. We believe that the adoption of SFAS 155 will not have a material effect on our consolidated financial statements.

In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN No. 48”) which is effective for fiscal years beginning after December 15, 2006. FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We are currently evaluating the potential impact of the adoption of FIN No. 48 on our consolidated financial position, results of operations and cash flows.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (SFAS 157), Fair Value Measurements, which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair

36




value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. Earlier adoption is permitted, provided the company has not yet issued fiancial statements, including for interim periods, for that fiscal year. We are currently evaluating the impact of SFAS 157.

In September 2006, the SEC released SAB 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108 allows registrants to adjust for the cumulative effect of certain errors relating to prior years in the carrying amount of assets and liabilities as of the beginning of the current year, with an offsetting adjustment to the opening balance of retained earnings in the year of adoption provided that management has properly concluded that the errors were not material to prior periods. SAB 108 also requires the adjustment of any prior quarterly financial statements within the fiscal year of adoption for the effects of such errors on the quarters when the information is next presented. Such adjustments do not require previously filed reports with the SEC to be amended. We have adopted the provisions of SAB 108 and determined that the impact on our consolidated financial position, results of operations and cash flows not to be material.

Results of Operations

Twelve Months Ended December 31, 2006 Compared to the Twelve Months Ended September 30, 2005.

Product Revenue.   Product revenue decreased by $1.1 million, or 3.8%, from $29.9 million in 2005 to $28.8 million in 2006. Product revenue by segment for the fiscal year ended December 31, 2006 and September 30, 2005 is as follows:

 

 

Twelve Months Ended

 

Division

 

 

 

December 31, 2006

 

September 30, 2005

 

$ Change

 

% Change

 

 

 

(in thousands)

 

Power Systems, US

 

 

$

4,361

 

 

 

$

8,803

 

 

 

$

(4,442

)

 

 

-50.5

%

 

Power Systems, Canada

 

 

  14,164

 

 

 

  11,557

 

 

 

2,607

 

 

 

22.6

%

 

Electronics

 

 

10,241

 

 

 

9,532

 

 

 

       709

 

 

 

7.4

%

 

Total product revenue

 

 

$

28,766

 

 

 

$

29,892

 

 

 

$

(1,126

)

 

 

-3.8

%

 

 

The decrease in product revenue was comprised of approximately $4.4 million from our Power Systems, US, division offset by increases of approximately $2.6 million and $0.7 million from our Power Systems, Canada, and Electronics divisions, respectively.

Power Systems, Canada, which focuses on alternative energy products and includes Solar Converters and Fuel Cell Inverters, saw revenues increase from approximately $11.6 million in 2005 to approximately $14.2 million in 2006. The increase in product revenue related to our Power Systems Canada product lines were as follows:

·       Solar Converter line revenue increased by approximately $5.5 million, from approximately $3.3 million in 2005 to approximately $8.8 million in 2006 and

·       Industrial Power Supply revenue increased approximately $1.0 million as compared to 2005.

These increases were partially offset by decreases in the following lines of business:

·       Plasma Torch product line revenues decreased approximately $2.6 million. In 2005 we recognized approximately $2.6 million in revenue related to sales to international customers. There were virtually no sales in 2006 related to the Plasma Torch product line,

·       Fuel Cell Inverter line revenues decreased approximately $0.7 million, to approximately $1.8 million and

·       other decreases amounting to approximately $0.1 million.

37




Power Systems, US, which currently focuses on Motors and Hybrid Electric Vehicle (HEV) components, saw revenues decrease from approximately $8.8 million in 2005 to approximately $4.4 million in 2006. The decrease in product revenue related to our Power Systems, US product lines were as follows:

·       Test and Measurement product line revenue decreased approximately $2.7 million. The decrease is due to our sale of our Shaker product line in December 2005, which accounted for approximately $3.5 million of revenue in 2005 compared to $0.9 million in 2006,

·       MagLev product line revenue decreased approximately $1.9 million from approximately $3.5 million in 2005 to approximately $0.8 million in 2006. Currently we are not selling MagLev products and a majority of our revenues from our MagLev product line was from one customer and

·       Other decreases amounting to approximately $0.3 million.

These decreases were partially offset by increases in the following lines of business:

·       Motor, HEV product line revenues increased by less than $0.4 million.

Revenues in the Electronics division increased approximately $0.7 million. The increase was primarily due to increased sales to commercial non-government customers as compared to 2005.

Funded research and development and other revenue.   Funded research and development and other revenue decreased $1.1 million, or 18%, from $6.1 million in fiscal 2005 to $5.0 million in 2006. This decrease was primarily attributable to the recognition of $1.5 million in revenue related to our contract with EDO Corporation in 2005, which did not repeat in 2006. (See Note K. Commitments and Contingencies—Contract Losses).

Cost of product revenue.   Cost of product revenue increased approximately $0.2 million, or 0.7%, from $27.6 million in 2005 to $27.8 million in 2006. Cost of product revenue by segment for the years ended December 31, 2006 and September 30, 2005 is as follows:

 

 

Twelve Months Ended

 

Division

 

 

 

December 31, 2006

 

September 30, 2005

 

$ Change

 

% Change

 

 

 

(in thousands)

 

Power Systems, US

 

 

$

5,765

 

 

 

$

9,367

 

 

 

$

(3,602

)

 

 

-38.5

%

 

Power Systems, Canada

 

 

13,545

 

 

 

10,462

 

 

 

3,083

 

 

 

29.5

%

 

Electronics

 

 

8,514

 

 

 

7,802

 

 

 

712

 

 

 

9.1

%

 

Total product revenue

 

 

$

27,823

 

 

 

$

27,631

 

 

 

$

192

 

 

 

0.7

%

 

 

The increase was primarily attributable to increased manufacturing and materials costs as compared to 2005. The decrease in our Power Systems, US division is a direct result of lower revenues as compared to 2005 offset by manufacturing inefficiencies in our Worcester, Massachusetts facility. The increase in our Power Systems, Canada division is primarily attributable to the increase in product revenue and increases in materials and manufacturing costs. The Electronics division saw a slight increase in the cost of product revenue commensurate with the increase in revenue for the period.

Gross Margin.   Gross margins on product revenue decreased from 8% in 2005 to 3% in 2006. Gross margin by division is broken out below.

 

Twelve Months Ended

 

Division

 

 

 

December 31, 2006

 

September 30, 2005

 

Power Systems, US

 

 

-32

%

 

 

-6

%

 

Power Systems, Canada

 

 

4

%

 

 

9

%

 

Electronics

 

 

17

%

 

 

18

%

 

Total gross margin %

 

 

3

%

 

 

8

%

 

 

38




The decrease in Power Systems, US, from approximately -6% to approximately -32% is a result of increases in warranty costs, inventory reserves and manufacturing depreciation. In our Power Systems, Canada division the decrease from approximately 9% to approximately 4% was a result of increases in warranty costs, due to higher sales, increases in product engineering costs due to increases in staffing, increases in manufacturing labor due to overtime, increases in raw materials cost and to some extent some lower margin business as compared to 2005. The gross margin as a percentage of revenue remained virtually unchanged in our Electronics division at approximately 17%.

Funded research and development and other revenue expenses.   Funded research and development and other revenue expenses decreased by $1.4 million, or 25%, from $5.4 million in 2005 to $4.0 million in 2006. This decrease was primarily attributable to the completion of the EDO fixed price contract in 2005. The gross margin on funded research and other revenue increased from 11% in 2005 to 19% in 2006. This increase is primarily attributable to the completion of the EDO contract in 2005, which had $0 margin offset by costs related to share-based compensation of approximately $0.1 million in 2006.

Unfunded research and development expenses.   We expended approximately $2.0 million on unfunded research and development in 2006 compared with approximately $0.5 million spent in 2005. The spending in 2006 and 2005 was related to unfunded engineering in our Electronics and Power Systems divisions for the continued development of new products and technologies.

Selling, general and administrative expenses.   Selling, general and administrative expenses increased by approximately $2.2 million, or approximately 20%, from $10.8 million in 2005 to $13.0 million in 2006. Approximately $0.7 million of the increase is directly attributable to non-cash compensation costs related to the issuance of stock options to our employees and directors pursuant to SFAS 123(R) charged to operations during the period. Corporate costs increased approximately $0.5 million primarily as a result of increased compensation costs related to the issuance of stock options to our employees and directors pursuant to SFAS 123(R) charged to operations during the period and increased accounting and legal fees for the period as compared to 2005. Increased sales and marketing costs in our Applied Technology, Electronics and Power Systems divisions accounted for the remainder of the increase over that of 2005.

Amortization of intangibles.   Amortization of intangibles remained flat at $0.4 million.

Gain on sale of assets.   In 2006, we received approximately $0.4 million related to our 2004 sale of our SPLC technology. In 2005, we received approximately $0.3 million related to this sale. We record the gain on sale as payments are received. There are no further amounts due related to this sale.

Restructuring costs.   During 2006 we commenced a restructuring plan designed to streamline our manufacturing and production base, improve efficiency and enhance our competitiveness and recorded a restructuring charge of approximately $1.6 million. These charges are comprised employee severance and benefits costs and the write-down in carrying value of assets along with the settlement of the Worcester facility lease. (See Note V. Restructuring Costs). The total pre-tax charges are estimated to include employee severance and benefits costs of approximately $0.2 million, the write down in carrying value of assets (of which approximately $0.2 million have been recorded in the period ended December 31, 2006) and facility exit costs of approximately $1.1 million, for which we issued 850,000 shares of common stock to the landlord on January 3, 2007 as consideration for the early termination of the lease. These shares were issued subsequent to year end and this amount is recorded in accrued liabilities as of December 31, 2006. We anticipate additional costs associated with our restructuring to be approximately $0.1 million in 2007.

Net unrealized gain on warrants to purchase common stock.   In 2005 we had an approximately $7,000 unrealized loss on warrants to purchase common stock, related to warrants we held in Beacon Power Corporation. We accounted for our warrants to purchase Beacon Power Corporation’s common stock in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and, therefore, we had recorded these warrants at their fair value. These warrants expired un-exercised in April 2005.

39




Other income (expense).   Other income was approximately $4.3 million, which is comprised primarily of charges related to the fair valuation of our derivative instruments. Other expense in 2005 was approximately $0.1 million, which is comprised of state tax payments, the amortization of the Silicon Valley Bank warrants and costs related to the August 2005 financing transaction.

Interest income.   Interest income was approximately $0.4 million for 2006 compared to approximately $41,000 in 2005. This increase is directly attributable to our cash on hand.

Interest expense.   Interest expense for 2006 was approximately $1.2 million, which is comprised primarily of the following:

·       Approximately $0.5 million in interest related to the Notes, which was paid in shares of common stock,

·       $0.2 million in amortization of the debt discount related to the valuation of the Notes,

·       $0.1 million of non-cash interest associated with dividends on the Series B Preferred Stock,

·       approximately $0.1 million related to change in the Series B Preferred Stock conversion price as a result of the Private Placement and

·       $0.1 million in interest charges related to our credit facility with Silicon Valley Bank, which was terminated on July 19, 2006.

In 2005 interest expense was approximately $0.7 million and was comprised of the following:

·       Approximately $0.1 million of non-cash interest associated with dividends on the Series B Preferred Stock,

·       approximately $0.3 million related to the change in the Series B Preferred Stock conversion price as a result of the August 2005 financing transaction,

·       approximately $0.1 million in interest charges related to our credit facility and

·       approximately $0.1 million related to interest on our capital leases and other items.

Three Months Ended December 31, 2005 (“2005”) Compared to the Three Months Ended January 1, 2005 (“2004”).

Product Revenue.   Product revenue decreased by $2.2 million, or 27%, from $8.3 million in 2004 to $6.0 million in 2005.

 

 

Three months ended

 

Division

 

 

 

December 31, 2005

 

January 1, 2005

 

$ Change

 

% Change

 

 

 

(in thousands)

 

Power Systems, US

 

 

$

1,648

 

 

 

$

2,404

 

 

 

$

(756

)

 

 

-31.5

%

 

Power Systems, Canada

 

 

1,817

 

 

 

3,626

 

 

 

(1,809

)

 

 

-49.9

%

 

Electronics

 

 

2,574

 

 

 

2,240

 

 

 

334

 

 

 

14.9

%

 

Total product revenue

 

 

$

6,038

 

 

 

$

8,270

 

 

 

$

(2,232

)

 

 

-27.0

%

 

 

The decrease in product revenue was comprised of approximately $0.8 million from our Power Systems, US division and approximately $1.8 million from our Power Systems, Canada division, offset by an increase of approximately $0.3 million from our Electronics division.

40




Power Systems, Canada, saw revenues decrease by approximately $1.8 million from approximately $3.6 million in 2004 to approximately $1.8 million in 2005. The decrease in Power Systems, Canada revenues, as compared to the same period in 2004 was largely due to the following:

·       Plasma Torch product line revenues decreased approximately $1.7 million. In the same period in 2004 we recognized approximately $1.7 million in revenue related to sales to international customers. There were virtually no sales in 2005 related to the Plasma Torch product line,

·       Fuel Cell Inverter line revenues decreased approximately $0.8 million. The decrease was in part due to revenue of approximately $0.4 million related to shipments during 2005 being deferred as their contract terms were FOB destination.

These decreases were partially offset by increases in the following lines of business:

·       Solar Converter line revenue increased by approximately $0.7 million.

Power Systems, US, saw revenues decrease by approximately $0.8 million from approximately $2.4 million in 2004 to approximately $1.6 million in 2005. The decrease in Power Systems, US revenues, as compared to the same period in 2004 was largely due to the following:

·       MagLev product line revenue decreased approximately $0.7 million,

·       Test and Measurement product line revenue decrease of approximately $0.1 million. Compared to the same period in 2004, revenues in our test and measurement product line, which includes the shaker and amplifier product lines that were sold in December 2005, were not significantly different. Moving forward there will be no more revenue from shaker and amplifier products. For 2004, shaker and amplifier revenues were approximately $2.4 million,

·       Other decreases amounting to approximately $0.1 million.

These decreases were partially offset by increases in the following lines of business:

·       Motor product line revenues increased by approximately $0.1 million.

Revenues in the Electronics division increased approximately $0.3 million. The increase was primarily due to increased sale to commercial non-government customers as compared to 2004.

Funded research and development and other revenue.   Funded research and development and other revenue increased $0.2 million, or 18%, from $0.9 million in 2004 to $1.1 million in 2005. This increase was primarily attributable to more business in our Applied Technology division in 2005. During 2004, delays in starting-up several existing contracts, combined with efforts focused on completing the EDO contract, took away from our ability to work on other revenue generating opportunities. (See Note K. Commitments and Contingencies—Contract Losses).

Cost of product revenue.   Cost of product revenue decreased $1.4 million, or 20%, from $7.2 million in 2004 to $5.8 million in 2005.

 

 

Three months ended

 

Division

 

 

 

December 31, 2005

 

January 1, 2005

 

$ Change

 

% Change

 

 

 

(in thousands)

 

Power Systems, US

 

 

$

1,812

 

 

 

$

2,373

 

 

 

$

(561

)

 

 

-23.7

%

 

Power Systems, Canada

 

 

1,888

 

 

 

2,972

 

 

 

(1,084

)

 

 

-36.5

%

 

Electronics

 

 

2,102

 

 

 

1,873

 

 

 

229

 

 

 

12.2

%

 

Total cost of product revenue

 

 

$

5,802

 

 

 

$

7,218

 

 

 

$

(1,416

)

 

 

-19.6

%

 

 

The decrease was primarily attributable to lower revenues compared to 2004 in our Power Systems divisions. These savings were offset, in part, by a slight increase in overhead costs during the period. The

41




Electronics division saw a slight increase in the cost of product revenue commensurate with the increase in revenue for the period.

Gross Margin.   Gross margins on product revenue decreased from 13% for 2004 to 4% for 2005. Gross margin by division is broken out below.

 

Three months ended

 

Division

 

 

 

December 31, 2005

 

January 1, 2005

 

Power Systems, US

 

 

-10

%

 

 

1

%

 

Power Systems, Canada

 

 

-4

%

 

 

18

%

 

Electronics

 

 

18

%

 

 

16

%

 

Total gross margin %

 

 

4

%

 

 

13

%

 

 

In our Power Systems divisions, the decrease in gross margin by 18% is a direct result of lower revenues, continued manufacturing inefficiencies (which includes overhead costs that are attributable to manufacturing), combined with higher materials costs, costs of labor and to a lesser extent the mix of products for the period as compared to the same period in 2004. The increase in gross margins in our Electronics division is primarily due to mix of products sold during the period compared to that of 2004.

Funded research and development and other revenue expenses.   Funded research and development and other revenue expenses increased by $0.4 million, or 49%, from $0.7 million in 2004 to $1.1 million in 2005. The gross margin on funded research and other revenue decreased from 18% in 2004 to (3%) in 2005. This decrease is a partly attributable to efforts spent during the quarter focused on continued bid and proposal activities, as well as, other non-revenue generating activities, such as ISO 9001 certification which are categorized as funded research and development and other revenue expenses.

Unfunded research and development expenses.   We expended approximately $260,000 on unfunded research and development in 2005 compared with approximately $45,000 spent in 2004. The spending in 2005 and 2004 was related to unfunded engineering in our Electronics and Power Systems division for the development of new products and technologies.

Selling, general and administrative expenses.   Selling, general and administrative expenses decreased by approximately $34,000, or 1.5%, from $2.5 million in 2004 to $2.5 million in 2005. Increases in corporate costs were offset by reductions in our Applied Technology, Power Systems and Electronics divisions. Corporate costs increased approximately $0.1 million primarily as a result of increased accounting and legal fees for the period as compared to 2004.

Amortization of intangibles.   Amortization of intangibles remained flat at $0.1 million.

Gain on sale of assets.   On December 13, 2005, we sold our shaker and amplifier product lines, and the associated inventory and intellectual property for proceeds of approximately $2.3 million. We recorded a gain on the sale of these assets of approximately $1.4 million for the quarter ended December 31, 2005.

Restructuring costs.   During April 2002, we commenced a restructuring plan designed to streamline our production base, improve efficiency and enhance our competitiveness and recorded a restructuring charge of $1.5 million. As of September 30, 2004 the balance of the restructuring accrual was $495,612. On January 27, 2005 we agreed to settle our outstanding lawsuit with the landlord of the Anaheim, California facility for $240,000, for which approximately $300,000 had been allocated. As a result of this settlement and our evaluation of the remaining restructuring charges we recorded a benefit in our statement of operations for the period ended January 1, 2005 in the amount of $255,612. (See Note T. Restructuring Costs).

Net unrealized gain on warrants to purchase common stock.   We had an approximately $22,000 unrealized gain on warrants to purchase common stock in the first quarter of 2004. We accounted for our warrants to purchase Beacon Power Corporation’s common stock in accordance with SFAS No. 133,

42




Accounting for Derivative Instruments and Hedging Activities, and, therefore, we had recorded these warrants at their fair value at January 1, 2005. These warrants expired un-exercised in April 2005.

Other (expense).   Other expense was approximately $4,000 for 2005 compared to approximately $18,000 for 2004. Other expense for 2005 consists primarily of tax payments.

Interest income.   Interest income was approximately $47,000 for 2005 and is directly attributable to our cash on hand.

Interest expense.   Interest expense was approximately $0.1 million for 2005 compared with interest expense of approximately $0.2 million for 2004. Interest expense in 2005 includes approximately $42,500 of non-cash interest associated with dividends on the Series B preferred stock, as well as, $45,000 of non-cash interest associated with amortization of warrants issued to Silicon Valley Bank. Interest expense in 2004 includes non-cash interest of approximately $0.2 million associated with our December 2004 financing and the related anti-dilution effects on the Series B preferred stock and warrants issued with the Series B preferred stock. In addition, during the quarter we had borrowing under our credit facility with Silicon Valley Bank, interest expense related to our line of credit during the quarter was approximately $16,000, and there was $2.0 million outstanding under the line at December 31, 2005.

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:

 

 

Fiscal Year Ended

 

Division

 

 

 

September 30, 2005

 

September 30, 2004

 

$ Increase

 

% Increase

 

 

 

(in thousands)

 

Power Systems, US

 

 

$

8,803

 

 

 

$

11,370

 

 

($2,567

)

 

-22.6

%

 

Power Systems, Canada

 

 

11,557

 

 

 

6,055

 

 

5,502

 

 

90.9

%

 

Electronics

 

 

9,532

 

 

 

9,546

 

 

(14

)

 

-0.1

%

 

Total product revenue

 

 

$

29,892

 

 

 

$

26,971

 

 

$

2,921

 

 

10.8

%

 

 

This increase of approximately $2.9 million in product revenue was comprised of approximately $5.5 million from our Power Systems, Canada division, offset by a decrease in product revenue from out Power Systems, US division of approximately $2.6 million, as compared to the same period in 2004.

Power Systems, Canada revenues increased by approximately $5.5 million, from approximately $6.1 million in 2004 to approximately $11.6 million in 2005. The increase in product revenue related to our Power Systems, Canada product lines was as follows:

·       Solar Converter line of approximately $2.8 million,

·       Fuel Cell Inverters line of approximately $0.5 million,

·       the Plasma Torch line of approximately $2.1 million and

·       other increases amounting to approximately $0.1 million.

Power Systems, US, revenues decreased approximately $2.6 million, from approximately $11.4 million in 2004 to approximately $8.8 million in 2005. The decrease in product revenue related to our Power Systems, US product lines was as follows:

·       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.

43




These decreases in our Power Systems, US product line revenue were offset in part by increases in other product lines of approximately $0.4 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 K. 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:

 

 

Fiscal Year Ended

 

Division

 

 

 

September 30, 2005

 

September 30, 2004

 

$ Increase

 

% Increase

 

 

 

(in thousands)

 

Power Systems, US

 

 

$

9,367

 

 

 

$

9,302

 

 

 

$

65

 

 

 

0.7

%

 

Power Systems, Canada

 

 

10,462

 

 

 

5,509

 

 

 

4,953

 

 

 

89.9

%

 

Electronics

 

 

7,802

 

 

 

7,562

 

 

 

240

 

 

 

3.2

%

 

Total cost of product revenue

 

 

$

27,631

 

 

 

$

22,373

 

 

 

$

5,258

 

 

 

23.5

%

 

 

The increase was primarily attributable to the increase in product revenue in our Power Systems, Canada division, as well as an increase in 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.

 

 

Fiscal Year Ended

 

Division

 

 

 

September 30, 2005

 

September 30, 2004

 

Power Systems, US

 

 

-6

%

 

 

18

%

 

Power Systems, Canada

 

 

9

%

 

 

9

%

 

Electronics

 

 

18

%

 

 

21

%

 

Total gross margin %

 

 

8

%

 

 

17

%

 

 

44




In our Power Systems, US division, the decrease in gross margin by 24% 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. Our gross margins in our Power Systems, Canada division remained consistent as compared to the same period in 2004.

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 T. 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 facility’s product lines over four and a half years, the then remaining life of our lease on the facility. Based on these cash flow projections we did 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.

45




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 Incorporated’s common stock and to purchase Beacon Power Corporation’s 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 Incorporated’s common stock expired unexercised on October 21, 2003 and January 31, 2004. Our warrants to purchase Beacon Power Corporation’s common stock expired unexercised 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 a loan modification agreement 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.

Quarterly Results of Operations (Unaudited)

The following table presents unaudited quarterly statement of operations data for the eight quarters ended December 31, 2006. 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 reclassificati